1.2.5. Change in Costs over Time

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Reliance on advertiser finance also allows advertisers’ potentially different valuation

of audience demographic to influence the mix of available programming. See

Napoli

(2002, 2003)

1.2.5 Change in Costs over Time

Because of technological change—mostly due to digitization—fixed costs have been

shrinking in relation to market size for many media products. Moreover, marginal costs

for physical media products such as newspapers and magazines have fallen to zero. Fixed

costs for media products fall in relation to market size, in turn, for two reasons. First, fixed

costs may fall absolutely, as when new digital technology makes it less expensive to pro-

duce and publish a text product. A newspaper or magazine does not, in principle, need

printing or distribution capabilities. Second, digitization enables broad geographic distri-

bution, so that products that were once local can instead be available nationally or

internationally.

The marginal cost of serving a household view newspaper has traditionally been the

cost of printing and delivering a physical paper. More recently, as newspapers have

moved toward digital distribution, the marginal cost has fallen toward zero.

New technologies have changed “radio” in a few important ways. First, US satellite

radio has as its market footprint the entire country. Given the large market size, it is

possible to offer a large number of program options, 151 on Sirius in the US.

This is

far more varieties than are available over the air in even the largest markets. Second,

satellite radio is user-financed, with monthly fees of $10–15.

Third, the Internet

has enabled distribution of audio programming online, with three features that differ

from terrestrial radio: (a) As with satellite, the market size is enlarged (an entire country

rather than a metropolitan area). (b) Programming is customized to the user’s taste.

Services such as Pandora and Spotify allow users to listen to individualized “stations” that

are customized to the users’ preferences. (c) These services have both ad-supported and

user-supported versions.

Many media markets—newspapers, radio, television (outside of prime time)—have

traditionally been local. The arrival of the Internet is in some ways like the dawn of free

trade. Providers can make their text, audio, and video available to consumers anywhere,

which creates opportunities to reach more consumers. But at the same time, products

everywhere now face greater competition.

1.3. THEORY

Preference externalities are part of the broader economic problem of product selection.

We do not attempt to review that vast literature. One stream has followed from

See http://en.wikipedia.org/wiki/List_of_Sirius_Satellite_Radio_stations.

See http://www.siriusxm.com/ourmostpopularpackages-xm, accessed June 17, 2014.

10 Handbook of Media Economics

Hotelling’s (1929) model of spatial competition, which provides a template for viewing

the product specification as a choice variable. A second stream follows

Chamberlin’s

(1933)

work on monopolistic competition, and focussed on the number of product var-

iants. This vein was resurgent after

Spence (1976) and Dixit and Stiglitz (1977) revisited it

using representative consumer models (most centrally the CES), and it is currently

employed in international trade research following

Melitz (2003). Meanwhile, structural

empirical work in industrial organization is based on discrete choice models, and fre-

quently on the logit model (following the seminal work of

Berry et al., 1995) that is

closely related to the CES.

Below, in

Section 1.3.3, we elaborate upon models in these veins in order to con-

centrate on preference externalities in the context of media. First though, we describe

(and extend) the classic contributions to media economics of

Steiner (1952) and

Beebe (1977). These authors, providing precursors to preference externalities, explicitly

addressed market failures in ad-financed markets, and it is with them that we begin the

narrative. Steiner’s principle of duplication stressed excessive attention to majority pref-

erences to the exclusion of minorities, while Beebe’s lowest common denominator

(LCD) programming type stressed a tendency to cater to base levels of tastes.

Questions we seek to address through the models include the determinants of the

number of products in the market, as well as their positioning, and the operation of pos-

itive and negative externalities. What determines when more media consumers make

other media consumers better or worse off? How do different business-finance models

(subscription/ads/mixed) affect predictions? What are the effects of mergers on product

positioning and other outcomes? What can we say about the efficiency of the market

outcomes?

We then describe some evidence in

Section 1.4.

1.3.1 Classic Models

1.3.1.1 Preference Externalities with Spectrum Constraints: Steiner and Beebe

Models

Steiner’s (1952) model was explicitly directed at media markets with advertising finance.

