Game Theory In The Music Industry


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Written within the context of an introductory Game Theory Honors Seminar Spring 09.

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Game Theory In The Music Industry

  1. 1. LAwschool11LL<br />Game Theory in The Music industryAn introductory lookWithin the modern context of the Music industry- there are drastic shifts in profitability and sustainability. With the classic business mindset no longer proving effective, survival necessitates the search for a different perspective. This paper takes a look at some of game theories responses to the current turmoil.2009Ben Kilmer4/18/2009<br />The music industry is in a radical time of change. The business model shifts from one that derived profit from the sale of recorded music, to one in which music has become free to all those who have internet access. The industry is left scratching their heads as to where they may derive their value from. Even though the copyright infringement law has not changed at all, the vast number of consumers who participate in this illegal activity makes it nearly impossible to enforce. While the music industry happens to be the poster child of this infringement, all media industries are experiencing similar troubles. When it comes down to it, the advent of Peer to Peer (P2P) file sharing has destroyed the sale of entertainment medias. Is this the end of music as we know it? Quite possibly, but game theory lends itself to framing these problems in a way that sheds light on possible solutions. The game itself is very complex with many players, and iterated games.<br />FIG 1.1 (“Shadow”Page 2) ‘06.)-2095501014095A good jumping off point is framing the crux of the problem itself, music piracy. In game theoretic perspective, this problem can be illustrated in a very familiar way- The Prisoner’s Dilemma. As discussed by Will Page, one such dilemma comes about between the Internet service providers and the record label’s themselves (Fig 1.1.) Just as in any prisoner’s dilemma, the highest payoff will arise when both the ISP cooperates to license the privilege of downloading, and the record labels license their music through many venues at variable prices. Record labels always like to receive a higher profit, so for the most part they’re unwilling to license their music through multiple venues, because they know that selling records and licensing Itunes has a higher price tag. Because of this inflexibility, they loose a consumer surplus of those willing to pay more than $0 for any given track but unwilling to pay as much as a $1. On the other side, ISPs have zero incentive to license the right to downloading in a separate package than the one they currently provide. If ISPs were to license in this manner, they would likely be able to charge more and profit more; without government action there’s no way there would be a unilateral change by all ISPs. Therefore, individual ISPs that tried to make the change would just loose out to other ISPs that operated at the status quo. This discussion of the ISPs also leads directly into the dilemma of collective action. In the case of people paying more for internet to receive unfiltered download privileges, versus the rest of the internet- the current set up as we see it today constitutes a moral hazard. The cost to ISPs for bandwidth required frequent downloaders is passed onto consumers who don’t use the internet to download a lot. In the case of the government instituting such a policy which differentiates the two types of consumers, they would have to use punishments for ISPs that didn’t follow suit. These punishments may serve as the government’s incentive to institute such a program, because such a venture could be profitable. <br />Another way to frame the Prisoner’s Dilemma is from the perspective of artist versus the record label. Artists have been able to increasingly sell/distribute more of their music by themselves without the use of the record label, because of the propagation of newer technologies. While the record label would achieve their highest personal payoff by giving the artist a better deal they could only do this if they had a large number of artists cooperate and sign onto their roster. Artists could also receive their highest payoff if they signed with a cooperative record label that gave them a good deal. Because artists cannot assure that record label will give them a fair deal, they many times will choose not to get with a label- even though the label has a vast amount more resources and could make their name bigger. Record labels will not give artists good deals on the other hand, because they cannot assure success of the artist, and they cannot assure they will have a large number of artists in which some may get famous. Therefore both parties settle with their dominant strategy, which results in a sub optimal or inefficient equilibrium.