Yes Virgina, There Is A Cost Disease

Over on the Marginal Revolution blog, Tyler Cowen opines that the arts are not impacted by Baumol’s cost disease.

2. I do not see the arts as subject to the cost disease very much at all. As for the “live performing arts,” the disease seems to afflict the older and less innovative sectors, such as opera and the symphony. There is plenty of live music these days, it is offered in innovative ways, and much of it is free.

I was a little confused by this point since all it really proves is that people aren’t charging for live music and doesn’t really address that there are costs involved with the performance.

Admittedly, he does seem to imply that innovation in the way the artistic product is offered makes all the difference. Back in June, I noted that Jon Silpayamanant made the point that there are alternative ways to make money when offering an experience.

Cowen goes on to say, (my emphasis)

“4. In many sectors of the arts, especially music, consumers demand constant turnover of product. Old music becomes “obsolete” — for whatever sociological reasons — and in this sense the sector is creating lots of new value every year. From an “objectivist” point of view they are still strumming guitars with the same speed, but from a subjectivist point of view — the relevant one for the economist – they are remarkably innovative all the time in the battle against obsolescence. A lot of the cost disease argument is actually an aesthetic objection that the art forms which have already peaked — such as Mozart — sometimes have a hard time holding their ground in terms of cost and innovation.”

I will grant him that some of the cost disease problems can be attributed to an adherence to aesthetic ideals rooted in the past and a resistance to innovation.

But I am not sure if consumers are truly demanding a constant turnover in product. There is reluctance to sample anything new and unfamiliar among consumers. This isn’t necessarily confined to symphony and opera where you might argue the new material is being presented to the wrong audiences (i.e. older existing audiences whose tastes are already set).

There is as much a sense of risk aversion among audience as among content creators. Broadway shows are often revivals or derivative of works that have already proven their success. Playwrights bemoan the fact that regardless of their proximity to Broadway, few theatres are producing new works.

The same is true with movies. The most well attended movies this summer were based on comic books. Even the plots of those stories had been revamped numerous times in the comics format. The plan for the adaptation of J.R.R. Tolkien’s The Hobbit went from two movies to three leaving fans to wonder, if the three books of the Lord of the Rings took three movies to tell, (albeit with much left out), how is the one book of The Hobbit going to be stretched to three?

A fair bit of emotion and nostalgia is responsible for perpetuating the conditions which contribute to Baumol’s cost disease. One of the points Cowen makes reinforces this:

“Live music” may seem like it doesn’t change much, but lifting the embargo on Cuba would boost the quantity and quality of my consumption of spectacular concert experiences, as would a non-stop flight to Haiti.

Opportunity rather than innovation is the only thing having any bearing on the quantity and quality of his consumption. It isn’t necessary for Cuban musicians to made any changes whatsoever since 1962 when the embargo began, they just need to be available.

There is an element of his aforementioned “aesthetic objection that the art forms…have already peaked” in this point as well. It is difficult to take an entirely objective view of a product or service possessing an artistic element.

If quality of product could be maintained by paring down performers and replacing them with technology, The White Stripes would have been a model everyone emulated. As interesting as the band’s work might have been, there wasn’t a rush to form duo performance groups.

It may be a difficult to define Platonic ideal, but there is a minimum one can offer before the perception of the experience suffers. Ultimately, because it is his area of expertise, I might find myself having to concede Cowen’s point in the face of a more detailed argument. But I think given that the resources necessary to provide the central experience remain generally constant, Baumol’s cost disease does indeed impact the arts significantly.

As for the solution, at this point I keep coming back to Jon Silpayamanant’s idea that ancillary elements surrounding the experience need to be developed in order to support it.

What Pricing Is Right?

Back in June the MIT Sloan Management Review had an article in pricing strategies. The bulk of the article discusses research on practices of companies that have sales forces that goes out to solicit business and has some degree of control over the pricing.

However, the research found some basic elements of price setting that are common regardless of industry and geography. (my emphasis)

1. Cost-based pricing. Here, pricing decisions are influenced primarily by accounting data, with the objective of getting a certain return on investment or a certain markup on costs. Typical examples of cost-based pricing approaches are cost-plus pricing, target return pricing, markup pricing or break-even pricing. The main weakness of cost-based pricing is that aspects related to demand (willingness to pay, price elasticity) and competition (competitive price levels) are ignored. The main advantage of this approach is that the data you need to set prices are usually easy to find.

To a certain extent, this is the pricing strategy used by many non-profit organizations–and their critics. I say it is used by critics of non-profits because one of the common refrains one hears is that if non-profits can’t make enough to support themselves, they should be left to fail rather than supported by government funding.

