The iPod: RAZRs and Blades 2.0 and 3.0

Lots of related news stories this week; such is the nature of business coevolution.

Take this group of stories. Monday the Wall Street Journal had a front-page story (paywall I assume) on podcasts, not by the blog forward wave but instead by ABC News and Clear Channel. The same day, the New York Times ran a story on efforts by the Japanese music industry to impose a content tax on iPod sales in Japan. This would be a royalty tax, and the revenues would be distributed among the participants in the music industry.

On Wednesday, Apple introduced a new iPod for video (stories here and here). That same day, Apple reported that its quarterly profit had quadrupled. And on Thursday, the Wall Street Journal ran two stories (here and here) about how Comcast was altering its strategy, including teaming up with Google to buy a piece of AOL.

What is going on? The answer is the ever-changing role of RAZRs and Blades. Well, not really RAZRs and Blades but razors and blades.

I am not interested in the hot Motorola RAZR cellphone—I can’t get excited about cellphones—and I am not talking about blade servers (no one save for network administrators gets excited by those).

I am instead talking about razors and blades. Gillette used to give away razors to sell blades. H&P and Dell and others basically give away printers to sell toner cartridges. This is a common business strategy, and can give rise to a variety of contract, antitrust and copyright issues (see the recent 9^th Circuit Lexmark case, and if you are really a glutton for punishment, my recently published paper). (The paper is a chapter in a new book on U.S. and EU perspectives on antitrust, patent and copyright; I haven’t seen the book yet, but it should be good.)

With the iPod and iTunes, Apple seems to have inverted the strategy, giving us Razors and Blades 2.0. Apple is making a bunch of money off of the iPod; I am not sure if Apple is making real money off of iTunes, but given that Apple isn’t really in the music business, it wouldn’t be at all surprising if Apple is working hard to keep iTunes prices low, all the better to drive sales of the iPod.

Give away the blades and sell the razor. Apple’s contracts at iTunes will expire and content creators are pushing to raise prices. The content guys aren’t making money on iPod sales—absent the content tax of the sort being pushed in Japan—and are willing to sacrifice iPod sales by raising iTunes prices.

But that takes us to R&B 3.0 (no B.B. King here, we are still doing business strategy) and the introduction of the video iPod. The full-page ads in today’s newspapers for the new iPod show six uses, including one for playing TV shows. You can now go to iTunes and buy current ABC television shows—including Lost and Desperate Housewives—for $1.99 the day after the show has broadcast.

This is what the TV guys are calling cable bypass. Cable jumped in as an intermediary between broadcast TV and their customers, and broadcasters have struggled with that ever since. The 1992 cable act made an important change in the rights that broadcasters have to control their TV signals in creating retransmission consent rights. Those rights have changed the shape of what we see on cable by bringing more channels affiliated with networks to the cable wires (you want Fox, says Fox, you have to take FX).

But retransmission consent hasn’t created cash payments by the cable operators to the networks, the desired second-stream of cash from the content (advertising being the first and dominant stream). Putting TV shows on DVD has started to monetize the TV shows, and online distribution on iTunes is a natural next step.

The point to note is that while the music industry has moved online kicking and screaming, and we still have the conflict between Apple and the music industry given how R&B 2.0 has operated. We seem to have much less of a conflict for video and R&B 3.0: Apple will want to sell video iPods, and broadcast TV may be happy to jump in and help, especially if they can push cable to the side in doing that.

Comments

[Doug Lichtman]

Randy -

Do you think the FCC should get involved in this? Back when cable was first rolling out, regulators worried that cable would erode viewership of and support for broadcast television. Thus, much of early cable regulation was designed to preserve a robust broadcast market, and indeed today we still have a lot of law that can only be explained as a life jacket for advertiser-supported broadcast tv.

If television shows start being sold a la carte, won't some of the best shows defect from broadcast, earning more money by selling each episode directly to consumers? Is that progress, or something to worry about? (As you likely know, back in the early days of cable, Congress passed a law that in essence forbid the NFL from putting the Super Bowl on pay-per-view; should we similarly preserve them there Desparate Homemakers?)

[Gus]

Prof. Picker,

Ahh, now this blog thing makes more sense. It is to papers and books as the razor is to the blade.

But more seriously. I have often wondered about the differences in the use of price discrimination between the movie and recording industries; this seems to fit the broadcast industry into that rubric. The movie industry uses tiered release schedules and formats to capture as much producer surplus as possible (releasing first to select theaters, then general domestic, then foreign, then PPV, then DVD, then broadcast). That is, from narrow expensive releases to broad inexpensive releases. The recording industry uses a somewhat opposite model (releasing to radio broadcast first, then to album, then to concerts); though their model might be better described as flat, releasing in every format in no particular order.

This move brings ABC firmly into the price discrimination rubric. They now have three release formats (broadcast, iPod, DVD), each with a different schedule and each meant to capture a different piece of the market pie. (It is particularly interesting to note that their shows are being released to DVD shortly at the close of the previous season, which suggests that DVD production is being undertaken as part of the initial production process; that is, it must be lucrative). But I am not sure how these releases relate to either other industry. For instance, for broadcast, the broadest/cheapest release is the first, the initial broadcast; but unlike movies (which follows the opposite model) and radio, the consumer is locked into a particular time slot to consume this release format. In fact, I see ABC and Apple's move as competing most directly with TiVO.

And given this last comment, and your comment about Apple's iTunes profits, I am drawn to ask whether Apple is becoming a media arbitrageur of sorts? They are, arguably, creating new, lower priced consumption markets and selling on the different prices between the new and the old. It just happens that they are also making a killing through the creation of the new market, too.

Any thoughts? Do you think that these considerations have factored into ABC's decision? Or is this more a technological inertia based development? And, perhaps of most import, could the differences between the price discrimination models used by the movie, radio, and now broadcast, industries shed some light on each industry's reception of Apple, and of technology generally?

--Gus

[slevmore]

Most examples of Razors & Blades involve exclusivity; the blades only fit that company's razor (or the other way around). The railroad builds lodges in the national parks, but most Americans can get there only by rail. Where there is no such link, there is less vertical integration, isn't there? Dell assembles computers, but it does not get in the business of software, and EA does not sell computers. Apple is not the only example of advanced R&B where the blades/music/video can be used with other hardware, but maybe there is something more to it?

[Bill Sjostrom]

One big difference between Apple's razors and blades as compared to Gillette's is that Apple's razors wear out but its blades do not. The opposite is true for Gillette. I'm on my third iPod in five years because the battery lasts for only two years and Apple charges $100 to replace it. Instead of paying the $100 I've concluded it makes more sense to put it towards the latest iPod. As for Gillette, I've used the same Sensor razor for at least 10 years (incidentally, Target now sells private-label blades for the sensor at a quarter of the price for the real things).

Various companies have introduced products competing with the iPod, but I have not even considered them. This is because I've spent hundreds of dollars and a lot of time on assembling a collection of iPod blades (which are still as good as the day I bought them), and these blades do not work in the competing products. Hence, unless I'm willing to scrap a large portion of my music collection to switch to a different player, I'm locked into buying iPods indefinitely. Feels like monopoly power to me. Someone has brought a suit. See http://www.out-law.com/page-6154.

[Royalty Free Beats For One Dollar]

Royalty Free Beats For One Dollar

At

http://upbeat.tk