Spotify has artists playing chicken, but they can fight back if they can cooperate

The New Zealand Herald reported today:

Spotify has recently faced backlash over its newly-implemented Discovery Mode program.

The initiative, which gives artists greater exposure on the platform in exchange for a lower royalty rate, was announced during the company’s Stream On event in March 2021 and has continued to be criticised all the way up to its 2023 launch.

Under Discovery Mode, artists or their teams can submit tracks for consideration to be included on Spotify’s radio and autoplay features. In exchange for this greater algorithmic exposure, they agree to receive a lower royalty rate for streams of their music.

For some, it’s an inventive new way to link potential fans to new music, but others in the industry believe it to be yet another way to shave the pay cheque of hardworking musicians whose work is the lifeblood of an app that rakes in billions of dollars each year.

This is a smart ploy by Spotify. As noted by DJ Luca Lush on Twitter:

Ideally for spotify, EVERYONE opts in, they take 30% more revenue & no one gets more plays

It's not clear that every artist would opt into Discovery Mode though. To see why, consider the decision as part of a simultaneous game, played by some artist (Artist A) and all other artists. The game is laid out in the payoff table below, with the payoffs measured as a percentage of the 'normal' level of royalties. If all artists (including Artist A) choose no Discovery Mode, then they all continue to receive the normal level of royalties. If all artists (including Artist A) choose Discovery Mode, then they all lose 30 percent of their income (as Luca Lush noted). However, if Artist A chooses Discovery Mode and all others do not, Artist A benefits greatly (let's say that their royalties go up by 50 percent - in the New Zealand Herald article, Spotify says that "artists have seen an average 50 per cent increase in saves" when participating in Discovery Mode), and other artists are negatively affected, but only slightly (because even when Artist A's Spotify streams increase a lot, that doesn't much reduce every other artist's streams). On the other hand, if Artist A chooses not to participate in Discovery Mode and all other artists do, it is the other artists that benefit greatly, and Artist A is made worse off. [*]

To find the Nash equilibrium in this game, we use the 'best response method'. To do this, we track: for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the definition of Nash equilibrium). In this game, the best responses are:

1. If Artist A chooses not to participate in Discovery Mode, the other artists' best response is to participate in Discovery Mode (since a payoff of 150 is better than a payoff of 100) [we track the best responses with ticks, and not-best-responses with crosses; Note: I'm also tracking which payoffs I am comparing with numbers corresponding to the numbers in this list];
2. If Artist A chooses to participate in Discovery Mode, the other artists' best response is not to participate in Discovery Mode (since a payoff of 99 is better than a payoff of 70);
3. If the other artists choose not to participate in Discovery Mode, Artist A's best response is to participate in Discovery Mode (since a payoff of 150 is better than a payoff of 100); and
4. If the other artists choose to participate in Discovery Mode, Artist A's best response is not to participate in Discovery Mode (since a payoff of 95 is better than a payoff of 70).

Notice that there are two Nash equilibriums in this game - where Artist A chooses to participate in Discovery Mode, and every other artist does not, and where Artist A chooses not to participate in Discovery Mode, and every other artist does.

We could repeat this exercise for any number of additional artists, rather than Artist A. We would come out with the same outcome. We could even try this as a multi-player game. We would find something similar. The artists are all better off if they can participate in Discovery Mode, but not too many of the other artists do so. Every artist would want to be participating in Discovery Mode. However, if all (or a large proportion) of them choose to participate in Discovery Mode, then every participant is made worse off. This is an example of the game of chicken. Two drivers driving towards each other can choose to speed ahead, or swerve out of the way. Both prefer to speed ahead, because they are trying to win the game of chicken. However, if they both follow that strategy, it all ends in a fiery crash (for a more complete explanation, see this post).

Usually, in the game of chicken, a player can get the outcome that they prefer if they can make a credible commitment to their strategy. In the classic game of chicken, a driver could commit to speeding ahead by disabling their brakes and throwing the steering wheel out the window. That is a pretty showy way of demonstrating that the driver won't change their strategy of speeding ahead.

However, in the game that Spotify has set up, there are too many players for a credible commitment to scare others off. Most artists will instead be thinking, 'I'm sure that one more artist choosing Discovery Mode isn't going to be the one that destroys the payoffs for everyone, so why shouldn't I?'. That's the sort of thinking that ends in a fiery crash, with all artists earning 30 percent lower royalties.

A cynic would interpret this as Spotify's strategy all along. They are profit maximising by steering the artists into a game of chicken that leads to all participating artists receiving lower royalties. However, the artists can fight back. This is a repeated game. In a repeated game, the players can cooperate in order to obtain a better outcome for them all. By cooperating, and choosing not to participate in Discovery Mode, the artists would be made better off collectively. This is essentially what the artists who have spoken out against Discovery Mode are trying to do. They are trying to coordinate a cooperative response that sees all artists boycotting Discovery Mode, which would be for the betterment of them all.

