7.3.1.3 Content Choice
The main cause of market failure in the analog era was due to advertising being the sole
commercial source of funds. The basic problem with advertising-funded television is that
whether or not a program is profitable need not depend closely upon how strongly viewers
like the program. If a cheap quiz show would draw the same audience as an expensive
drama, then there would be no point in an advertising-funded broadcaster spending extra
resources on the latter. Similarly, programs that appeal strongly to a relatively narrow
audience would not be produced, even though they might generate substantial social
surplus.
Moving to a subscription television system, however, greatly mitigates this problem.
Since the broadcaster can extract viewers’ surplus directly, we expect that it will have an
incentive to show a diverse selection of programs of quality appropriate to viewers’
willingness-to-pay (WTP). For instance, drama series might be unprofitable for an
advertising-funded broadcaster, but not for a subscription broadcaster which can extract
viewers’ higher WTP for this genre compared to soaps, say.
To illustrate this, suppose for simplicity that viewers suffer no disutility from adver-
tising (so δ ¼0) and the broadcaster can obtain maximum revenue r per viewer from
advertisers.
39
There are a number of program options available, labeled i, which vary
in audience size n and the WTP v of that audience. (Thus, each option has rectangular
demand, with inelastic demand n so long as price is below v.) Program option i has audi-
ence n
i
, reservation price v
i
, and fixed cost F
i
. If the broadcaster must choose just one of
these options, then without the ability to charge for content, the broadcaster will choose
the content with the highest value of
n
i
r F
i
:
However, if it can charge for viewing, it will charge viewers their reservation price and so
choose the content which maximizes
n
i
r + v
i
ðÞF
i
:
Since the latter choice takes into account viewer surplus, it is likely to be better aligned
with total welfare (although viewers are left with no surplus). If there is a program type
(“lowest common denominator” content) which is just better than nothing for most peo-
ple and which costs little to produce (i.e., n
i
is large, while v
i
and F
i
are small), this will be
offered by the broadcaster in the free-to-air regime, but some other content would likely
be offered in the pay-TV regime.
This discussion can be applied to the particular case of program quality.
40
Suppose that
the broadcaster can choose quality, and making (or otherwise sourcing) programs with
39
See also Chapters 1 and 6 of this volume for further discussion of the theoretical literature on content
choice in media markets. See also
Liu et al. (2004) and Godes et al. (2009) for applications to television
markets.
40
This discussion is adapted from the model presented in Armstrong (2005).
297
The Economics of Television and Online Video Markets
quality q requires a fixed cost C(q). Suppose that viewers demand content with quality q
and total viewing price P is x(Pjq), where x increases with q. Adapting expression
(7.3)
implies that the broadcaster’s total profit is
xPjqðÞRPðÞCqðÞ, (7.7)
where R is R
pay
or R
free
according to the regime.
If the broadcaster is unregulated, it chooses (P, q) to maximize this expression. The
broadcaster may be regulated in one dimension and be free to choose the other. The
relevant comparative statics—for example, how quality is affected by a constraint on
price—depends on the precise way in which quality and price interact in the demand
function. A simple case to illustrate the possibilities has quality expand the market pro-
portionately, so that x(Pjq) ¼qX(P). In this case,
(7.7) implies that the choice of P does
not depend on chosen quality. This implies that a regulation which forces the broad-
caster to raise its program quality, if feasible and if it does not cause it to go bankrupt,
will benefit viewers.
If X(P)R(P) is single-peaked in P and total price is below the maximizing price, then
the broadcaster’s choice of quality is an increasing function of P. Thus, as is intuitive,
when it is permitted to charge viewers a higher price, the broadcaster responds by raising
its quality. For example, consider a regulatory policy which puts a ceiling on advertising
intensity in the free-to-air regime. For fixed quality, this policy surely benefits viewers, as
it lowers the effective price they pay. But the policy reduces the revenue per viewer the
broadcaster can extract from advertisers, and this may reduce its incentive to invest in
quality and the combined impact on viewers could be negative. Likewise, in the pay-
TV regime, a regulatory ceiling on the direct charge the broadcaster can levy on viewers
might be counter-productive once the firm’s quality response to the lower price is taken
into account. Finally, a regime shift from free-to-air to pay TV, which we know will
harm viewers with quality held constant, may benefit viewers once the firm’s likely boost
to its quality is factored in.
