Once upon a time, musicians made money by selling albums. Now that people download music, this strategy doesn't work well. But what is the alternative?
In 2007, Radiohead thrilled fans and economists alike with a new approach to music distribution. They distributed their album In Rainbows electronically, allowing fans to pay any price they chose - a penny, a dollar, or 100 dollars.
It worked for Radiohead - they garnered massive publicity, respectable sales, and a permanent place on public economics exams (download sample question here).
But there's a problem with the Radiohead strategy. Given two choices: "download and pay nothing" and "download and pay something", people will generally opt for the first. It costs less.
People donated to Radiohead as a feel-good vote for a new order. But the long-run feasibility of the strategy is better evidenced by Wikipedia - 400 million users and $14.5 million in annual donations, revealing an average willingness to pay of about 4 cents per year.
So are we living in a world where the hottest new acts are those tailored to demographics who don't download, such as Susan Boyle?
Former student Rob Carrothers sent me a link that suggests a new alternative may be evolving. Political rap band Public Enemy is financing their latest album through www.sellaband.com. This is how it works. The band, in this case Public Enemy, announces a fundraising goal - $75,000 to record an album. Fans make on-line donations through sellaband - but if a fan changes his mind, he can switch his funding to another band at any time, up until the point when Public Enemy's fundraising goal is met. Fans can expect some future payback - downloads, a share of any profits, whatever the band promises.
At first glance, Public Enemy's approach doesn't look so different from Radiohead's or Wikipedia's. Yet individuals' incentives to contribute are fundamentally different. Wikipedia is there whether I donate or not, so the best strategy (warm glow of giving aside) is not to donate.
But imagine that 7,499 other people have aready donated $10 to Public Enemy. My $10 donation brings the total up to $75,000, enough to generate a new Public Enemy album. I have no incentive to withdraw my donation, because if I do, the project won't be funded. My donation is a "pivotal contribution."
Indeed, if any one of the 7,499 people pull out, the project won't be funded. Each one of those 7,499 donations are pivotal, so no one has an incentive to pull out.
In the language of game theory, the situation where Public Enemy's album is financed by 7,500 people each donating $10 is Nash equilibrium - each person is making the choice that is best for themselves, taking the behaviour of other people as given.
O.k., so does this mean that we have a new paradigm for music finance? Free riding is no longer a problem?
The problem is now one of coordination. There are thousands of possible ways of dividing the finance for Public Enemy's album - 7,500 people donating $10 each, 7,000 people donating $10 and 5,000 people donating $1, and so on. Any one of those, once it is established, is an equilibrium. But how do we get there in the first place?
Elinor Ostrom won last year's Nobel Prize in economics for the insight that social institutions - norms about contributions, social sanctions for deviations - can overcome incentives to free ride. It worked in Nick Rowe's neighbourhood - the community got together and financed the cost of paving their road. It works for elevators in Paris. Building residents choose by 2/3 majority vote whether or not to install an elevator, and if the vote passes, there are well-established (and legally enforcable) norms that allocate the cost of elevator finance across dwellers of apartment buildings, with those on higher floors paying more than those on lower levels.
But any particular group of music fans is typically large, dispersed and diverse. Fans spread out across the continent cannot use social norms, such as praising contributors and shunning or cajoling non-contributors, to elicit cooperation. Unlike the clearly set out rules in place for financing Parisian elevators, there is no accepted norm of what a standard contribution to sellaband.com "should" be, and no legal enforcement mechanism.
So I don't know if the Public Enemy model is viable on a large scale. But it should make for some cool exam questions.