This sort of cooperative outcome is only possible if the artists can trust each other. There is an incentive for any artist to cheat on the agreement. That's because, if Artist A (or any other artist) knows for sure that the other artists will not participate in Discovery Mode, then Artist A can participate and make themselves better off. Once that starts to happen, the cooperative agreement can quickly break down.

The questions now are, will the artists be able to agree not to participate, and if they do, will they be able to maintain trust and cooperation?

*****

Another way of thinking about the payoffs in this game is to recognise that Artist A is probably made wildly worse off by every other artist opting into Discovery Mode. The game with these new payoffs is shown below.

The best responses for the other artists are unchanged. However, for Artist A, the best responses are now:

1. If the other artists choose not to participate in Discovery Mode, Artist A's best response is to participate in Discovery Mode (since a payoff of 150 is better than a payoff of 100);
2. If the other artists choose to participate in Discovery Mode, Artist A's best response is to participate in Discovery Mode (since a payoff of 70 is better than a payoff of 25).

Notice that now, Artist A has a dominant strategy to participate in Discovery Mode. Participating in Discovery Mode is better for Artist A, no matter what the other artists do. They should always choose to participate in Discovery Mode. And this would apply to any other artist, if we replaced Artist A with them instead. This provides an even stronger incentive for artists to participate in Discovery Mode than in the chicken game shown earlier (it wouldn't be a chicken game any more, but much more like a prisoners' dilemma game with multiple players). However, the other points I make about the repeated game, cooperation and trust, all still apply to this version of the game as well.

Brexit negotiations as a game of chicken

In a post last month, Tim Harford perceptively characterised the posturing between Britain and the European Union over Brexit as a game of chicken:

First: to be an effective negotiator often means accepting some risk of disaster. The simplest model of this is the game of “Chicken”, in which two leather-clad rebels get into their cars, and drive towards each other at a furious pace. The first one to veer off the road loses his dignity, unless neither of them swerve, in which case both of them will lose a lot more than that.

Chicken is an idiotic game, whose players have little to gain and much to lose. But Chicken teaches us that you can gain an advantage by limiting your own options. Imagine detaching your steering wheel and flamboyantly discarding it as you race headlong towards your opponent. Victory would be guaranteed. Nobody would drive straight at a car that cannot steer out of the way. But here’s a worrisome prospect: what if, as you hurl your own steering wheel out of the window, you notice that your rival has done exactly the same thing?

All this matters because both the UK and the EU are doing their best to give the impression that they’ve thrown their steering wheels away. Control of immigration is non-negotiable, says Theresa May. Fine, says the EU — in that case membership of the single market is out of the question. Fine, says May: we’re out. Don’t let the door hit you as you leave, says the EU.

It’s easy to see why both sides are behaving like this — it’s the logic of Chicken. But the eventual result may be something no sane person wants: a car crash. In May’s recent speech, she set out her willingness to risk such a crash by saying she might walk away without a deal. That does make some sense: it’s how you act if you want to win a game of Chicken. But there are games of Chicken that nobody wins.

The Brexit negotiations chicken game is laid out in the table below. The EU and the UK can choose to 'make concessions', or to 'play hardball'. If both make concessions, the outcome is essentially pretty neutral (a payoff of zero for both of them). However, if either the EU or the UK plays hardball while the other makes concessions, whichever of them plays hardball comes out better off (positive payoff) at the expense of the other (negative payoff).  Finally, if both play hardball, both will be much worse off (very negative payoffs).

Where are the Nash equilibriums in this game? To identify them, we can use the 'best response' method. To do this, we track: for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the definition of Nash equilibrium).

For our game outlined above:

1. If the UK makes concessions, the EU's best response is to play hardball (since + is better than 0) [we track the best responses with ticks, and not-best-responses with crosses; Note: I'm also tracking which payoffs I am comparing with numbers corresponding to the numbers in this list];
2. If the UK plays hardball, the EU's best response is to make concessions (since - is better than --);
3. If the EU makes concessions, the UK's best response is to play hardball (since + is better than 0); and
4. If the EU plays hardball, the UK's best response is to make concessions (since - is better than --).

Note that there are two Nash equilibriums, where one of the EU or the UK plays hardball, and the other makes concessions. However, both of them want to be the one playing hardball. This is a type of coordination game, and it is likely that both the EU and the UK will try to play hardball (but leading both to incur big losses!).

The solution to getting your preferred equilibrium outcome in the chicken game is to make a credible commitment (such as removing the steering wheel that Harford suggests for the classic chicken game). In the case of Brexit though, it isn't clear how either side can make a credible commitment to the hardball strategy, and both are already moving their feet towards the accelerator. But if neither are willing to make concessions, the outcome is clear.

Read more:

• Brexit and the chocolate war

Book review - Narconomics

Back in March I promised a review of Tom Wainwright's new book, "Narconomics: How to Run a Drug Cartel". I finished reading it last week, and although I'm not sure that it has fully equipped me to run a drug cartel, it certainly contains lots of interesting parts. Below I share some of the highlights (at least, to me).

