firms and markets 2:b - 1(71) entertainment and media: markets and economics market structures

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Entertainment and Media: Markets and Economics

Market Structures

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Agenda

Price theory – market equilibrium Monopoly Monopsony Intermediate cases

Economic Rent and Capitalization

Profits and Losses

Market Outcomes – Market Power

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Setting a Price – How To?

Car Amazon.com – Econometric Analysis Restaurant – A Meal Software Vendor – Online Distribution 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, …)

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Monopoly Equilibrium and ProfitTraditional View

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Sources of Monopoly Profits Sources of monopoly

Possession of some unique feature or product Rockefeller’s oil empire Google, Microsoft Supply based vs. demand based.

Where do the economic profits reside? The music industry The movie business E-books publishing Broadcasting

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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.

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Antitrust case vs. Manhattan theaters

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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 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.)

“Pick Your Monopoly: Apple or Amazon,” Steven Pearlstein, Washington Post, 3/11/2012

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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.

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Winner Take All and Foreclosure

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.

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Monopolistic Competition

Model for publishing Distinct monopoly

power, indistinct

rates of return. Rents are dissipated

at earlier stages

in the production

chain. Applications: Books, many

consumer products,…

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Monopsony: Labor Markets

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Monopsony 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

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

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Tech Sector

Monopsony

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

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

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Bargaining Situations and Market Power

The bargaining range

The outcome depends on the bargaining strengths of the two parties.

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Bilateral Monopoly Applications

Baseball Arbitration Free agency

Movies Stars as free lancer Stars taking equity stakes in movies

Music: (ASCAP/BMI) v. (AOL/Yahoo/Real)

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Entertainment and Media: Markets and Economics

Economic Rent

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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.

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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)

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Entertainment and Media: Markets and Economics

Profit

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Profits…

Gross Revenue Minus Total Cost Cost includes the cost of capital Ambiguities in the allocation of cost Contractual arrangements

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Profits and Losses

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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

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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

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Profits in the Movies

Sharing rules: Some participants (usually actors, e.g., Tom (Gump) Hanks) and directors get a % of gross distribution revenue.

Production Distribution

Exhibition

30-50% There is no net!

Box OfficeGross

Net

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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.”

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On the trail of the economic rent.Garrison v. Warner Bros (1995)

Who was Jim Garrison? “On the trail of the Assassins (of JFK. Oliver Stone et al.) Class action on behalf of “talent” Defendant: Every movie studio plus various unnamed

coconspirators. “There is no net” http://variety.com/1998/biz/news/class-is-out-in-garrison-1117471334/

Garrison lost – class action suit was denied.

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Economic Foundations for Entertainment and Media

Organization of Firms in E&M Industries

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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

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Virgin -- Conglomerate

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Integration of Firms:Conglomerate, Horizontal, Vertical

Markets Financial Services Professional Sports Traditional Publishing

Final Consumers

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Economic Foundations for Entertainment and

Media

Organization of Firms in E&M Industries: Conglomerates

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Conglomerate Mergers

Markets Financial Services Professional Sports Traditional Publishing

Economic Motivation for Pure Conglomerate Merger: Perhaps Portfolio Diversification

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Media 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.

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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

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Time Warner

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CapitalLiberty Media Entertainment

Interactive

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Economies of Scope

Markets Financial Services Professional Sports Traditional Publishing

Sports broadcasting and newspaper

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“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?

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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.

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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)

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?

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Major League Baseball Teams

Huizinga

Zimbalist

Baseball team Fans in seats

Broadcasting

Parking, Licensing, etc.

Stadium Sky boxes

Concessions

Naming, etc.

Fans in seats

Broadcasting

Parking, Licensing, etc.

Sky boxes

Concessions

Naming

Baseball team

Stadium

Other productive inputs

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Economic Foundations for Entertainment and

Media

Organization of Firms in E&M IndustriesHorizontal Integration

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Horizontal Integration

MarketsFinancial Services Professional Sports Traditional Publishing

What objective?

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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

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Regulatory Inducement

In 1996, the Telecommuncations Act of 1996 became law. This act deregulated media ownership, allowing a company to own more stations than previously. Clear Channel went on a buying spree, purchasing more than 70 other media companies, plus individual stations.

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Clear Channel’s really bad adventure

20/78

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Concert Ticket Prices

Connolly, M. and Krueger, Al, “Rockonomics” http://www.irs.princeton.edu/pubs/pdfs/499.pdf

Clear Channel owned Live Nation until 2006

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Sirius and XM

The merged firms would have 100% of the market. Or, would they?

What is the relevant market? Costs and benefits of the merger? Will the Justice Department and the FCC oppose the

merger? Regulators summarily rejected a similar monopoly merger

of the nation's only two satellite television companies - DirecTV and DISH Network - just a few years back."

The DOJ also rejected a Hollywood Video and Blockbuster merger.

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Benefits of the Merger?

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Firms and Markets2:B - 59(71)http://www.nytimes.com/2008/12/28/business/media/28radio.html?scp=1&sq=Satellite%20radio+payday&st=cse

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Sirius XM - 2009

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Sirius XM - 2013

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Big 4 Record Labels Become Bigger 3

Warner

EMI

Independent

Universal

Sony/BMG

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Universal Music Group completed its acquisition of EMI on 28 September 2012. In compliance [with] the conditions of the European Commission, Universal Music Group sold a German-based music rights company BMG, the Mute catalogue, previously property of EMI on December 22, 2012. On February 8 2013, Warner Music Group is made to [take] control of Parlophone Records, Chrysalis Records, EMI Classics, Virgin Classics and EMI's regional labels across Europe, pending the approval of both European and American regulators, to a value of $765 million (£487 million).[

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Measuring Competition

2

Firms in the market

Hirfindahl Index

10,000*

Number of Competitive 'Voices'

N*=10,000/H

iH S

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Comcast – Time Warner Cable

0 < HHI £ 10,000

Levels>2500 Highly Concentrated

1,000 - 2,500 Moderately Concentrated

Merger Impacts on HHI are Problematic

>200 if Concentrated

>100 if Moderately Concentrated

National Cable Market: About 1815

Post Comcast-TWC Merger About 2454

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Major Studio Market Shares

N* = 8.6 - This is plenty.

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Domestic Movie Studio Market

http://boxofficemojo.com/studio/ March 8, 2014

N* = 8.9HHI = 1,120