In this blog I will evaluate how Spotify uses both second and third degree price discrimination.

Versioning is the provision of two different versions of a product to target different consumer segments. This is a form of second degree price discrimination where consumers self-select themselves into a product instead of the firm that segments consumers. A benefit of versioning is that firms don’t need to know consumers characteristics precisely. Spotify implements this type of price discrimination by offering a premium version next to a free version. Users can listen offline to music without having to listen to adds after every 30 minutes with a premium account. Shapiro & Varian (1998) argue that firms can best apply versioning by offering three types of their product as consumers are extremeness averse. This bias is ignored in the two-version strategy (ibid.), as it might cause people to not chose any of the two. As Shapiro & Varian (1998) argue that having three versions increases the likelihood of consumers buying the middle option, wouldn’t it be better for Spotify to implement this pricing strategy? Next to versioning, Spotify also applies third degree price discrimination. They have four different prices for its premium product, that is similar in each different abonnement. Spotify Premium is normally offered for €9.99 per month. Students, users that have to prove they are registered at a university, pay €4.99 to use Spotify Premium for one month. People living together are offered the opportunity to create an account for €12.99 per month (hence, they pay €6.45 per person). Lastly, Spotify offers a family abonnement that costs €14.99 per month. This family abonnement can be used by 6 people. Hence, the price per person is €2.50. The condition here is similar to the Duo abonnement: people have to live at the same address. As mentioned, the product is similar for each abonnement: having a Spotify Premium account. Students living together with at least 3 other people are better off when taking a family abonnement. Since many students meet this condition its family offer isn’t only targeting families and its student offer is actually only targeting students living with at most 2 others. Hence, should Spotify also revise its third degree price discrimination strategy as well? Next to this, as Spotify can’t accurately control whether people actually live at the same place, is this pricing strategy viable at all? Couldn’t they better differentiate the market in another way?

References:

Keuzehulp: Zo vind je het beste Spotify-abonnement voor jou

Shapiro, C., & Varian, H. R. (1998). Versioning: the smart way to. Harvard business review, 107(6), 107.

The music industry is disrupted by the introduction of Spotify. Before the introduction of Spotify, people that wanted to listen to music went to the store to buy a CD. In most stores, only the most popular artists were available. When preferring a relatively small music group, consumers had to put a lot of effort in finding the album of that group. With the introduction of Spotify it became extremely easy to find any music group. The effort for finding almost any group dropped dramatically. This was especially beneficial for the customers that want to listen to relatively unknown artists. Also, as it was possible to listen to only one song of an album and then listen to a completely different song. According to monotonicity, “more is better”; having more choices increase the likelihood that you find the product that perfectly suits your needs. Hence, having a wider choice of songs to listen to should improve the utility of customers.

However, this wide choice could also have a negative impact on customers utility as the cognitive costs increase. Customers might have a hard time choosing a song and feel regret for not listening to other songs. Iyengar and Lepper (2000) investigated the effect of choice sets by presenting either 6 or 24 different types of jam. They found that that large choice set attracted more customers while the smaller choice set increased the likelihood with 11 percentage points for people to purchase a product (ibid.). This finding indicates that the wide choice of songs to listen to actually lowers customers’ utility.

An important question to ask is: For customers, is it better if companies follow a long-tail strategy or when giving customers a limited choice set? This might differ across industries and how products are offered. In the experiment from Iyengar and Lepper (2000), the choice for customers is directly visible while in the case of Spotfiy, users might not know the amount of choices offered to them. This might reduce the cognitive effort for customers when choosing the song they want to play, especially because Spotify gives recommendations to its users. Next to this, the costs of choosing a song are much lower than choosing to buy Jam. Therefore, the opportunity costs are lower. Also, because customers themselves chose to use Spotify instead of buying CDs at a store is also a suggestion that, Spotify’s long-tail strategy is better for consumers.

To conclude, a long-tail strategy seems to be beneficial for the demand side when the choice set is not directly shown to customers and when the opportunity costs are relatively low. With the introduction of the internet it is easier for companies to have a wide product range. This can be offered to customers, for example with a recommendation system, in such a way that it does not disproportionally increase their cognitive costs. Also, the combination of changing the pricing scheme (monthly fee instead of paying per product) and unbundling made it possible that the opportunity costs are limited nowadays.

References:

https://neilpatel.com/blog/too-many-choices/

Iyengar, S. S., & Lepper, M. R. (2000). When choice is demotivating: Can one desire too much of a good thing?. Journal of personality and social psychology, 79(6), 995.