Entertainment and Media: Markets and Economics

1. Entertainment and Media: Markets and Economics Market Structures

2. Agenda Price theory – market equilibrium • Monopoly • Monopsony • Intermediate cases Economic Rent and Capitalization Profits and Losses Market Outcomes – Market Power

3. Setting a Price – How To? • Tangible Commodity • Car • Amazon.com – Econometric Analysis • Restaurant – A Meal • Software Vendor – Online Distribution

4. Setting a Price – How To? • Not so tangible products. • Royalty Holder – Price for an advertiser who uses your jingle or tune • Single track of music on iTunes • Creative output: Price for someone who wants to have or use your invention: (book, music, tool, tennis stroke, surgical move, …)

5. Monopoly Equilibrium and Profit: Traditional View A monopolist is able to sell at a higher than competitive price, and sells less than would be sold under competition Monopoly Price Competitive Price Qm Qc

6. Sources of Monopoly • Possession of some unique feature or product – e.g., ownership of a unique piece of land • Rockefeller’s oil empire – a patent • Facebook, Google, Microsoft – what is the source? Supply based vs. demand based.

7. Pockets of Market Power Where do the economic profits reside in these multistage businesses? Anywhere? • The music industry – composition, production, distribution • The movie business – production, distribution, exhibition • E-books publishing – authoring, publication, distribution • Broadcasting – production, aggregation, exhibition

8. Antitrust case vs. Manhattan theaters

9. Raymond Syufy Corners the Movie Market • Raymond Syufy buys out the competition in the Las Vegas first run theater market 1982-1984. • 1990 Antitrust sues for monopolization • Government case is denied • There was still free entry • There was no suppression of competition • Syufy had no power to raise movie prices.

10. Kindle and e-Readers • “Shared monopoly” at the publishers level (with Apple): Agency Model • Monopoly on e-readers: Amazon’s price model. The answer has to do with how Amazon went about building its e-book monopoly in the first place — namely, by setting a [book] price that was lower than what Amazon was paying publishers for the book. What looked to consumers like a great bargain at $9.99 a book looked to others in the industry suspiciously like predatory pricing, or selling below cost today in order to gain a monopoly and raise prices in the future. What is wrong with this argument? (And with the Syufy case.)

11. Monopoly in the Reader Market So which is better: a market in which Amazon uses low prices to maintain its e-book monopoly and drive brick-and-mortar bookstores out of business, or one in which the major book publishers, in tacit collusion with Apple, break Amazon’s monopoly and raise prices? For the moment, the government has come down on the side of lower prices. Under threat that they will be taken to court for conspiring to fix the price of e-books, the book publishers are trying to work out a settlement with Justice Department’s antitrust division. “Pick Your Monopoly: Apple or Amazon,” Steven Pearlstein, Washington Post, 3/11/2012 Apple lost this case, March 8, 2016. Settled for $450M

12. Winner Take All and ForeclosureThe Tech Industries One thing that makes it different is that it is happening in a high-tech sector that, by its nature, is prone to winner-take-all competitions. We saw that with IBM in the 1960s, Microsoft in the 1990s and more recently with Google and Facebook. Because of the “network” quality of such industries, customers prefer to do business with the firm that has the most customers. Moreover, once you decide to do business with one company, the cost and hassle involved in shifting to a competitor is sufficiently high that customers tend to be “locked in” to their original choice. Antitrust regulators have come to believe that, in such industries, restrictive contracts between firms and their customers, or between suppliers and distributors, may not be as benign as free-market economists and judges once believed. Fiona Scott Morton, chief economist at the Justice Department’s antitrust division, recently dubbed them as “contracts that reference rivals” and warned companies that such provisions would now be viewed with heightened suspicion.

13. Monopsony in Labor Markets

14. Monopsony: Two Classic Applications • Major League Baseball – A Strategy for Using Monopsony Power • Cartel – enjoyed supreme court approval • Reserve clause’s demise (Curt Flood, Catfish Hunter, Andy Messersmith) • Free agency • Movie Studios and the Star System • Illegal cartel • Largely became obsolete and irrelevant

15. Fashion Models (Ford, etc.) … whoops! Who knew the antitrust laws applied to us too?

16. Tech SectorMonopsony http://pando.com/2014/03/22/revealed-apple-and-googles-wage-fixing-cartel-involved-dozens-more-companies-over-one-million-employees/

17. An old fashioned, per se illegal, conspiracy in restraint of trade

18. Entertainment and Media: Markets and Economics Economic Rent

19. Doug Glanville’s Economic Rent “One superagent took the time to explain why I should ask for three times the market rate for my signing bonus. He made the compelling argument that since I would be forgoing the use of an Ivy League engineering degree, the team that chose me should compensate me for my lost wages. He made it clear that the sum of this compensation and a little extra should make up my total bonus.” (“Doubleday and Darwin,” by Doug Glanville, NYT, 7/5/2008)

20. Doug Glanville’s Economic Rent “One superagent took the time to explain why I should ask for three times the market rate for my signing bonus. He made the compelling argument that since I would be forgoing the use of an Ivy League engineering degree, the team that chose me should compensate me for my lost wages. He made it clear that the sum of this compensation and a little extra should make up my total bonus.” (“Doubleday and Darwin,” by Doug Glanville, NYT, 7/5/2008) This argument makes no sense. By this construction, Glanville should have been able to tell a prospective engineering firm that they should compensate him for his foregone baseball career. Good luck with that.

