How Much to Charge for Movie Downloads

In 2012, digital movies overtook their hard-copy counterparts in rentals and sales for the first time—and are on course to account for two-thirds of all films purchased by 2016, according to IHS Screen Digest Research. Downloadable movies are more convenient for many consumers than DVDs, and more immediate, thanks to online vendors such as Apple and Amazon.

Yet movie studios have been slow to capitalize, and it’s costing them potential viewers and profits. Assistant Professor Anita Rao evaluates some possible pricing strategies.

Plenty of research suggests that the most profitable way of pricing a durable good such as a car or refrigerator is to charge a single, sustained price, and to maintain that price over time. That notion applies to digital goods too, says Rao, and her research confirms that demonstrating the same kind of commitment to stable prices for movies has the potential to be very rewarding: her study shows that it can boost profitability by as much as 42%.

Even while maintaining a fixed price, a studio could implement different strategies, Rao says. First, it could sell the movie to people eager to watch it multiple times and promote rentals to people more likely to watch it only once. Second, it could try to sell the movie to everyone, eschewing rentals. And third, it could focus on selling to only the most profitable types of consumers. Rao empirically finds that the best strategy is to set a low price and try to get everyone to buy the movie.

Rao acknowledges that studios are likely to push for pricing flexibility and resist committing to a long-term price. In those instances, she says, it makes sense to offer sales and rentals. But what pricing options should those vendors use, and over what time period?

To find out, Rao conducted a nationwide study, between December 2010 and February 2011, in which she asked respondents to choose whether they would rent, buy, or postpone watching one of four digitally downloadable films based on specific pricing options. The movies had yet to be released for either sale or rental. She measured how eager respondents were to see the films by varying the current and future prices charged for these movies, and tracking at what price level people decided to postpone their movie watching.

By offering consumers options with different degrees of durability (purchase and rental), Rao was able to infer customers’ future preferences, a key element in determining profit-maximizing flexible-pricing models. Although “buying and renting have identical values in the current period, they have very different implications for the future,” Rao observes.

The research suggests that studios with information about these consumer preferences could use it to design better pricing strategies. When vendors set the initial purchase price of a movie high, only to drop it incrementally following the film’s release date, they want the lower price to appeal to low-valuation customers.

A vendor may find that some high-valuation viewers who are less eager to see a new release are willing to wait for the price-drop, so long as it doesn’t feel too far in the future. The overall result is a decline in profitability. Rao calculates that if all consumers were similarly willing to wait to see a new release, this would result in a 22% decrease in profitability.

She concludes that studios should move quickly, by including a lower-priced option early on, to monetize consumers’ eagerness to see a new film, before that eagerness fades.

By the same token, Rao recommends offering a rental option for newly released movies—rather than delay the rental offering, which was common practice from 2008 to 2010. Vendors can’t gain in purchases what they lose from the lack of rental sales, and by foregoing rentals, they risk losing consumers who will only see a movie soon after its release and are unlikely to watch it after that. Eschewing rentals causes studio profitability to fall by 6%.