<br />A third way to frame the Prisoner’s Dilemma is between the artists versus consumers. Artists and consumers can reach an Pareto Optimal solution when artists allow consumers to pay what they want to pay for their music, and consumers pay money to consume music. Consumers are unwilling to pay money for music- even though this will support their continual consumption from an artist that will continue to produce and release music. Their dominant strategy is to pay nothing for music because regardless of what the artist does, they’re always better off. On the other hand, the artist would sell more units if they offered a lower price or consumer choice price for their music, as more people would buy it. Because there’s no way to be sure whether the majority of consumers will pay nothing for it, their safer option is to charge a higher amount to their consistent consumers; they can sustainably continue their career. The result of these headsets are artists who sell overpriced music, and consumers who pay nothing for music. In terms of an iterated game, which this absolutely is- this is not a long term equilibrium. Eventually the artist’s pocket will dry up and they will no longer be able to release music to the public. Clearly this is not what the consumer wants either- but as it would appear now they are only concerned with the short term. A great example of the optimal equilibrium playing out within the real world is the historic sales of the Radiohead album “In Rainbows.” The band released the album through their webpage, and each consumer could pay whatever price they want for the sale whether that’s $0 or $10,000. The result was record breaking sales- $10 million their first day of sales. <br />What do these Prisoner’s Dilemmas lead to for the market? A market price of zero for the sale of music. As for the consumer market, the consumer will in most cases play their dominant strategy, pay nothing for music. Aside from framing this as a dominant strategy one might also look at the situation as a Free Rider Dilemma. While it holds no truth, many consumers have the impression that because they’ve heard the artist on the radio that the artist is already very rich (FIG 1.2). Logically the assumption would follow that if the artist is very wealthy than there are already enough people that pay for the music, as one person they wont make a difference, so why should they pay? This situation is referred to as a tragedy of the commons; consumers believe that they as an individual will not make a difference by downloading illegally, which results in almost no consumers paying for music for all- even though this mentality eventually ruins the benefits for everyone. <br />FIG 1.2Royalty Statement Example of an Artist that’s gone Gold (500K Records Sold):<br />While this may have been an excuse a number of years ago, its now common knowledge that the music industry is dying; a result of consumers playing their dominant strategy in a zero sum game. Regardless of what the music industry does, they are always better off paying nothing for music. Consumers will almost always prefer to pay nothing over pay something for recorded music when the option is presented; there’s not too much that can be done short of preventing access to paying nothing, and because of the internet’s current structure, there’s virtually no way to do this. Between the forces of technology and consumer mindset, a very dismal shift for the industry is occurring; music is shifting from a private good to a pure public good. Because media is so easily replicated with no constraints or quality loss music is both non excludable and non rival (FIG 1.3.)<br />FIG 1.3 (“Zero” Page 5)<br />The market reality of this shift is music’s price shifting closer and closer to zero. So how can the industry respond to this shift and avoid going bankrupt? The key lies in identifying, and capitalizing on where the added value exists within the market.<br />Added Value as defined by Co-opetition, is “the value of the game when you’re minus the value of the game when you’re not there.” This concept is not so valuable by itself in terms of the music industry; its easily discernable if record labels were not part of the market, then in the most simple terms there would be no such thing as Pop music. This idea of value is very important, when complemented by the idea of a Value Net. This is where the generation for solutions to the status quo begins. The value net consists of five elements: Company, Customers, Complementors, Suppliers, and Competitors. For the purpose of illustration, we will define the company as a major record label. In this, customers consist of: private individuals, radio stations, record stores, retail stores, music artists, television channels, etc. Complementors are defined as a partner that causes customers to value your product more when they have both your products, than when they have just your product alone. In the case of a record label this list has a fairly extensive scope: merchandising (clothing, backpacks, lunchboxes, figure toys, etc.),radio stations, pop culture magazines, television stations, music web pages, social networking web pages, etc. In the case of suppliers, for the most part we can narrow the list to artists, producers, and managers. A Competitor is defined as a player which causes customers to value your product less when they have that players product in addition to yours, than when they have your product alone. As for competitors, one might say that any other form of entertainment can be