Mental accounting costs and the eMusic model

4 minute read

Reading a post by Clay Shirkey concerning Scott McCloud’s abandoning the use of micropayments, I (re)discovered a 10-year-old article by Nick Szabo on mental accounting costs (a topic I touched on briefly in my previous post). It’s a bit dense, but the key paragraph is worth quoting:

The function of prices, from the point of view of a shopper, is to let the shopper map his personal resources (budget) to his personal values (unique and not directly observable). This mental process requires comparison of the purchase price of a good to its personal value. This entails a significant mental cost, which sets the most basic lower bounds on transaction costs. For example, comparing the personal value of a large, diverse set of low-priced goods might require a mental expenditure greater than the prices of those goods (where mental expenditure may be measurable as the opportunity costs of not engaging in mental labor for wages, or of not shopping for a fewer number of more comparable goods with lower mental accounting costs). In this case it makes sense to put the goods together into bundles with a higher price and an initutive [sic] synergy, until the mental accounting costs of shoppers are sufficiently low.

For large, diverse set of low-priced goods read the millions of tracks available on eMusic (or for that matter the iTunes Store, or any other digital music service with a large catalog). In the eMusic context the mental accounting issue shows up at two levels.

First, a customer must make a decision to actually purchase something. If eMusic were a pure a la carte service offering only individual tracks for sale then this decision would be made on a track by track basis: Is it worth my spending 25 cents on track 4 of album X vs. track 7 of album Y vs. track 2 of album Z (and so on, ad infinitum)? As Szabo notes, making such decisions almost certainly requires mental expenditure greater than the prices of those goods. For example, assume that a customer makes $6.00/hour (not much above the US Federal minimum wage). If it takes the customer more than 2.5 minutes to decide whether to purchase a given track (including the time spent in searching for the track, listening to a 30-second preview, reading user reviews of the artist, etc.) then the cost of the mental expenditure is more than the cost of the track. For a customer making $60/hour (not unrealistic for eMusic given that its customer base skews older) the opportunity cost of selecting and purchasing tracks one by one is correspondingly higher: spending any more than 15 seconds per track on a purchase decision isn’t economically rational.

eMusic addresses this problem by in effect bundling multiple tracks into a subscription product priced high enough that mental accounting costs become less relevant: The prospective eMusic customer simply has to decide whether or not it sounds like a good deal to be able to download, e.g., 30 tracks per month for $9.99. Assuming that the customer’s musical tastes are roughly congruent with what eMusic has to offer, this is an easy decision to make.

The next level (at least in the eMusic case) is deciding what to download. (In a pure a la carte model the purchase decision and download decision are of course one and the same.) The problem of mental accounting costs occurs at this level as well, as any eMusic customer who has an extensive Save for Later list can testify. However at this point dealing with mental accounting costs is the customer’s problem, not eMusic’s, since eMusic already has the customer’s money. In fact, customer indecisiveness at this level works to eMusic’s advantage: If the customer can’t decide what to download (or doesn’t want to devote the mental time to decide, which amounts to the same thing) and as a consequence lets unused downloads expire, eMusic and its label partners end up getting more revenue on a per-track basis.

However as I’ve previously commented, eMusic has at least some interest in relieving customers of this mental burden. The primary mechanism to do this is to provide the option to download an entire album at once, so the mental decision to download or not takes place at the level of the album and not at the level of the track. This is especially important for the types of music eMusic sells: Everybody knows what the hot single is on Justin Timberlake’s new album, but a customer would have to be pretty dedicated to know exactly which tracks are worth downloading from, e.g., Of Montreal’s latest. I don’t recall David Pakman or anyone else at eMusic ever providing hard data on this, but I wouldn’t be surprised if the ratio of whole album downloads to partial album downloads on eMusic is much higher than it is at the iTunes Store or similar mainstream digital music stores.

eMusic has other mechanisms to alleviate mental accounting costs for its customers. For example, the eMusic Dozens recommendations reduce the mental exertions of deciding which albums to download, while eMusic occasionally does the same thing for single tracks through a feature recommending end of the month downloads to use up one’s quota. As it happens, I couldn’t find an example of the latter feature on eMusic right now–which perhaps illustrates my point that eMusic’s concern for making it easier for its customers to decide which music to download has to be balanced against its business interest in not having them make full use of their subscriptions.

Anyway, back to the original article I referenced: Szabo also has some interesting ideas on how to reduce mental accounting costs in the context of online commerce, and if I have some time at a later date I’ll try to revisit his proposals and give my opinions on them.