The "In Rainbows" model

This is a response to Navin's comment in the last post. He asked whether Radiohead, providing it's latest album In Rainbows for download, for a voluntary contribution made any economic sense (zero is also an allowed contribution).

A seller, if he is greedy (in the sense that he prefers more to less and given a choice chooses more) typically tries to make as much money as he can by selling. The ideal situation for him is to sell his goods to each person charging them the maximum they are willing to pay. This is what you see in an ordinary auction: the buyer has to bid the maximum he is willing to pay to compete for the auction. In this sense, the seller is a profit-maximizer. In a market when he is selling to a multitude of people however, he does not have the liberty of engaging in any activity to discover the maximum willingness to pay (MWP) of each of his customers. He usually charges a price, aware of the fact that this price may be below some people's MWP and above some other's. So by definition, he caters only to the people who are willing to at least pay the price he quotes.

The seller estimates what the people are willing to pay and contructs a demand curve (relationship between price and how much people buy) and chooses a point such that he makes maximum profit. This is the tradeoff that he has to contend with. If his goods are priced low enough, it is more likely that a larger number of people will have a MWP greater than the price but on each unit he is making less profit.

So how does the radiohead model work? They have spent some money making their new album. By offering it on the internet for a voluntary contribution, the choice is left to the buyer to state his MWP and pay it. The only problem is that their is no mechanism or incentive for the buyer to actually state his MWP (except possibly his conscience). This is where they deviate from predicted seller behaviour. They don't seem to be greedy. This makes for an interesting new point of view. A west versus east kind of thing. What if I get into a business saying that I want to cover my costs and over and above that all I want to do is make x rupees of profit. Then I don't need to worry so much about getting the price just right. Now all I need to do is ensure that so many units of my good gets sold. Then I tell my customers to pay whatever they want to in excess of the cost of making it. Will anybody pay more? They certainly have no incentive to. The only thing that could motivate them is some sense of loyalty to the seller or some kind of personal touch. I would probably pay more at my local shop where I know the proprieter, but not at a McDonald's.

Radiohead however only had this offer on for a limited period, which leads me to believe that they did this more as a publicity gimmick than as some kind of revolutionary business model that's going to change the world. Would it have been a sustainable new model? I don't think so because it ultimately boils down to a quesiton of telling the truth and not many people tell the truth.

I think it's a step in the right direction because the entire music industry is going to change. The recording industry association of america says that the losses from music piracy already runs up to 12.5 billion dollars. That is a lot of people not paying for what they listen to. Fighting piracy is one way to go about it. It's definitely not the smart way though. Work with it. Accept that it has come to the phase where people expect to get music for free and work around it trying to make the most of it.

Think about what google does. Their product for their customers is internet search, and they charge nothing for it. On the other hand they've got their hand in the advertising pie and that's where they make their money. This is similar to the indian railways: charge your customers less and make up for it in another market (freight). I think this is a sustainable model for the music industry. Musicians could start putting their hand in some other pies too. Advertising is an obvious option or they could link up with the producers of CD's and music equipment and have some kind of tie-up there. There may be something more specific that could pay better. An innovation here could be the final answer.