Wednesday, January 7, 2009

ITunes Moves to Variable Pricing

At the recent MacWorld conference, Apple announced that it is changing its pricing of downloaded songs from a uniform price of $0.99 per song to have songs available at one of three different price options: $0.69, $0.99 and $1.29. Typically, older songs are priced at $0.69 and new songs will be priced at $1.29. Previously Apple has resisted variable pricing (or what economists call price discrimination) and favored one set price (what I call uniform pricing) since one set price is simpler.

What are the economic advantages to Apple of variable pricing? Well, to make things easier, let's say that the demand for songs downloaded from ITunes is the same under either pricing mechanism. If customers are willing to pay an extra 30 cents for new songs, then Apple will increase it's revenue on these downloads over the its current pricing structure. Here is the danger, if customers are not willing to pay an extra 30 cents or more likely are not willing to purchase the same amount of songs at $1.29 as opposed to $0.99 then the amount of songs downloaded will decrease and so will revenues. Given that Apple is primarily charging the higher price on new songs, my guess is that most customers will be willing to pay an additional 30 cents for new songs.

Another advantage is that existing customers who may not be willing to pay 99 cents for an older song may be willing to pay 69 cents for that song. If this is the case, then for those songs, this is just additional revenue to Apple. The problem is that if customers previously were willing to pay 99 cents are now only having to pay 69 cents, then Apple is leaving some money on the table. My guess is that Apple will be paying close attention to those songs that are being downloaded at significantly higher rates in the 69 cent price point and may want to move them up to the 99 cent price point.

The bottom line is that Apple is responding to investors, the music industry and ITunes customers in charging different prices for downloadable songs. Oh, it is also consistent with profit maximization - go figure!

UPDATE (10/29/09): Check out the article at The Economist. (subscription may be required)

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