AfterDawn: News

Record labels could face trouble over subscription services charges

New York Attorney General Eliot Spitzer recently launched an investigation into price fixing in online music sales but now he is also being requested to investigate how record labels charge music subscription services, such as those offered by Napster and Real. Sources inside the music industry say that each agreement made between a major record label and a service includes a "most favored nation" clause. MFNs basically mean that a service would have to increase payments to a label if another label strikes a better deal.

So for example, if Label A was receiving 10c per a song streamed to a customer, then Label B signs a deal for 12c per song, Label A automatically will now also get 12c per song. It is a common practice in retail for example, where a company would come to an MFN agreement with a wholesaler. However the existing music subscription services frown upon MFNs being involved in their business.



"Seller-side MFNs are inherently price-increasing and anticompetitive," says Jonathan Potter, executive director of the Digital Media Association. Among the members of the Digital Media Association are Apple, MSM, AOL, Yahoo, Napster, MTV, MusicNet Inc. and RealNetworks. MFNs cause a collusion on pricing and force subscription services to pay additional costs, which might made up by charging consumers more for the service.

Of course, subscription services actually have to agree to MFNs, but most probably have had no choice but to accept it in order to get access to a label's music. It will be interesting to see if anything will come from this.

Source:
Arstechnica

Written by: James Delahunty @ 15 Jan 2006 14:08

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• 12 comments

• punx777

  I completly dont understand this article,
  
  say, has the job been filled yet for the new afterdawn news writer??

  15.1.2006 18:02 #1

• chandlew

  This article was well written and clear. I did not know about this MFN deal existing in the on-line music industry. I hope Spitzer gets in there and tears the whole thing down. The recording labels already have an advantage in the market, their monopoly over the distribution of the songs/artists they have signed. They don't need another advantage that hinders free-market efficiency.
  
  It will be interesting when the on-line distributors become more powerful than the labels.

  15.1.2006 18:48 #2

• Dela

  punx777, if you have something to say about my news articles, then fair enough, I have a PM inbox, and I don't mind criticism. News comments isn't a place for it however, they are for comments on what has been reported.
  
  As well as that, your...
  Quote:say, has the job been filled yet for the new afterdawn news writer??Seems to be a quite nicely placed smart ass comment... or a complete coincidence. If coincidence, then whatever, and just so you know, no we haven't picked anyone yet - if it's not coincidence and you get some sort of buzz from trying to offend people, then your best off not commenting anymore.
  
  But ye, that being said, if it was coincidence and you just said it to ask the question, then fine.

  15.1.2006 19:42 #3

• SD2

  Sounds like we need a time out. Didn't know this but not surprised.

  16.1.2006 05:52 #4

• Steve83

  Don't worry, Dela. I'm sure his lack of understanding is directly related to his "completly" inability to spell, punctuate, or capitalize - he probably can't read very well, either. So we can HOPE that would be enough to exclude him from consideration as an official writer anywhere on the planet.
  
  Back on-topic, though...
  
  Interesting article, and I hope the $#!t gets stirred - the MPAA & music labels have been fixing prices FAR too long already. We certainly don't need that carrying over to online services.

  21.1.2006 12:26 #5

• XENON

  I'm not suprised by this. But what's amazing is that Mr. Spitzer is actually doing something about it. It also sounds like he knows what he is doing too. Who knows? Maybe It'll get so bad that they'll be congressional hearings on this subject. Stranger things have happened

  21.1.2006 13:43 #6

• duckNrun

  MFN's are an interesting concept. I can see it's use in say a situation where a a retailer insists that they cannot absorb the 'wholesale' price and so a Distributor A (in any line of business) decides to sell it's products at a price below 'market' or 'expected' level so as to at least earn SOME profit on it's items. Under this thought process it would seem reasonable that if said retailer later makes an agreement, with Distributor B, to buy a comparable item at a higher price then why could they not do so for Distributor A instead of using their 'so called' inability to pay as a means to entice a reduced price out of them. And such it would seem 'reasonable' that Distributor A would include this type of 'clause' within their contract.
  
  That being said...I am unsure of my feelings on this issue in connection to the music labels.
  
  Although on the surface there doesn't seem to be much difference between say Sony and Levi Strauss (in terms of both being sellers who are trying to turn a profit) the MAJOR difference is that Levis doesn't own a good portion of ALL the jean makers world wide.
  
  Worse case scenario for the clothing store: The MFN clause is rejected and they sell competitors jeans and although they may not be the 'popular' brand they do the job.
  
  Worse case scenario for a music store: MFN clause is rejected and they loose access to a HUGE portion of available music and hence customers. So for music stores it could easily be/become basicaly a 'take it or leave it' attitude. And they would HAVE to take it to survive!
  
  While many people may not care about Levi's VS the WalMart brand people do care about music that sounds good and music that sounds bad.
  
  The labels have all the cards. They 'own' the artists (until the contract expires), they own the music (past and present) and they own the distribution system (and it's outdated business model). Perhaps they should have to 'give a little' or even meet the Music Stores at more than the 'middle'.
  
