An Economic Analysis of Online Streaming: How the Music Industry Can Generate Revenues from Cloud Computing

Music can be characterized as an information good and is therefore amenable to digitalization and copying through online sharing networks. Chances and risks arise from digitalization for the producers and right owners of these goods. Digital piracy is accountable for massive losses in revenues of the music industry which is induced to search for new sources of income in the era of digitalization. This work intends to provide a theoretical analysis of a business model which offers the requested music as a so called stream to potential customers. The origin of such model is a conception which allows for consumption of music without physical possession of the music file. Therefore music will be stored on a server and can be listened on demand by consumers. Such a business model is generally funded through two sources. On the one hand, customers who made a subscription are allowed for legal free of charge listening. Funds are generated through commercial breaks between the particular songs (analogous to free TV). On the other hand, ’flat-rate contracts’ are offered to customers allowing for unlimited and ad-free access to the musical content after the payment of a monthly blanket fee. Within the framework of such a business model and under consideration of a monopolistic market structure, the investigation yields the following results. Advertising funding may generate high revenues provided that customers feel lowly disturbed by commercial breaks. In this case, it will be optimal for the provider to chose a high ’flat-rate price’ in order to factitiously excite free of charge demand and therefore to capture higher, advertising created rents at customers’ costs. If consumers are given the alternative to illegally share music through ’peer-to-peer file sharing networks’, one can investigate that prosecution for illegal file-sharing appears as a rent allocation mechanism between the monopolist and music consumers. At this juncture, an increasing law enforcement causes a decreasing consumer surplus. However, an intensified legal prosecution does not necessarily lower welfare. On the contrary, from a certain level of legal prosecution, sharply increasing equilibrium profits of the monopolist offset and overcompensate decreasing consumer surplus and let welfare increase.

Thomes, Tim Paul (2011), An Economic Analysis of Online Streaming: How the Music Industry Can Generate Revenues from Cloud Computing, ZEW Discussion Paper No. 11-039, Mannheim.