iGetit – iTunes and Pricing Digital Content

Are iTunes and other purveyors of digital content leaving revenue on the table with their pricing practices?  Many suspected this and now there is empirical research to provide evidence.

Before April 2009, every iTunes song was sold at a uniform $0.99 price.  (Only after April 2009 has iTunes switched to a tiered pricing system albeit a crude one). Yet, in virtually every other market, similar products are sold at different price points reflecting diverse product attributes & configurations, local market conditions and different competitive environments.   Why do online content retailers like iTunes offer uniform pricing when others practice price discrimination?  

Based on what I have witnessed in firms selling digital content, their pricing strategy was not rooted in deep customer analytics and demand elasticity studies. Rather, the rationale for uniform pricing centered on the need for simplicity and the desire to get a $0.99 price point.  Revenue modeling was performed in a quick n’ dirty fashion and was driven off of the yearly revenue objective, as opposed to what would be the projected bottom-up demand at various pricing levels.  While simplicity and speed are their own virtues, new research suggests that iTunes and other digital content retailers can maximize profits through different pricing schemes.

A new study from The Wharton School of Business studied how buyers and sellers of online music valued songs under different pricing schemes.  Studying over 23,000 different song valuations over the past 2 years allowed the researchers to measure total revenue based on different demand projections at various pricing levels.  The conclusions were very interesting. The seller’s revenue was maximized at a uniform pricing per song that ranged from $1.46 to $2.30, significantly higher than iTunes’ $0.99 per song.

The Wharton researchers went further and evaluated a variety of pricing strategies.  One scheme, which is currently being utilized by iTunes in a limited way, considered a song-specific model.  In this strategy, more popular or contemporary music would carry a higher unit price than older music.  The results indicated that this tactic would raise total revenues by only 3% versus a uniform price strategy.

The model that maximized revenue (and generated a 30% lift versus the best uniform price point) was where the online seller charged an entry fee for use of the service and then a modest fee per song.  The study determined the optimal entry fee to be $21.19 and the optimal price per song to be $0.37.  Some firms have figured this out.  Spotify, an iTunes rival, has developed a similar “all you can eat” model with its premium service.   Interestingly, the research also showed that bundling songs (similar to an album) with a higher package price – but at a per song discount to the $0.99 price point – produced almost identical revenues as the entry fee plus price per song model.

As any COO worth their salt will tell you, there is always extra cost (e.g., complexity, implementation) to deploying multiple pricing schemes as compared to a uniform pricing strategy.  However, as the Wharton study proves, it should be possible through comprehensive research and testing to determine the optimal pricing model and price points that maximizes revenue, safeguards customer goodwill and minimizes operational cost.

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