  On the other hand if a store can pay Sony 12 cents a song then why shouldn't the other labels expect their product's fair market value to be the same?
  
  Are ALL of Distributor A's songs WORSE than the label who is getting paid more per song? And a MFN clause only raises that companies products price TO the level of their competitors so this could not be used as a means of consistant raising of all prices. Although with each new contract that demanded more per song the others would rise as well so depending on how the agreements are made, and how the labels are broken down (i.e into individual subsiduarys or a 'top domain' contract covering all the underlings).
  
  Of course one could possibly argue from my post that what is really needed is a more flexible pricing scheme all together. One where the contract deals with individual songs instead of as a catalog. And I AM AGAINST that at least in the manner that the recording labels have presented it so far or would 'probably' use it to further their grip and control.
  
  What is really at the bottom of this is
  
  1. How MUCH is an individual song worth at retail (especially taking into account the distribution method requiring no media, no shipping, no handling, and in terms of subscription based service no ownership of the 'bought' product etc etc)
  2. What should the expected profit margin RANGE for retailers be
  3. Can a business model be supported that takes #1, #2, and the cost of the e-Tailer doing business online actually be profitable and supported?
  
  These answers really can only be answered with market forces. For example, on a $10 CD there may only be 2-3 songs that people would buy as singles. So in 'reality' those other 7-8 songs are virtually worthless and people are only buying the CD for those 2-3 songs.... so those 2-3 songs are REALLY worth $3 - $5 A PIECE! (Yes... I agree I also WOULD NOT PAY that per song!) Or do we look at the whole of a CD and then say 10 song CD = $1/song? Thoug in reality I think that those other songs MUST have some value since few people would pay $10 for a CD containing only 2-3 songs! So if nothing else those other 7-8 'worthless' songs are actually quite valuable ON A CD.... as bait to get the consumer to part with their money! In a digital 'single' model the truth about which songs people are really paying for on a CD is revealed by how many songs off that CD are actually bought!
  
  WOULD the market support $1.50/song? Would it support $2/song? I don't know and no one else does either because it's never been allowed that the markets rule the price. All I know is what I would or would not pay for a DRM infested (or non DRM infested) downloadable compressed (or uncompressed) song that I am interested in. Would I pay more for some songs? Probably. Would I buy songs I am not buying now if they were cheaper? Probably.
  
  But the problem is that the music labels have NEVER really let the market set the price of it's products! They decide what a new CD will cost. Over time (sometimes a LOT Of TIME!), as sales decrease, they reduce that price. But then they 'bottom out' and get stuck at $9.99 occasionly they get 'super saver' stickers pasted on them and they drop to $6.99. Yet, I remember when CD's FIRST came out how the talk was how much cheaper CD were to make then LP's and yet the prices NEVER were reduced to reflect that! Why? Because as a virtual monopoly they didn't have to!
  
  So unfortunately since we can't trust the labels to truly follow a pricing scheme that was set by the 'free market' we also cannot allow them to have this type of control on the music market!
  
  Perhaps a 'Demand and Demand' (since in digital distribution the word Supply in 'Supply and Demand' becomes virtually meaningless!) scheme needs to be contrived. Something that takes into account HOW MANY times a particular song is downloaded being part of the equation that determines the price paid for that song by the Music e-Stores. Another part of the equation would have to be whether it was a 'rental' (i.e subscription based) or a 'purchase' (self explanatory lol). This would also give the labels what they say they want....a differentiation between song pricing to reflect the 'true value' of a particular song. Of course this could also result in some songs not being paid for due to no downloads or only paid a few pennies if downloaded only a few times....
  
  
  Hmmm... is it me or am I really this freaking brilliant?? lmao
  
  
  ;-)

  21.1.2006 22:34 #7

• duckNrun

  oops.... my edit button is gone from my posts again so sorry for the typos... and the length (lol).
  
  I must have thought I was WRITING the article not just responding to it (haha)
  
  

  21.1.2006 22:37 #8

• freshguy

  Quote:"Seller-side MFNs are inherently price-increasing and anticompetitive," says Jonathan Potter, executive director of the Digital Media Association.One fundamental problem I have with the way these deals involving the record label slicksters usually play out is that they always seem to be able to pull a clause or a paragraph out of God knows where to turn the tables in their favor.
  If I'm late for work one morning, and decide that I am going to drive 100 mph to avoid being any later than possible, then I most likely would (and should) be heavily fined for the possible harm that I could easily inflict on other drivers. What has this to do with the the business world as I am breaking laws with my hypothetical roguish behavior?
  Only this. The business world has existed and even thrived on one fundamental principle, or law, if you will, that being the law of supply and demand. If the record labels are not only allowed immunity from this basic law, but also are able to smoke their tires as they go flying down the economic boulevard in their MFN vehicles, then we, the consumer, are put into potential economic peril. When companies insist on operating in a manner that is directly counter to the law of supply and demand then it can have the consequence of creating another crack in the foundation of the world economy. To increase the price of an item when said item is decreased in demand is clearly unnatural. At best, it is an example of anticompetitive consumer-hostile behavior and blatantly in the vein of supply-side economics, which IMHO has shown to be beneficial mainly to a privileged few at the expense of everyone else.
  

