The RIAA Sucks at Economics. Surprise.

February 26, 2008 in Finance

Inflation popped up today, as it tends to, and in the course of my reading on the topic I came across a gem of a paper with the brilliantly inspiring title "CDs: A Better Value than Ever."

The subtitle, "Prepared for the Recording Industry Association of America, Inc.," made it impossible to ignore. Watching these people is like passing a car crash -- it's horrible and disruptive, but you can't help slowing down to stare at the mess...

I now present the first four lines central thesis of the paper:

Even without taking into account substantial improvements in product quality, the cost of recorded music to consumers has fallen dramatically since CDs were introduced in 1983. Between 1983 and 2001, the average retail price of a CD fell by 32%. Over this same period, consumer prices (measured by the CPI) rose 77.8%. If CD prices had risen at the same rate as the CPI over this period, the average retail price of a CD in 2001 would have been $38.23 instead of $14.64.

If you are familiar with such topics, you probably just thought "Wow. What a gross abuse of statistics." But if by some unfortunate chance you are not, well, nobody's perfect.

The CPI, as you may be aware, is an index (specifically, the Consumer Price Index) which tracks the cost of a basket of goods. It is designed to capture inflation: if the basket costs $1.00 in 2007 and $1.04 in 2008, then inflation was 4%. The more heavily-weighted CPI goods are housing (including shelter and fuel) and food. Technology items have relatively little weight (~3%) and media items (including CDs) are a tiny 0.16%.

Critically, the CPI is a constant basket. This is what makes it comparable year over year. An apple in 1988 is pretty much the same "product" as an apple in 2008. That's not true for most technological devices, like computers, televisions or cars, where one year's state of the art gadget is next year's obsolete hunk of plastic. It goes without saying that the newest iteration of a product causes previous versions to lose value. The CPI must be carefully calibrated to account for that idea. You can't just compare the price of a single technological good to the CPI, because the price of that good should be dropping!

We are quite familiar with the phenomenon of technology prices falling-- LCD prices have slid precipitously in the last few years. This is because innovations in production have allowed the same panel to be made more cheaply, while newer technology applies downward price pressure. A 50 MB hard drive would have set you back a small fortune in 1980; today it's a challenge to find one so small. A scientific calculator cost about $200 back then. Today some people wear one on their wrist. Are these products cheaper today? Yes. Are they better values? No, because the lower price reflects descreased utility.

So here's my central thesis: innovation causes prices to fall. And here's something I will say very rarely: The RIAA is (almost) right that a CD today is a better value than a CD 25 years ago. Why? On the face of it, sure, it's now cheaper to manufacture a CD than it was before, meaning otherwise identical CDs are a better value at a lower price. But more than that, the RIAA has absolutely refused to adopt any technological innovations. This implies that a CD is, in fact, a constant good, meaning it has not been replaced by something more advanced. Critically, it is a constant good whose price has nonetheless fallen in the absence of technological progress. That's deflation, or an increase in value.

Let me now clarify/redeem myself: The RIAA is more or less right that CDs are now a better value, nominally. However the RIAA is only "right" because their hamfisted prohibitory policies have prevented alternative media from materializing and eroding that value.

Since the CD was introduced in 1983 the RIAA has failed to progressively advance the state of the art. As evidence, witness contemporary attitudes: The RIAA is commissioning papers on the value of a CD 25 years after its introduction and after the successive development of two concrete generations of optical media (DVD and Blu-Ray). Why haven't these newer formats been adopted? Why not enhance the music with extra tracks, videos, enhanced sound, digital files, bonus features, interviews, previews, interactivity, digital booklets, etc.? A much more savvy industry group, the MPAA, found great success by doing just that, though they have a distinct advantage of being composed of arguably intelligent individuals.

In essence, the RIAA would claim that cheap CD's represent greater value because they are the identical product now to what they were 25 years ago, and no new music medium has replaced them. Or has it? I would argue strongly that digital sales have finally antiquated this obsolete disc. Third-party advances in music media are forcing CD prices down, just as in any other technological continuum. Buried in today's NPD report is the facinating statistic that an astounding 48% of teenagers, a population subset highly responsive to changes in technology, did not buy a single CD in 2007.  Why would they, when the same information is available for less with dramatically better "fidelity, length, durability, ease of use at home and on the road, range of choice, etc.," to borrow the RIAA's description of the CD.

So, I take it all back. The RIAA is wrong, as usual. The price of the CD hasn't been falling steadily as the value of its goods remained constant, as they would claim. The value of its goods is falling as the market becomes aware of not only alternative media but the opportunity cost surrendered during the RIAA's prohibition of such advances. Basically, the price of the CD has been dropping to reflect the market's disenchantment with a forced adoption of increasingly archaic technology. I can't put it more plainly than this: CDs are cheap because no one wants to buy them anymore.

Here the RIAA is claiming that CD's are a wonderful value because of their relatively low price. Even so, they rail against the digital industry, insisting that it is selling songs too cheaply. Now, I'm no economist (oh, wait.) but it seems to me that to ignore technological progress for nearly three decades is tantamount to artificially maintaining a high price point while the underlying technology becomes cheaper to produce. In other words, the normal march of technology should have driven the price of a CD down even more than it has fallen to date. In plain English, maybe, just maybe - and I say that in a way which means "definitely" - CDs are simply overpriced. Blasphemy, perhaps, but devilishly hard to disprove.

So, RIAA paper, stop comparing CD prices to the CPI. It doesn't make sense from any economic standpoint. One would expect the price of a CD to fall over time. Moreover, it would have fallen a lot more if the RIAA weren't blocking technological progress. Plummeting CD sales that are offset by downloads in volume but not market value provide irrefutable proof of the last.

Welcome to the free market, where any claims that digital prices are too low can be correctly interpreted as claims that CD prices were artifically too high.  Where any claims that the industry is losing revenue should be restated as the industry losing access to cartel profit.  Where Radiohead has demonstrated that people will pay for music even if they can get it for free.  Where an entire industry can be threatened by the policies of a few RIAA executives taking every opportunity to make a strong case for their own incompetence.

Anyway, iTunes, congrats on being the number 2 music retailer in 2007!

Image from chop on that's Flickr

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