It assumes that each viewer is worth the same amount to advertisers, and that viewers’

single-home, media platforms strive to deliver the maximal number of viewers to adver-

tisers. Each viewer has one preferred genre choice, and will not watch/listen to another

choice. If several platforms serve the same genre, viewers are split equally, so there is no

interaction among the platforms (for example, they do not compete by restricting ad nui-

sance in order to be more attractive than rivals in the same genre).

There is a spectrum

See Chapter 2 for extensive analysis of platform competition when ads are a nuisance to media consumers.

The Steiner and Beebe models are also discussed in Chapter 6.

11Preference Externalities in Media Markets

constraint on the number of channels that can be broadcast into the market: we shall see

in the logit analysis that similar forces are at play without this.

The setup gives rise to duplication of popular channels at the expense of those with

fewer adherents. An ensuing preference externality is thus that a more popular genre

attracts too many platforms. There thus can be a negative preference externality on small

groups that cease to be served when numbers of viewers in a larger channel rise and plat-

forms switch format. There is, though, a positive externality on own-group members by

having more variety (although Steiner suppressed this possible welfare benefit by assum-

ing that more choice within a genre is purely duplicative).

The social cost is expressed

through wasteful copying, although if there are many channels (low fixed costs), prefer-

ence externalities disappear because each preference type will get what it wants.

Suppose that were just two groups of viewers in a TV market. Each viewer is worth

the same amount to advertisers. Seventy percent will watch only a game show and 30%

will watch only a reality show. With one market slot available, only the majority will be

served. With two market slots, two private firms will both air game shows. This is

Steiner’s Principle of Duplication that the market solution doubles up on the more lucrative

niche (as long as this is large enough).

Sharing a 70% market is more profitable than

airing a reality show.

This wasteful competition is the simplest form of the Tyranny

of the Market (

Waldfogel, 2007): majority tastes override minority ones in a marketplace

of few alternatives. Notice that the market failure can be resolved in several ways. One is

to set one channel aside for a public firm that would cater to those who want drama.

Another resolution, surprisingly, is to allow the market to be served by a two-channel

monopoly.

Such a situation, where the platform would not cannibalize its own

Notice that when there are no channel number restrictions (for example, in magazines), then a group’s

preferences are served only if fixed costs can be covered. In that sense, there remains only the traditional

monopoly underserving problem that firms cannot extract the full social surplus from their creations, and

so may not serve when they ought to. However, preference externalities might still arise if platform costs

depend on the number (and scale) of other platforms. For example, input prices (journalists, say) might rise

with the number of platforms. Then the preference externality problem might work in a manner similar to

the spectrum restriction case: popular genres crowd out less popular ones, and more people in the popular

genre may attract more platforms there and raise costs across the board and so strand less popular offerings.

This duplication (and an unserved minority) prevails as long as v

/2 >v

, where v

is the viewership in

segment i ¼A,B.

If we had a subscriber price system, with subscribers all with the same willingness to pay, then we have very

different outcomes: because of Bertrand competition, two media firms would never select the same chan-

nel. Instead, they differentiate to relax price competition, entailing a monopoly in each segment. Nuisance

costs of advertising would also mitigate the tendency to duplicate.

Yet another is by stipulating that the bidding process factor is not just which franchise would pay more for

the slot, but also broadening the competition to require that other factors than pure profitability be deci-

sive in awarding the franchise. For example, the fourth ITV slot in the UK also asked participants bidding

for the prize to describe the program content they would provide.

Handbook of Media Economics

reality show, was one of Steiner’s chief findings: monopoly can outperform (wasteful)

competition.

Now modify the numbers so that 78% will listen only to rock and the other 22% only

to classical radio. With three slots (or indeed with fixed costs between 22% and 26% of

total possible revenues), all will air rock programming, leaving the classicists unserved.

With four stations and beyond, the classical listeners will be served (providing, of course,

that fixed costs can be covered with a 20% market share). More generally: minorities will be

served providing there are enough stations, but resources will still be wasted through excessive

duplication of the most popular genres. Notice that the assumption of a fixed number of

slots was not important to generating the outcomes. For example, if fixed costs lay

between 30% and 35% of the total possible market revenue in the first case, then the out-

come is the duplication, with drama unserved.