Chapter 1 discusses the supply chain for cocaine, and simply reiterates the futility of governments targeting supply in the war on drugs. Here is one bit:

Because cartels depend on coca leaf to make their cocaine, governments have targeted coca plantations as a means of cutting off the business at its source. Since the late 1980s, the coca-producing countries of South America, backed by money from the United States, have focused their counternarcotic efforts on finding and destroying illegal coca farms. The idea is a simple economic one: if you reduce the supply of a product, you increase its scarcity, driving up its price... Governments hope that by chipping away at the supply of coca, they will force up the price of the leaf, thereby raising the cost of making cocaine. As the price of cocaine rises, they reason, fewer people in the rich world will buy it.

Wainwright then points out the main flaws in this argument. First, this is a giant game of whack-a-mole. Governments target coca producers in Peru, and production simply moves across to Colombia. When coca producers are targeted in Colombia, they move back to Peru. And so on. Second, the drug cartels are monopsonies - buyers with substantial market power. It is local farmers who grow the coca (not the cartels themselves), and since the farmers can only sell their illegal coca crop to the cartels, the cartels are able to dictate the price. So, even if coca eradication efforts are successful, they don't much affect the price that the cartels pay for the raw product. Third, even if the price of the raw material increases, it will have almost no effect on the street price of cocaine. Wainwright notes that the markup on cocaine is more than 30,000 percent (from farm-gate price to street price). So, even if government efforts managed to treble the farm-gate price of coca, the street price of cocaine would increase by only 0.6 percent - a trivial change. The takeaway is something I've noted before - targeting demand is likely to be more effective than targeting supply.

The second chapter looks at competition and collusion in the drug supply chain, and has a really interesting bit on gang tattoos:

The defining feature of El Salvador's young mareros is their head-to-toe tattoos. Like Old Lin, nearly all gang members sport body art declaring their allegiance to either the Salvatrucha or Barrio 18... Once a young man has become a member and has gotten his body covered in Salvatrucha tattoos, defecting to join Barrio 18 is out of the question, and vice versa. Even leaving the mara to start a new, noncriminal career is virtually impossible, as employers tend to be perturbed by job candidates who show up for an interview with skulls and crossbones etched on their foreheads. In economic terms, this means that whereas Mexican gangbangers are highly footloose, liable to change sides to work for whichever cartel seems to be stronger or higher paying, the labor market for Salvadoran mareros is completely illiquid.

I see this as gang tattoos acting as a form of credible commitment by the mareros. In a simultaneous game, where the marero chooses whether to be loyal or not and the gang must decide whether to trust the marero or not, the marero can make a credible commitment to be loyal by covering themselves in tattoos. Note that this is also a form of signalling - revealing private information about their loyalty to the gang - as only the truly loyal would go to the trouble of getting head-to-toe tattoos.

Chapters 3 and 4 talk about the human resource management issues of cartels, and their corporate social responsibility activities (yes, you read that right), while Chapter 5 talks about international outsourcing (or offshoring) and Chapter 6 covers franchising. I didn't find too much of particular interest in those chapters, though the chapter on franchising did raise some questions for me about whether international terror groups are also undertaking a form of franchising.

Chapter 7 covers the legal highs industry, with particular reference to New Zealand, and Chapter 8 talks about digital disruption. In the latter chapter, I found the discussion of drugs as a 'network good' of interest. Network goods are goods that can only be bought or sold if you belong to a particular network. Here's one bit:

Under these conditions, life is good for the established dealer. A key feature of network markets is that they tend to work strongly in favor of incumbents, who have had time to build up the biggest and strongest networks. Picture the stable, longtime drug dealer, who has been supplying the same city for years. He knows the importers. He has a long list of clients. He may even have contacts in the police whom he pays to turn a blind eye to his business. Now picture the young up-starts, someone who spots that the local market is uncompetitive, with watered-down drugs being sold at high prices. It ought to be easy to enter the market and win some business. But entering the drugs markets - a network economy - isn't so easy. Buying wholesale quantities of illegal drugs requires a rare set of high-level contacts. Selling them in smaller quantities requires a second, larger set of potential buyers. Without a network to buy from and sell to, the new dealer won't get far (and that is before even thinking about the possibility that the established dealer may not take kindly to someone else operating on his patch).

Of course, digital disruption means that whole new networks are being created online, and the chapter talks about the marketplaces on the 'dark web'. Chapter 9 talks about the diversification of the cartels, including from drug smuggling to people smuggling. Chapter 10 talks about the legalisation of cannabis in several U.S. states, and how that is affecting cartel business.

Wainwright concludes with what he sees as the main mistakes in official efforts to tackle the drugs industry: (1) the obsession with supply (see above); (2) saving money early on and paying for it later (prevention is much cheaper than cures, but cures win votes); (3) acting nationally against a global business (see the note on whack-a-mole above); (4) confusing prohibition with control (simply making something illegal is not a solution in and of itself).

Overall, I found this to be an excellent, well-researched book that maintained my interest throughout. I recommend it to anyone who wants to know more about the drugs trade, and how the economics (and business management) concepts we teach in business schools applies in that industry.