Non profits use this approach to determine what level of revenue they need to cover their costs in the context whatever other funding sources (donations/sponsors) exist. But as the authors say, it can ignore the level of demand that may exist potentially increasing the revenue stream if the price were set higher (or perhaps ignoring the lack of demand and setting the price too high.)

2. Competition-based pricing. This approach uses data on competitive price levels or on anticipated or observed actions of actual or potential competitors as a primary source to determine appropriate price levels. The main advantage of this approach is that the competitive situation is taken into account, and the main disadvantage is that aspects related to the demand function are again ignored. In addition, a strong competitive focus in setting prices can exacerbate the risk of a price war.

I am not aware of too many price wars among arts organizations, but it can be a mistake to taking your pricing cues from competitors. For one thing, just because you perceive your product to be of equal value to your competitor’s doesn’t mean your customers necessarily do.

3. Customer value-based pricing. This approach, which is also often called “value-based pricing,” uses data on the perceived customer value of the product as the main factor for determining the final selling price. Instead of asking, “How can we realize higher prices despite intense competition?” customer value-based pricing asks, “How can we create additional customer value and increase customer willingness to pay, despite intense competition?” The subjective and quantified value of a purchase offering to actual and potential customers is the primary driver in setting prices. Customer value-based pricing approaches are driven by a deep understanding of customer needs, of customer perceptions of value, of price elasticity and of customers’ willingness to pay.

The advantage of customer value-driven pricing approaches is their direct link to the needs of the one constituency paying for the respective goods or services: the customer. The big disadvantage of such approaches is that data on customer preferences, willingness to pay, price elasticity and size of different market segments are usually hard to find and interpret. Furthermore, customer value-based pricing approaches may lead to relatively high prices, especially for unique products. Though that may seem optimal in the short run, these pricing approaches may spur market entry by new entrants or create a risk-free zone for competitors offering comparable products at slightly lower prices. Finally, it is important to note that it is an error to assume that customers will immediately recognize and pay for a truly innovative and superior product. Marketers must educate customers and communicate superior value to customers before linking price to value. Customers must first recognize value in order to be willing to pay for value rather than base their purchase decision solely on price.

Despite these shortcomings, many pricing scholars consider customer value-based pricing to often be the most preferable way to set new product prices or to adjust prices for existing products

Now I don’t have any real evidence that non-profit arts organizations use customer values as the basis of their pricing decisions, but damned if the language the authors use doesn’t match the language being used in discussions of arts management issues: increasing value and customer willingness to pay for it; the necessity of understanding needs of customers/community; high prices for unique products (unique at least from the NP org point of view); audiences not recognizing truly innovative and superior product; need to educate customers/community about the superior value of the artistic product.

Factor in movies/internet/video games as competitors offering what is perceived to be comparable product with lower monetary/social/time, etc. costs and it sounds like they are describing a the situation facing the non-profit arts and culture industries.

Except that these factors are rarely connected with discussions of pricing for non profit arts organizations. While creating the perception of value in audiences does often enter the discussion, I don’t know that it is necessarily accompanied with a “deep understanding of the customer needs, of customer perceptions of value, of price elasticity and of customers’ willingness to pay,” but rather with hopes and assumptions. How many pricing decisions arts and cultural organizations make every year are based on this understanding?

This may be due to lack of will as much as lack of funds to conduct the research necessary to achieve the deep understanding. Since customer value-based pricing seems to be recognized as the best approach, perhaps research into the intrinsic value of the arts should include a greater focus on pricing to see how value and pricing are connected.

Though I am not sure if the knowledge will be of practical use to a significant number of organizations. The authors point out the information is difficult to gather and interpret. I imagine the results will probably be specific to an organization or geographic region.

Tweet Me Your Gift Now

Non-Profit Quarterly (NPQ) had a piece today encouraging people to pay attention to the fact that Chinese are using social media service Weibo to give directly to the needy. The NPQ piece is in reaction to a Washington Post article about how recent charity scandals had turned a lot of Chinese off from giving to the state approved charities. Now people are using services like Weibo (China’s Twitter/Facebook hybrid social media service) to give to people directly, even though it is illegal to do so.

The scandals have shaken public confidence so badly that the Chronicle of Philanthropy reported in June that giving in 2011 was down to $7.9 billion from $9.5 billion in 2010. The Chronicle’s numbers come from a story on the state run China Daily which attributed the drop to a number of factors in addition to the scandals, including the economic downturn and general giving practices in China.

“In China, people’s willingness to give is ‘disaster-driven’ while in the US, donating is a habit.”