Another concern was the danger that competing broadcasters would duplicate pro-
gramming, while a monopoly broadcaster could have greater incentive to provide
diverse output. This is a genuine danger in a free-to-air market with limited channels,
but less so with pay TV. For instance,
Steiner (1952) analyzes a rather extreme model
where each viewer only considers watching a single type of content, and prefers to
switch off rather than watch anything else. To illustrate, suppose there are just two types
of channels, A and B, with respective audiences n
A
and n
B
and per-viewer surpluses
v
A
and v
B
. For simplicity, suppose that program costs are zero and there is no viewer
disutility from advertising. Then a monopoly broadcaster with two channels will choose
to offer both types of channels in order to maximize its total audience. (This is true in
both the free-to-air and the pay-TV regime.) In the ad-funded world where each of
298 Handbook of Media Economics
two channels is provided by a separate broadcaster, it may be that both choose to offer
the same program type.
41
The general principle is that when broadcasters charge viewers directly for content,
they have an incentive to differentiate their content in order to relax price competition.
More modern treatments of this issue have tended to use a Hotelling model as a way to
capture the choice of genre (or other aspects of content such as political stance). In such
models, it is well known that when rivals cannot compete with price, there is a tendency
to converge to the middle of the Hotelling line in a bid to maximize market share. This is
a reasonable reflection of a free-to-air broadcasting market where broadcasters cannot
affect advertising intensity (or viewers do not care about advertising intensity). As such,
this model bears out the intuition that ad-funded broadcasters often offer the same fare.
However, in a pay-TV regime where broadcasters can charge viewers directly, there is a
tendency to choose locations which are far apart so as to relax price competition.
42
Gabszewicz et al. (2001) study a Hotelling model when media duopolists first choose
location and then compete for consumers. Consumers are assumed not to care about
advertising intensity (i.e., δ ¼0 in the above notation), and so a media outlet chooses
its level of advertising purely to maximize advertising revenue. If this revenue is so great
that outlets offer content for free to consumers, they find that the outlets duplicate their
content, while if positive prices are offered in equilibrium the outlets differentiate their
offerings. This analysis was extended by
Peitz and Valletti (2008) to allow for advertising
disutility (which is more relevant in television markets than in the newspaper context con-
sidered by
Gabszewicz et al., 2001). They find that with pay TV, broadcasters differentiate
their content to the maximum extent, as in
Gabszewicz et al. (2001), while in the free-to-
air regime broadcasters do differentiate their content to some extent, for otherwise
competition for viewers who dislike ads would force their advertising levels to zero.
7.3.2 Evaluating the Simple Model
7.3.2.1 Testable Implications
Under its maintained assumptions, the preceding model produces a number of testable
implications about differences in outcomes in ad-supported and pay (ad plus subscriber-
supported) television markets that I summarize here.
41
This is the case when audiences are significantly skewed, in the sense that n
A
>2n
B
, when a broadcaster
prefers to get half the mass market rather than all of the niche market. However, if broadcasters can charge
viewers, they are more likely to choose distinct program types in equilibrium. If they choose the same
content A, say, competition drives the viewer price to zero, and they each obtain profit (1/2)n
A
r, while
if they choose distinct program types they can extract viewer surplus, and so one firm obtains n
A
(r + v
A
)
and the other obtains n
B
(r + v
B
). It is an equilibrium to choose distinct program types when
1=2ðÞn
A
r < n
B
r + v
B
ðÞ, which is a weaker condition than in the ad-funded regime.
42
See d’Aspremont et al. (1979) for this analysis.
299
The Economics of Television and Online Video Markets
• Prices and Welfare: The total price to viewers (i.e., the subscription price plus the dis-
utility from advertising) is higher in pay TV than ad TV under both monopoly and
oligopoly, and so, conditional on the content being offered, viewers and advertisers
are worse off in pay TV, with broadcasters better off.
• Content Choice: Because of this increased profitability, broadcasters will offer more
content in a pay-TV environment. Furthermore, where both free and paid content
are available, lowest-common-denominator programming will be offered on free
channels and niche programming will be offered on pay. Finally, we should see max-
imal content differentiation in a pay-TV oligopoly.
• Quality and Regulation: Optimal quality increases with total price (and thus should be
higher in pay markets). Regulations that cap prices or advertising levels will lower
quality and viewer surplus.
