Efficiency of the Market

By Richard Menta 7/06/03

The other day I came across a portable CD and it caused that odd little ripple to run through my senses. The player itself was not anything special, just the opposite in fact. It was produced by Memorex and sold for $29.99. A simple, basic device to play music with.

But the way my mind was working that day this was the thought that immediately popped into my head. "Gee, for that much money I can buy to play on it - one-and-a-half CDs"?

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This elicited a pause and I picked up the blister pack encased device.

I stared at the player while my mind proceeded to mentally take that CD player apart. I thought of its myriad of parts - memory chips, relays, a mechanism to spin the CD, a laser to read the 1s and 0s contained on it, a small processor to convert those 1s and 0s into audible sound, etc. All of these parts, each with a crucial role to perform, are assembled into a single unit and sold for a penny under thirty bucks retail.

My mind then held up a CD. The answer was a simple one - a flat, shiny disc.

Now I must add it's a flat shiny disc with music on it. Music that is produced through the sweat and toil of thousands of artists, their producers, the 40-story skyscraper housing the executives and studio staff, and the marketing department. A lot of what we call fixed costs there.

Memorex has a marketing department too. It also has a large office filled with product managers and engineers developing the latest devices. It has an assembly line filled with employees to put together the hundreds of parts that make up each product. Electronics manufacturers also spend considerably on R&D to invent the products that will hit store shelves a few years from now.

CDs are just stamped out in one quick swoop.

So why are CDs relatively so much more expensive relative to the electronic products that play them? If you think about it, the person who purchased the Memorex unit above probably did so because they felt the $45 player (equal to 2 1/4 CDs retail) was too much.

The answer is the industry is run inefficiently. This naturally happens when a few conglomerates control an industry because executives seem to always find some way to spend the excess. It is also what makes such supposedly powerful and controlling industries vulnerable to change. Inefficient operation exposes such industries to the significant schisms in the market that inevitably occur every 20 to 30 years, changes that effect even efficient industries. For example, when was the last time you used a typewriter?


The record industry has been able to control the distribution channels to effectively push prices up. It has limited competition to the mass market to a point where its members - members who viciously compete with one another - could still effectively collude to fix retail prices. They were caught, but the price of CDs went up further. List price today is $20. Street price is something a little less.

Rock historian Dave Marsh once commented that the record industry would prefer to sell you only one CD a year for a hundred bucks rather than five for that price because it would further reduce their costs and make them even more money. The fewer artists to promote, the lower the expense. They have no desire to sell you twenty CDs for $100, even when it's popular music a decade or more old.

The record industry has been quite successful at achieving this end. By parceling the latest artists through an eyedropper they create artificially limited supply and push prices up. The Beatles released four great albums in 1965 alone. That was normal back then, everyone put out multiple albums in a year. Today the average artist is lucky to come out with one album every four years. Furthermore, since 1999 the industry has introduced 20% fewer new artists, reducing the variety of new music even more.

The industry cries both sales volume and sales revenue are down each of the last few years because of file trading. Yet, every time I hear that claim the industry conveniently leaves out all the other potential reasons like the fact that prices have significantly risen, choices have been reduced, recession, competition from DVDs, recession etc. Alan Greenspan's biggest concern these days is deflation caused by dropping prices witnessed by all industries. If the record industry insists on raising prices in such an environment (an environment that has seen drops in their own cost of materials) why should anyone be surprised if revenues instead drop?

File trading lays bare the simple fact that CD prices are artificial and too high. Consumers who trade are getting their music in volume now and they want to continue receiving their music in volume. As the success of Apple iTunes shows, many who trade will gladly pay for that ability as long as the price is reasonable and the terms fair.

It is not ironic, by the way, when industries that make excess profits blow tremendous amounts of money to retain the status quo, thus wasting a considerable portion of that profit. The music industry spends billions to lawyers for such market controlling efforts as; congressional lobbying, payola to the radio stations, and of course taking small companies and individual fans to court knowing court fees alone are enough to make most acquiesce. Memorex can afford to sell a $29.99 CD because it is efficient in putting that item to market. If the record industry were efficient it could (and eventually would) drop prices significantly to compete.

A market drop in prices would force the industry to be more efficient. It will also hurt. The more inefficient the industry is the more pain it will witness. That's why the record industry resisted for years competing head-to-head with file trade services. They didn't want to sell digital music online; they wanted online music to disappear all together.

It didn't work that way.

Online music is a competitor in the industries eyes pure and simple. They don't want open competition. They don't want to be the American automobile industry in the 70s who bled market share to overseas competition. The big three automakers deserved to lose market share for punching out mediocre, unreliable vehicles while Japanese competitors competed with superior craftsmanship. Japanese manufacturers FORCED the American manufacturers to build better cars, which they eventually did, and today the consumer is far better off. It was very painful for the American industry, but it was good.

The record industry does not want to build a better product if they don't have to. Consumers have been complaining for years of mediocre product, even before Napster hit the web. To some consumers, CDs are rusting on the record store racks like the Chevrolet Vega used to rust in automobile showrooms.

Could Online music force the same improvements. It already has and that is no surprise as 40 million active American file traders can't be wrong. Still, the record industry is making its moves kicking and screaming.

To be continued...


Other MP3 stories:
Copy Protection and the Reasonable Man
Review: Neuros MP3 Digital Audio Computer

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