considered, as well as other major record labels, independent labels, and websites that allow the artist to distribute their content by themselves (ie. Myspace, youtube, facebook, P2P torrents, etc.) What’s of considerable importance to this value net are complementors. If the music industry can find a way to make their product more attractive they need to do so. <br />FIG 1.4 (“Zero” Page 6)One strategy for this is through marketing strategy referred to as bundling. Bundling is the practice of selling two or more services or products in a package. It increases the chances of purchase because there is a higher chance of the package holding a product that entices the consumer to purchase, that they wouldn’t purchase by itself. In the case of selling music- this idea makes sense because people are no longer willing to pay much for music by itself, but if they get a free t-shirt, concert ticket, artist promo package, etc. than the chances for purchase are much greater. This logic is illustrated in Figure 1.4. <br />“The revenue maximizing price of 1.00 generates aggregate revenue of 4.00 when sold seperately, however if the tracks were bundeled together at 2.20 each, then the revenue would increase to 4.40. Bundling increases revenues in this example because the willingness to pay for the bundle is less dispersed than the willingness to pay for the components.”(“Zero” Page 6.)<br /> In game theory bundling can be analyzed as a cooperative game referred to as a coupling game. A coupling game “considers the influences of cooperation or hostility, and then make decisions according to the new game and existing non cooperative game theory. After the new coupling game is constructed, the algorithm for determining equilibrium is exactly the same as that for Nash Equilibria in existing pure strategy or mixed strategy non cooperative game theory.” With the analysis of these equilibrium quantities in mind, labels may than consider expanding such that they can own/produce their own complements. While labels bundle songs frequently; the practice of bundling things such as merchandise with the involvement of Complementors is not so widespread. <br />Another strategy which record companies utilize is the use of Digitals Rights Management otherwise known as DRM. What DRM does for them is attempts to reduce the added value of music that was not sold on a CD but in its pure digital form on the computer, IE a song bought on Itunes. In theory this makes buying files on the internet less valuable not only because you don’t get a CD cover, and booklet, but because you have limited rights as to the distribution of that music. In contrast if you were to buy a CD you can simply rip it to your CD, and have DRM free files. The reality of this ineffective strategy is that people who are trying to get files that are DRM protected onto their Mp3 player simply use the latest FairUse Program, or any other freeware that strips the file of its DRM. This is not to say that this isn’t a good idea- it’s a great one. If the music industry can successfully develop effective DRM they will be able to gain back the control of the distribution of their content. <br />Furthermore, there are other strategies that could be used to prevent the snowball or band wagon effect of rampant illegal downloading. The education of young people as to what this is doing not only to the industry, but to individual artists might help to slow down the spree of illegal downloads. While people have no qualms about stealing from a faceless company, with unknown beneficiaries, they might think twice about stealing music from their favorite artist- who depends on their contributions to continue to make good music for them. <br />The music industry is in a radical change in which the power and money may be shifting from label to artist; in an industry where the label was essential for music distribution, the internet now enables musicians to DIY (Do it Yourself.) While this may be a marginally better outcome for the artist- the implications are there likely no more superstars- ever again. Because the market will become so saturated with independent music- it will be harder and harder for one artist to rise over another without the use of widespread distribution and connections- a void that the dinosaur record label once held. As for the record label, there may still be hope, but only if the label treats the artist better, and gives some real heed to strategic thinking, and game theoretic moves within the market. Game theory is valuable for the problems of today, and the future. <br />Works Cited <br />Brandenburger, Adam M., and Barry J. Nalebuff. Co-Opetition : A Revolution Mindset That Combines Competition and Cooperation The Game Theory Strategy That's Changing the Game of Business. New York: Currency, 1997. <br />Dixit, Avinash K., and Susan Skeath. Games of Strategy, Second Edition. New York: W. W. Norton, 2004. <br />Page, Will. " Is the Price of Recorded Music Heading Towards Zero?" Transmission (2006): 1-13. Independent Research. 30 Nov. 2006. PRS For Music. 16 Apr. 2009 <>. <br />Page, Will. " Shadow Pricing P2P's Economic Impact." Economic Insight (2008): 1-4. Independent Research. 30 Oct. 2008. PRS for Music. 16 Apr. 2009 <>. <br />