He added that the Chinese philanthropic sector’s over dependency on corporations could be another possible explanation to understand the dramatic changes in donations.

“Our research shows that companies, especially private companies, are dominant contributors. Last year, many export companies suffered from the global economic downturn, so they didn’t have much money to donate,” said Deng.”

What interested most about these stories wasn’t so much that people are using social media to give. We already know that is becoming a bigger factor in giving in the U.S. and recent laws are making it easier to crowd fund projects.

What I was paying attention to was that people were giving via social media even though they acknowledged that it is no more transparent and just as ripe for exploitation as giving to an official charity. In fact, some Chinese observed that personality and good looks seemed to motivate giving more than need in a few cases.

There seemed to be a psychological factor inherent to giving to someone directly that gave people a higher degree of confidence in the act of donating.

The US doesn’t have scandals the size of those in China, but there is still a lot of conversation about administrative overhead and Non Profit CEO salaries. Even though these criteria are generally unfair, they can still motivate giving decisions.

There is an old adage that people don’t give to organizations, they give to people. Based on these stories about China and some general observations I have had about the way people generally behave in the US, non profit arts organizations may find they need to provide giving mechanisms that give people a much more immediate sense of connection and response than in the past.

In addition to the ability to give online, an arts organization may need to allow people to give via their smartphones so that patrons can donate during a performance and immediately gain the sense that they are supporting that actor/singer/dancer that just came onstage. If the person walks off stage before they can give, it may be too late.

Two years ago during a public radio fund drive I was so moved by the quality of the show I was listening to, I pulled over into a parking lot to make my pledge because the show was almost over and I felt like I needed to make my pledge before it ended. There wasn’t really any reason not to wait until I got home because the money was going to the station and not the show directly and I already knew I was going to give again that year—But I just had to show my support for that show!

As people become accustomed to giving to things like Kickstarter projects, non profit arts organizations may find themselves having to solicit donations specifically for each project they plan to do rather than based on a general promise to do quality work as has been typical.

Arts organizations may be faced with the dilemma of positioning their programs this way. Restricted donations have always been a problem for non-profits. Do you want to be faced with having every $25 donation restricted to a specific project because people are more motivated to give to something to which they feel a direct connection?

You might as well have a for-profit structure if you are going to have market demand dictate what is funded, eh?

Info You Can Use: If You Missed Your Chance To Steal It Before

While Oscar Wilde may have said, “Good writers borrow, great writers steal,” and blogging by its nature does involve citing others quite a bit, I generally try to avoid having my blog entries involve someone else’s work entirely.

However, occasionally someone provides information that can prove so valuable, it pretty much bears repeating entirely. Last month Thomas Cott assembled a series of links in his daily email which he titled, Steal This Idea.

Many of those he linked to posted entries urging people to steal their ideas, including Trisha Mead on 2AMt , the Association of College Unions International’s Steal This Idea contest and the Please Steal This Idea blog.

After reading this series of articles, you could almost forget that companies are actually concerned about preserving their Intellectual Property rights.

There are a lot of great ideas for the arts in these links. I must confess however that one which resonated very closely with me was an article from the Library Journal (also titled Steal This Idea) which talked about how the Hartford Public Library solicited ideas from their patrons and created a series of library cards people could pick and choose from.

This is a great idea for cultivating a sense of ownership among arts patrons and subscribers. However, the reason it resonated so closely with me is because I actually have kept every library card I have owned since I was a kid. And since I have moved around a fair bit in my career, my collection is between 10-15. Had those libraries offered a choice of more personalized cards, I would have probably “lost” my card frequently so I could add to my collection.

One interesting idea that Cott hadn’t included was covered by Sarah Lutman of the Speaker blog. She discussed the Great River Shakespeare Festival’s (GRSF) decision to sell 10 year bonds to fund their organization. The board of directors authorized the sale of 100 bonds at $5000 each. As of a month ago, they had sold 39.

Though there is some hope that at the end of the 10 year period, people will roll over or donate the proceeds of the bond to the organization rather than calling it due, GRSF is prepared to pay 4% annually on the bond. And they may choose to repay the bond at the end of the term rather than having it roll over. Ownership of the bond can be transferred.

The legal and filing fees for Minnesota were under $2000. It may be more in your state. It is an interesting idea to get people literally invested in your organization. There is some precedent for this sort of thing. The Green Bay Packers football team is a non-profit corporation and has famously offered stock to support their operations.

Fans grab shares when they are made available mostly for the pride of claiming ownership because the team doesn’t pay dividends. How much better is it then to be able to proudly invest in your favorite arts organization and actually be promised a financial return on top of whatever benefit the organization has to the community.