Price Discrimination & Vertical Integration in the Entertainment Industry

Price Discrimination In The Music Industry

A clear example of price discrimination in the entertainment industry is iTunes’ tiered pricing. Since the launch of iTunes in 2003 all downloads were priced at 99 cents. The tracks purchased were all DRM protected. In early 2009, Apple introduced a 3-tiered pricing system. Although the majority of the tracks are still priced at 99 cents, catalog (old) tracks were arranged to be priced at 69 cents, and “hit” songs were arranged to be sold at $1.29 (DRM Free). The other, lower priced tracks are still DRM restricted though.

Price Discrimination in this circumstance occurs among users who want to purchase DRM and DRM free tracks. Consumers can still purchase “hit” tracks for 99 cents, but they will remain DRM protected. The DRM free tracks, although they sound the same as DRM tracks, are priced higher for the consumer (who is willing to pay more for a track that has no restrictions on what they can do with it), whereas DRM tracks remain regularly priced at 99 cents (because those consumers only care about having the track and aren’t concerned with what they are/aren’t allowed to do with it).

The reason for iTunes doing this was to make higher margins on the DRM free tracks (pushed for by the major labels). The tiered pricing strategy was also implemented to increase sales of catalog (converting older users from physical to digital). The lower price point was aimed at people who had the music physically and found it easier to just pay to digitize their music (rather than do it themselves) and the lower price point was also to gain new interest in old tracks for price sensitive individuals. The 99 cent downloads remained the same price as they always had been due to its demand being inelastic.


Vertical Integration In The Music Industry

An example of vertical integration, among contemporary entertainment firms, can be found with major record labels owning the distributors of their physical music. UMG owns UMGD and independent distributor Fontana, Sony owns Sony Music Distribution and independent distributor R.E.D., Warner Music Group owns WEA and indie distributor ADA (as well as Ryko and Lumberjack—before they closed them both down some months ago), and EMI owns EMI distribution (they used to have an indie distribution arm—Caroline—that operated through EMI but now runs independently, yet runs in conjunction with EMI Label Services now).

Indie labels aren’t typically vertically integrated. They tend to have distribution deals but don’t own the distributors (like the majors do). Indie labels, if they are large enough and have talent, whose albums will sell at a physical retail level, will most likely have deals with the majors’ indie distributors (Fontana, R.E.D., and ADA). To get their products distributed (through the majors’ indie distributors) they pay. They pay to have their products carried by the distributors, listed in the release books, and pitched to traditional retailers. According to the Klein, Crawford, and Alchian article, “Vertical integration, Appropriable rents, and the Competitive contracting process,” major labels most likely decided to vertically integrate (by owning their distributors) because, “the costs of contracting will generally increase more than the costs of vertical integration.” Unfortunately, for most indie labels, their limited funds prevent them from vertically integrating their distribution.