  22.1.2006 00:24 #9

• duckNrun

  freshguy, no offense but I think you misread the article or mistyped your reply. You said "to increase the price of an item when said item is decreased in demand..." but that is not what is taking place. The cost to the music service would be raised ONLY IF they agreed to pay another label a higher price than they agreed to pay the label who has the MUTAULLY AND CONTRACTUALLY AGREED UPON MFN status. Also adding another label's music to their offerings has no reflection on the demand of the previous label's offerings, though it could possibly hint at a higher demand and lesser supply of the label's music with whom they agreed to pay more to. Though I would tend to believe that any higher price agreed upon would more likely be caused by the second label saying "take it or leave it" to the music e-store.
  
  
  Secondly, this quote is from: http://www.investopedia.com/university/economics/economics3.asp
  
  
  "Imagine that a special edition CD of your favorite band is released for $20. Because the record company's previous analysis showed that consumers will not demand CDs at a price higher than $20, only ten CDs were released because the opportunity cost is too high for suppliers to produce more. If, however, the ten CDs are demanded by 20 people, the price will subsequently rise because, according to the demand relationship, as demand increases, so does the price. Consequently, the rise in price should prompt more CDs to be supplied as the supply relationship shows that the higher the price, the higher the quantity supplied.
  
  If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed up because the supply more than accommodates demand. In fact after the 20 consumers have been satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers attempt to sell the remaining ten CDs. The lower price will then make the CD more available to people who had previously decided that the opportunity cost of buying the CD at $20 was too high."
  
  
  
  The problem is that DIGITAL has turned the world of supply and demand upsidedown! Based upon economic principles (simplified above) an infinitely high supply of a product (an mp3 download) causes an infinitely low price for that product. How does one address the supply side of online/digital music? I'm not talking about piracy or it's combatant DRM. I'm simply talking about an endless supply of a product with a limited demand.
  
  From the above quoted example, what if instead of those 30 CD's we changed the number to a MILLION? Or in terms of digital... those 30 CD were were changed to Infinite?
  
  
  Increased demand eventually causes decreasing prices because the higher demand (while th esupply remains the same) causes an increase in prices (you can see this when there is a 'rush' on bottled water before a hurricane). This spurs manufacturers to increase the supply so that they can make more money. And as supply increases to meet this demand prices eventually decrease but ONLY once the supply catches up to the demand and then exceeds that demand. Until manufacturers can increase production to meet the current level of demand the price could continue to rise. If an increasing supply was able to be stopped at exactly the amount of demand then the price would remain fixed at that point. This would happen since there would neither be excess or shortage, this is termed equilibrium.
  
  However, once iTunes or Rhapsody (etc) have placed a song into it's server that ONE FILE can meet the demand of everyone who visits that site, effectively destroying the see-saw balancing act of Supply/Demand that normally sets and adjusts pricing. A thing, again, that the labels are immune from due to a CD never being able to have true competition except from different CD's which isn't really competition at all because if you still want 'Shakira: Oral Fixation' there is ONLY 1 label you can go buy it from.....
  
  

  22.1.2006 01:35 #10

• freshguy

  Hi duckNrun,
  Of course no offense taken. I may have oversimplified the MFN concept. It's a practice that I am unfamiliar with. It seems to be a bit like blackmail, or the practice of paying a local association a protection fee to make sure that your business doesn't somehow burn to the ground overnight while you are asleep. However, don't think that I am too happy with the retailers by agreeing to this practice. I am fairly certain that whatever amount of artificial overhead this MFN clause adds to the final pricetag, the bottom line is that extra cash to pay will be coming out of my MF'n pocket.
  In regard to the supply and demand issue, I interpreted it as a situation in which a new, previously unavailable source came into the picture. (That could be a wrong assumption on my part as this source may have been available all along.) It seemed to be not a far stretch to believe that this source was bringing to the table either a larger quantity and/or a better quality of this product in order to justify the increased price being paid in reference to the source with the MFN status. You can probably see where I am going with this. I drew the inference that all other factors remaining the same that at least indirectly the demand would be decreased. I say indirectly because I'm not exactly sure if, technically speaking, demand is inversely proportional to supply. As you can see, I did not major in economics. (Actually I never had to take a course in economics as I went to DeVry Tech.)
  
  BTW duckNrun, I didn't recall you having such a high average of words per post. No one can accuse you of just trying to pad your post count. You've written a really nice book here this morning. - LOL - I used to feel like I had just written an essay on at least half of my posts. (I kind of layed-low during the holidays.) It's nice to see that someone has me beat.
  {:-D)
  

  22.1.2006 04:19 #11

• duckNrun

  to quote elvis:
  
  thank you...thank you very much...
  
  lol. And I agree about whose, as you so elegantly put it, MF'n pockets these increaes will come from!
  
  :-)

  22.1.2006 14:03 #12