Unfortunately, one cannot take these predictions directly to the data, as there is a sizeable
gap between the simple model’s maintained assumptions and the institutional character-
istics of TV markets, including multi-homing consumers, multi-dimensional prefer-
ences, multichannel firms, competition within and between commercial broadcasters,
public service broadcasters, and pay-television providers, and unmodeled heterogeneity
in utility of content, disutility of ads, costs of program production and quality choice, and
regulatory constraints across countries. As an example, a model allowing heterogeneous
disutility of ads and competition between a single broadcast and pay provider offering
identical content but with a different mix of advertising versus subscriber payments
would likely yield, in contrast to the first prediction above, (relatively) ad-loving con-
sumers facing a lower total price from the broadcaster, ad-hating consumers facing a
lower total price from the pay operator, and the consequent self-selection of consumers
into the environment that suited them best.
43
7.3.2.2 What Can We Learn?
The theory instead has been useful in at least two distinct ways: identifying both the vari-
ables of economic interest and the mechanisms by which different economic environ-
ments (e.g., broadcast vs. pay support, monopoly vs. oligopoly) determine welfare
outcomes in television markets, mechanisms that are likely to continue to operate in
richer theoretical environments, and identifying relevant model primitives on which
to focus empirical research. As examples of the first type, I highlight several data patterns
from
Section 7.2.
43
My thanks to Simon Anderson for this example. As a historical note, the television theory literature’s focus
on the tradeoffs between broadcast and pay-television regimes going back to
Steiner (1952) and Beebe
(1977)
reflects the combination of capacity and regulatory constraints that limited the development of
the pay-television sector. Pay television’s large and growing dominance of television markets evident
in
Figures 7.9, 7.12, 7.13, 7.14, and 7.16 has, however, largely mooted this as a policy question. We
all want our MTV.
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Handbook of Media Economics
On the topic of content choice, the handful of networks in the US broadcasting sector
described in
Table 7.1 versus the hundreds of pay-television networks summarized in
Tables 7.2 and 7.3 suggests the ability of pay-television networks to better extract viewer
surplus indeed likely enables them to offer more content than can ad-supported net-
works, particularly in a multichannel world that limits the ability to build the kinds of
large audiences of greatest value to advertisers.
44
Similarly, the immense variety of avail-
able pay-television channels in these same tables suggests significant (if not maximal) con-
tent differentiation is occurring in pay-television markets. Whether the mechanism
driving this differentiation is the desire of programmers to enhance market power over
their audiences with advertisers (the motivation of the effect originally developed in
Peitz
and Valletti (2008)
using a similarly stylized modeling environment) or to enhance mar-
ket power over their subscribers in negotiations with distributors (an unmodeled effect) is
an interesting open research question. Regarding quality choice,
Figures 7.6 and 7.14
indicating the simultaneous growth in pay-television price and quality (as measured
by programming expenditure) and constancy in broadcast television quality suggests
the complementarity of quality and price identified in the simple model may be a robust
theoretical prediction.
45
Further theoretical work on all these questions would be
welcome.
As for empirical work identifying model primitives,
Wilbur (2008) and Analysys
Mason and BrandScience (2010)
both estimate consumer sensitivity to advertising (δ),
but obtain very different results: the former, using aggregate ratings data, estimates an
elasticity of approximately 2.5, while the latter, using household viewing data, estimates
an elasticity indistinguishable from zero. As it is an important input into the welfare effects
of advertising (and thus advertising support), further estimates of this key parameter
would be useful. Furthermore, several papers have estimated preferences for program-
ming (v), research on which I summarize in more detail in
Section 7.4.4.
While welcome, there remain important features present even in the simple model
that have not received much, if any, attention in empirical work. Examples include
accounting better for the simultaneous influence of both subscriber and advertiser
44
Similarly perhaps for program choice within networks of different types: Crawford (2007) found that
there are important differences between the programming provided on broadcast versus cable networks,
with “niche” or special-interest programming less widely available on broadcast channels than is general-
interest programming (and vice versa on pay).
45
A final example is the possible concordance between the predictions of the simple model about subscriber
price caps. That such caps would reduce quality has found support in the literature evaluating such reg-
ulations imposed by the 1992 Cable Act (
Besanko et al., 1987, 1988; Crawford, 2000, 2013; Crawford and
Shum, 2007
). Assessing the quality effects of caps on advertising minutes remains an open question; see
Analysys Mason and BrandScience (2010, Annex E), Crawford et al. (2012a), and Filistrucchi et al. (2010)
for related research.
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The Economics of Television and Online Video Markets
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