21. Sources of Economic Rent • Market value in excess of the value of the next best alternative (opportunity value). (This is the definition.) Where does it come from? • Natural endowment • Creation of something of value to a market + property right (ownership) • Positioning and market disequilibrium • Creation (or exploitation) of a market failure (apartment brokers in New York)

22. Entertainment and Media: Markets and Economics Profit

23. Profits… • Gross Revenue Minus Total Cost • Cost includes the cost of capital • Ambiguities in the allocation of cost • Contractual arrangements

24. Profits and Losses

25. Profits in Multiple Output Processes • Allocation of revenues to activities • Multiple revenue sources (outputs) • Allocation of costs to activities • Fixed costs in multiple output firms • Theater: Exhibition and Concessions

26. Disintegration? A Miami Fish Story • 1997 Florida Marlins (World Series Winner) Tickets+Broadcast+Concession+Other: $58.9M Payroll+Team Costs+Stadium+Other: $88.2M Net loss: ($29.3M) • Owner Wayne Huizinga claimed the Marlins were hopelessly losing money. • 1997 Florida Marlins + Pro Player Stadium: Net profit = $13.8M • How should the related revenues and costs be treated? • Pro Player Stadium (owner receives revenues) • Miami Dolphins (football team, same stadium, same owner) • Sports Channel (same owner) • Why was Don Smiley offering $169M for the Marlins if they were losing so much money?

27. Profits in Multistage Processes • Allocation of net revenues to activities • Revenue stream arrives at the end of the chain • Allocation of revenue streams to activities in the chain – essentially transfer pricing • Net vs. gross in Hollywood

28. Profits in the Movies Sharing rules: Some participants (usually actors, e.g., Tom (Gump) Hanks) and directors get a % of gross distribution revenue. Gross Box Office Production Distribution Exhibition There is no net! 30-50% Net

29. There is No Net • Forrest Gump (1994) (Paramount Pictures) • US Box Office $330M • Foreign Box Office $350M Total, About $830M • Soundtracks, etc. $150M • Net profit -$ 62M (!) A disappearing act? • U.S. Box  50% to Exhibitors (Theaters) • Paramount Receives Approx $191M • Distribution “Fee” = 32% $ 62M • Distribution Cost $ 67M (Advt., Prints, Screening, etc.) • Advt. Overhead $ 7M (10% of Distribution Cost) • Production “Negative” Cost $112M • (Tom Hanks, Robert Zemekis, $20M (8% of GROSS, each) • Studio Overhead $15M • Interest on Negative Costs $ 6M • Net Profits from the Project -$62M • Winston Groom, Author 19% of NET = 0 • Eric Roth, Screenwriter 19% of NET = 0 • Coming to America (1988) – The Art Buchwald Case pried open the books at Paramount and revealed “Hollywood Accounting.” The judge called it “unconscionable.”

30. Economic Foundations for Entertainment and Media Organization of Firms in E&M Industries

31. Theoretical Departure Pointon Firm Integration • Perfectly Competitive Markets • All firms atomistic price takers • All firms fully informed and efficient • Integration of some firms in competitive markets • Reasons for firm integration: None • Reasons against integration: None • Why do we observe integration? Usually: • Reaction to a market failure of some sort • Creation of a market failure

32. Virgin -- Conglomerate

34. Integration of Firms:Conglomerate, Horizontal, Vertical Markets Financial Services Professional Sports Traditional Publishing Final Consumers

35. Economic Foundations for Entertainment and Media Organization of Firms in E&M Industries: Conglomerates

36. Conglomerate Mergers Markets Financial Services Professional Sports Traditional Publishing Economic Motivation for Pure Conglomerate Merger: Perhaps Portfolio Diversification

37. Media Conglomerates • Some “common elements” (see “Virgin”) • Natural “synergies” • Strategic firm organization as markets evolve

39. The Big 6 (or is it 5?) Media Conglomerates NBC/Universal/Vivendi now owned by Comcast Sony is a broader kind of conglomerate: Electronics, movies, financial services

40. Time Warner

44. Conglomerates • Some “common elements” (see “Virgin”) • Natural “synergies” • Strategic firm organization as markets evolve: E.g., AOL - Time Warner sought an “option” on an uncertain future.

45. Economies of Scope Markets Financial Services Professional Sports Traditional Publishing Sports broadcasting and newspaper

46. “Synergistic” Mergers • Firms in related industries • Not a conglomerate merger • Exploitation of commonalities • Are there economies of scope? • Applications? • Hockey and basketball? • Newspapers and book publishing? • Others?

47. What are the Benefits? Cablevision has no background in newspapers, but executives there say they can use their digital assets and Newsday to promote each other. They also envision combining ad sales, and using Newsday’s strength in local advertising to drive revenue to Cablevision. An executive of another business who has worked closely with the Dolans said their interest in Newsday could not be entirely economic “because there’s not a business rationale to spend what they’re willing to spend.” Cablevision paid the Tribune Company $650M for Newsday.

48. Economic Foundations for Entertainment and Media Organization of Firms in E&M IndustriesHorizontal Integration

49. Horizontal Integration Markets Financial Services Professional Sports Traditional Publishing What objective?

50. Horizontal Mergers • Increases market share • Extends market power forward • May extend market power backward • What justifies horizontal integration? • Economies of scale • “Synergies?” (What is this?) • Capture market power