Format War Deja Vu. Now in Hi-Def!

The ongoing war between the next-generation high definition formats HD DVD and Blu-Ray Disc seems to be finally coming to an end, with the latter emerging as a clear winner.

The defections from the HD DVD format, backed by companies like Microsoft, Fuijitsu and Kenwood, was prompted by the announcement in early January of Warner Brothers to release its titles exclusively on the Blu-Ray Disc, supported by companies Sony, Apple and Dell. The exodus from HD DVD has continued: Netflix, the online DVD rental service in the States announced a month later that it too will start phasing out HD DVD and switch to Blu-Ray only by the end of the year, and The Times has reported that as many as 20 companies currently part of the HD DVD Promotion Group are contemplating removing their names from that list [1].

Since both the formats were introduced in 2003, neither had shown a clear lead in the race. Having learnt from the infamous format wars in the late 1970s – 80s between Sony’s Betamax and JVC’s VHS home video formats, both the HD camps have maneuvered to gain a majority share in the home entertainment market, so as to benefit from network externalities and ‘bandwagon effects’. Network externalities refers to how an individual purchasing a good would indirectly benefit other consumers; in this case, the more consumers choose Blu-ray Disc players, the more likely rental services or DVD shops are likely to stock Blu-Ray discs, and the easier for other consumers to find and enjoy their high definition DVDs. This in turn would lead to the ‘bandwagon effect, where momentum for a particular product builds up, encouraging the support of consumers, distributors, licensees, such that it becomes the industry standard. Considering this, it seems rational for Sony to have release their Playstation 3 game console—which features a Blu-Ray Disc drive—at a significant loss.

It has been argued that unlike the Betamax-VHS format war, the present competition has effectively been decided in boardrooms, with the major studios making the decision of where their loyalties lie before consumers. In this respect, network externalities and bandwagon effect at the producers and distributors’ level was what mattered in the current war– the more studios back one format, the easier and cheaper it would be for producers to mass produce the discs. However, it must be noted that Blu-Ray discs were already outselling HD DVDs by about two to one in the first three quarters of 2007 [2], such that it may be too early right now to declare whether it was the consumers or producers who decided the winner of the format war.

Rationale Reckons:
- Since companies are already working on the successor to Blu-Ray Disc format, and DVDs are still holding up, is it possible that we may leap-frog this HD format, such that it doesn't quite matter who won this round?
- Would this development matter much to those of us who seem to be increasingly enjoying our media in out formats (...downloading, anyone?)
- Lord of the Rings on Blu-Ray...at last!

Sources
[1] Lewis, Leo “Blu-Ray takes inside edge in war with HD-DVD” (8th January, 2008) Times Online
http://business.timesonline.co.uk/tol/business/industry_sectors/media/article3153038.ece

[2] McBride, Sarah. “DVD formats Blu-Ray, HD square off” (30th September 2007) http://www.charleston.net/news/2007/sep/30/dvd_formats_blu_ray_hd_square_off17561/

How I Made My Millions

On 10th October, the English rock band Radiohead released their album ‘In Rainbows’. What was special about this was not the fact that it wasn’t a physical album, or that it scores a whopping 89 on Metacritic. No, the reason why ‘In Rainbows’ would be remembered in years to come is because of its peculiar delivery method: it was made available online at the album’s official website inrainbows.com, and downloaders are prompted to name their own price.

WWHD?
Let’s pause for a minute and ask ourselves that all time important question which may make or break (or neither?) Radiohead – what would homo economicus do? Putting the endless jokes about his names and caricatures (and doubtless, criticism) of our friend aside for the time being, we assume that he is a rational being, and wished to maximise his utility subject to the amount of resources he has. Let us now assume that HE can spend his money on two goods – Radiohead’s ‘In Rainbow’ and a composite (and one would assume, very heavy) basket of all other goods. One less dollar spent on Radiohead would mean one more dollar’s worth of all other goods; as more is better, and HE can pay nothing for the music, as a rational being, he would pay nothing.

No surprises
So did the ‘In Rainbows’ downloaders act like HE did, ie, did they all pay nothing? The answer, it should come as no surprise, is a no. A report released on 8 November by comScore, a company which measures the digital world, finds that worldwide, 38% chose to pay for the download. The percentages were higher in the UK and US, at 48% and 40% respectively.

Interesting too were the results of the amount spent on the downloads. For people who chose to pay, the average they spent per download was £2.93. In the US the figure was £3.94, and in the UK, £2.47, much lower than what one would be expected to pay for a CD at any high street store. We see HE at work here, even if not to our extreme conclusion of paying nothing – given the chance, people would still more likely pay less than they would otherwise have done.

However, comScore’s study is based on data obtained from the company’s database of “several hundred” who have provided the information voluntarily. Moreover, it only covered a short period, 10-29 October, so the results should be taken as a preliminary indication of downloaders’ behaviour only.

Hail to the Thief
Then does this mean that all 38% who chose to pay for the download are completely bananas?

The economist Dani Rodrik conducted a similar experiment on his blog by letting his readers bid for his new book, with the difference that all the money would go to charity. The results were very similar to the Radiohead figures – many opted to pay nothing, amounts paid averaged $21, and a few people paid ridiculously high amounts ($100-$145). What was interesting is that many of those who chose to pay felt a rational justification was necessary—many claimed they paid so much only because they wanted to contribute to charity.

Charity too, is what drives most people who give to buskers. Do you give because that 70 year old guy standing on the corner of the street just gave a haunting rendition of ‘Mary had a little lamb’ on his recorder, or do you give because… well, he’s a 70 year old guy standing on the corner of the street with a recorder, and you feel he could probably do with a little charity?

The same goes for tipping. There is no ‘rational’ (in the economic sense) reason for giving the hotel bellboy a fiver for moving your luggage, or for tipping the waitress more because she drew a smiley face on the check.

Not that this author is implying that Radiohead are buskers, or that the 38% are merely tipping the band for their jolly good effort, or because they were charitable. What motivated these people though, is perhaps similar to what motivates us daily to throw spare change to buskers or tip our waiters. Why we do it is still less than clear, as the economist Greg Mankiw confesses on his blog “Economists do not have a good theory of tipping.”

Million Dollar Question
Are we on the verge of a distribution revolution? Sadly, not really. Albums to download have long been in existence. It’s not a case of a ’legalization’ of free downloads either – it has never been illegal; iTunes has long offered free download samples, and Spiralfrog (US and Canada only, for now) provides ad-supported free music from major music publishing companies like Sony and Universal.

And what at first seems like a fun exercise of first degree price discrimination – getting people to pay exactly what they value the product at—turns out to be no more than a veiled attempt at product differentiation. Available to order, only online, alongside the ‘In Rainbows’ album download is the £40 discbox set consisting of two CDs, two vinyl records and other memorabilia. Less price sensitive customers would likely order the more expensive set, and the increased internet traffic due to the whole pay-as-much-as-you-want hullabaloo undoubtedly helped in driving some less price sensitive customers to the site. In fact, comScore’s research finds that for every one dollar generated from album downloads, sales of the discbox made two dollars. Offering cheaper (or even free) products to attract customers who would potentially buy more expensive but related products is not new either – both Rodrik and Mankiw have started blogging (the free product) because they have new books coming out (the more expensive but related product).

Even though the results of the Radiohead experiment are less than compelling, it seems to be a step in the right direction – no more dodgy torrents, legal DRM-free music, artists manage to make good money out of it… and if it means it gets more people to think about the economics behind what they do, all the better.

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Picture a screenshot of their website, so not sure about the copyright.

Link to the comScore report : it would be nice if we can get some of their results in graphical form.