The Inevitable March of Recorded Music Towards Free

2007 is turning out to be a terrible year for the music industry. Or rather, a terrible year for the the music labels.

The DRM walls are crumbling. Music CD sales continue to plummet rather alarmingly. Artists like Prince and Nine Inch Nails are flouting their labels and either giving music away or telling their fans to steal it. Another blow earlier this week: Radiohead, which is no longer controlled by their label, Capitol Records, put their new digital album on sale on the Internet for whatever price people want to pay for it.

The economics of recorded music are fairly simple. Marginal production costs are zero: Like software, it doesn’t cost anything to produce another digital copy that is just as good as the original as soon as the first copy exists, and anyone can create those copies (meaning there is perfect competition and zero barriers to entry). Unless effective legal (copyright), technical (DRM) or other artificial impediments to production can be created, simple economic theory dictates that the price of music, like its marginal cost, must also fall to zero as more “competitors” (in this case, listeners who copy) enter the market. The evidence is unmistakable already. In April 2007 the benchmark price for a DRM-free song was $1.29. Today it is $0.89, a drop of 31% in just six months.

P2P networks just exacerbate the problem (or opportunity) further, giving people a way to speed up the process of creating free copies almost to the point of being ridiculous. Today, a billion or so songs are downloaded monthly via BitTorrent, mostly illegally.

Eventually, unless governments are willing to take drastic measures to protect the industry (such as a mandatory music tax), economic theory will win out and the price of music will fall towards zero.

When the industry finally capitulates and realizes that they can no longer charge a meaningful amount of money for digital recorded music, a lot of good things can happen.

First, other revenue sources can and will be exploited, particularly live music, merchandise and limited edition physical copies of music. The signs are already there – the live music industry is booming this year, and Radiohead is releasing a special edition box set of their new album for £40.00 simultaneous to the release of their “free” digital album.

Second, artists and labels will stop thinking of digital music as a source of revenue and start thinking about it as a way to market their real products. Users will be encouraged (even paid, as radio stations are today) to download, listen to and share music. Passionate users who download music from the Internet and share it with others will become the most important customers, not targets for ridiculous lawsuits.

The price of music will likely not fall in the near term to absolutely zero. Charging any price at all requires the use of credit cards and their minimum fees of $0.20 or more per transaction, for example. And services like iTunes and Amazon can continue to charge something for quality of service. With P2P networks you don’t really know what you are getting until you download it. It could, for example, be a virus. Or a poor quality copy. Many users will be willing to pay to avoid those hassles. But as long as BitTorrent exists, or simple music search engines like Skreemr allow users to find and download virtually any song in seconds, they won’t be able to charge much.

Update: There are some blog responses to this post that are, inevitably, complaining about fairness. Arguing against basic economics makes about as much sense as arguing against gravity. Zero marginal cost + competition (anyone can create a copy of a song) results in a zero price, unless government creates artificial barriers to a free market.

Update 2: NBC Universal chief Jeff Zucker: “We need, across the board, to move IP enforcement up the agenda of the federal government.” Scary stuff.

Update 3: Paul Glazowski writes a rebuttal, essentially arguing from the fairness perspective. I talk about the fairness argument in the comments below a lot. As I say below, gravity may not be fair, either, but its inevitable. Paul also says the medium has “value,” which I don’t dispute. But the fact is that zero marginal production cost plus perfect competition (every consumer is also a potential producer of any song) inevitably equals a zero price. I think Paul’s main point is, even though he doesn’t say it, that government should step in and set a “fair” price of $5 – $8 per album. Of course, that will involve getting the feds involved to enforce these laws (see update 2 above), or some kind of music tax (which creates really, really bad incentives).

Update 4: The discussion below is awesome. I think I’d like to do a podcast or video debate with someone who disagrees strongly. Paul Glazowski, mentioned in the third update above, seems to disagree strongly and intelligently and may be willing. If there are any pro-label types out there, I’d be happy to consider them as well. Let me know. Perhaps we could get Scoble or Gillmor to video this for us, too.