1.3.1.2 The Tyranny of the Yuppies

In the advertising-financed business model, media firms aim to deliver bundles of con-

sumers to advertisers. Firms then are paid by advertisers according to the dollar desirabil-

ity of the audience delivered—different audiences involve different demographics of

heterogeneous desirability to advertisers. Competition among platforms in providing

genres is then governed by the tastes of advertisers for the audience composition. Con-

sumer sovereignty is consequently indirect—the consumer’s preferences are not counted

directly, but rather it is the preferences of the advertisers that count. Consumer prefer-

ences only count to the extent that consumers are wanted by advertisers. Thus, some

consumer groups can be disenfranchised in the market system for the twin reasons of

fixed costs (or limited spectrum availability in the central examples below) and the desire

to deliver consumers attractive to advertisers. Even with traditional market systems, we

can have a majority tyranny, but the ad-finance system exacerbates this. A pay system

(pay-per-view on TV, Internet paywalls, or subscription to satellite radio) removes

the latter distortion, but many media remain ad-financed, or with a mixed system (news-

papers and magazines that carry ads and charge a subscriber price too).

We can illustrate the indirect sovereignty of the ad-financed system in the context of

the Steiner model. Suppose that in the original example the watchers of reality are worth

to advertisers five times as much as game-show watchers. This could be because viewing

preferences are correlated with willingness to pay for advertisers’ wares: yuppies are par-

ticularly attractive to broadcasters because they are attractive to advertisers. They are just

coming into incomes, and their early choices (e.g., Ford or Bank of America) will likely

persevere. Influencing their choices early on will likely have a high present value.

Because they are worth five times as much, they are now the prime desired real estate.

Accordingly, two private firms will now air reality shows. The simple mapping from dol-

lar values and market shares to viewer attractiveness is to multiply each viewer segment by

its economic weight. Thus, normalizing the game-show watchers to 1, the game-show

13Preference Externalities in Media Markets

segment is worth 70 points in total, while the reality show segment is worth 150, thus

flipping the pattern of duplication. The example is extreme, but it underscores the impor-

tance of the advertisers, and it shows the algorithm of converting viewer numbers into

dollar terms and then performing the Steiner analysis with the economic weights.

Here then the tyranny is that of the economic majority, which may well be the

numerical minority. Arguably, this is why we see sitcoms with 20-something yuppies

living in New York lofts.

1.3.1.3 Lowest Common Denominator

Steiner’s setup is extreme because he supposes that viewers will only watch one genre.

Beebe (1977) extended Steiner’s preference setup to allow viewers to have taste rankings

over program types. Second choices will be watched if first choices are not available.

A second choice that is shared by several viewer groups is a LCD programming type.

As we show, with few possible channels, LCD programming might prevail, even to

the extent of being duplicated.

To illustrate, suppose 60% of the audience will listen to folk music, and country if folk

is unavailable. The other 40% have bluegrass as first preference, and country as second.

Here country is the LCD taste, the one people will listen to if their first preferences are

not available. Now, a monopoly channel need air only country to get the whole market,

and has no desire to set up a second channel. By contrast, competition with two slots will

yield first preferences being aired. Then, in contrast to Steiner’s setup, the monopoly per-

forms worse than competition, by aiming just for the minimum acceptable.

The LCD is not just a monopoly phenomenon. Suppose now that first tastes are

drama, news, and sport for each third of the population. If the first choice is unavailable,

viewers will all watch sitcoms. Now the equilibrium for two private stations is to both

provide sitcoms. Doing so gives each half the market, while choosing any other genre

gives a third. As with the Steiner analysis, the same points apply if it is fixed costs that

determine the number of platforms. Also, if there are enough slots, then first preferences

are satisfied by the market outcome, although duplication remains. Furthermore, LCD

programming is supplanted in favor of first preferences. This suggests the pattern of how

the market is catered as a function of overall market size: small markets get LCD program-

ming, while the largest ones get programming catering to quite specialized tastes.

The framework above suggests a general tendency of offerings that get finer as the

market expands, and positive externalities within own-group size, with possible positive

spillovers to similar groups (and such spillovers less likely for more dissimilar groups).

Again, a public broadcaster’s role may be to provide nature programs that might have a high consumption

benefit that potential watchers cannot express through the ad-financed market system, especially if these

watchers are older and perhaps less prone to altering their purchase behavior in response to ads.

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