FCC Chairman Caves, Economics of Lobbying Prevail (sort of)

The effort to impose new cable television regulations that renewed discussion of selling subscriptions to individual channels has apparently collapsed under strong pressure from cable companies.

However, potential changes in ownership restrictions and other regulations, not the sale of individual channels, were behind the collapse. Reports this morning say a Nov. 27 meeting of the Federal Communications Commission delayed a decision on the new rules because of a dispute over data showing how many people actually subscribe to cable.

If more than 70 percent of consumers have access to cable -- a number that is not in dispute -- and more than 70 percent of them subscribe, the FCC will have legal authority to limit ownership of cable companies. FCC Chairman Kevin J. Martin argues the 70 percent subscriber threshold has been met, but the industry and other members of the commission disagree. (Chloe Albanesius at PCMag.com does a good job explaining details of this argument about subscriber data.)

A Battle to Capture the FCC

The cable companies' effort to block new regulations at first appears to be a textbook example of why regulators often favor the interests of the industry they regulate. However, this is a case where the interests of three major media industries are at stake.

Clearly, if you own a cable company, you don't favor regulations that restrict which systems you can buy. Cable companies are also a relatively small group compared to millions of subscribers and advertisers also affected by ownership rules.

That means there are relatively low costs of organizing cable companies to talk to each other, negotiate a common position on the proposed regulations, and then hire people to contact government officials and argue their case. What I've just described, of course, is an industry association. Cable is represented by the National Cable & Telecommunications Association.
It costs far more for consumers or advertisers to create similar organizations. Advertisers tend to consider themselves part of an industry represented by an industry association, and not the larger group of all businesses that advertise on cable.

There are too many consumers to organize into a single group, even with instant communication. Some Washington groups, like the Consumers Union, do represent consumers and have been active on this issue. But these groups don't represent cable subscribers and their interests in the exclusive way that the industry association represents cable owners.

The difference means the industry probably has more focus, and resources, available to lobby the FCC. The effort to block new regulations included a meeting with top White House officials.

There are More Than Two Sides in This Fight

Groups representing another powerful industry are also in this fight. Chairman Martin says the new cable regulations will increase competition, lowering prices and increasing the range of voices on cable television.

However, Martin separately wants to change a long-standing regulation limiting newspaper company ownership of broadcast television stations. This rule prohibits a newspaper from owning a television station in the same market to ensure there are multiple media voices with diverse views.

Martin accepts newspaper industry arguments that the cross-ownership rule should be relaxed because of competition from new forms of media. The newspaper industry, of course, has its own association to lobby for its interests, the Newspaper Association of America.

Commissioners like Jonathan S. Adelstein, who might agree with Martin on cable, suspect he will use the cable changes to also push for a relaxation of the cross-ownership rule, decreasing competition in newspaper and broadcast markets.

Cross-ownership also evokes a strong response from the public. Consumer groups, such as the Media Education Foundation and Common Cause, are working to keep the cross-ownership rule. But consumer groups also support Martin's proposed changes for cable.

So, perhaps yesterday's collapse was inevitable. This is not a case where just one industry is trying to capture the FCC. Instead, multiple well-organized industries are competing against each other to capture the FCC. Meanwhile, less well-organized consumers are taking different sides depending on the issue in dispute.

Thinking About Buying Cable a la Carte

The Federal Communications Commission is making serious noises about new regulations for cable television, including allowing subscribers to buy channels one at a time. This idea is likely to have strong superficial appeal for anyone paying for channels that they never watch -- a group that may include most cable subscribers.

But, as Joe Nocera points out in his New York Times column, if a la Carte programming becomes a reality, subscribers are likely to regret it on the morning after. He writes artfully about the politics and likely effects of a la Carte, but leaves some larger questions untouched.

The proposal is supported by consumer groups, groups worried about sex and violence, and FCC Chairman Kevin J. Martin. This is one of several major regulatory changes being considered. The FCC is also revisiting rules on cable ownership, access to cable channels for producers of independent programs, and rules barring companies from owning newspapers and broadcast stations in the same market.

But the change in subscriptions would have the most immediate effect on consumers. Nocera does a nice job explaining why a la Carte programming would leave many subscribers paying more than they do now.

Fewer Subscribers Will Increase Cable Prices

Networks charge cable operators a fee based on the number of subscribers. Cable operators can spread the cost of, say, The History Channel across everyone who pays for the bundle that includes this channel, even if many don't watch programs about history. That keeps each subscriber's cost below the amount that would be charged if only those who watch The History Channel subscribed. This is true even for for channels with wide appeal, Nocera reports:

"Take, for instance, ESPN, which charges the highest amount of any cable network: $3 per subscriber per month. (I’m borrowing this example from a recent research note by Craig Moffett, the Sanford C. Bernstein cable analyst.) Suppose in an à la carte world, 25 percent of the nation’s cable subscribers take ESPN. If that were the case, the network would have to charge each subscriber not $3, but $12 a month to keep its revenue the same."

The proposal faces stiff opposition in congress. This is probably because legislators don't want to risk the wrath of voters if predictions like the one for ESPN prove correct.

Do Market Economics Favor a la Carte?

But what is good for cable subscribers and good for congress may not be good economics. A basic principle of market economics holds that people should only pay for things they want. If people have to pay for things they don't want, it creates distortions in the distribution of goods and the use of resources to produce those goods. Consumers end up getting more than they really want of some things, and not enough of others.

This argument suggests we may be getting too much programming about history, and too much programming about sports. (You decide which networks we don't get enough of.)

Sophisticated supporters of a la Carte are likely to make this argument, and it will carry some weight. That is because the argument holds true unless cable programs fall into the category of goods that are exceptions to some general rules of market economics.

NBC Breaks the IPod's Chains

NBC is ending sales of its popular programs on Apple's popular Itunes, making digital versions of "The Office" and its kin available for free from the network. Viewers will watch the programs for 7 days before the file self destructs, but they won't be allowed to avoid the commercials. The network will also sell commercial-free versions that don't vanish from the customer's hard drive.

There are good reasons to question the move, which comes as Apple is reintroducing its ubiquitous Ipods with attractive new features, colors and advertising. But there is a chance NBC will succeed at bending the economics of the Web away from Apple and toward the network's own interests. If NBC succeeds other producers and distributors are also likely to abandon Itunes.

Problems the Network Must Overcome

NBC will lose serendipitous sales to the horde of Ipod customers who --they have no other choice --repeatedly visit the site searching for particular videos or music, and then pick up a couple of NBC programs along the way. The customers who arrived at Itunes actually looking for NBC programs will now have to find and navigate a separate website before they can watch their favorite shows.

NBC may raise the price for commercial-free downloads of its programs, charging as much as $3 more than Apple's current price of $1.99. Viewers who don't want to pay more will be left with nothing 7 days after downloading the version that won't let them avoid commercials.

All of these changes mean NBC must expect a decrease in paying customers. The potential rewards, however, could more than make up for any short-term losses.

Fighting the Power of Steve Jobs

Apple still enjoys its image as a benevolent revolutionary created by the famous commercial comparing Microsoft to Big Brother. But to NBC, Apple is using its power to produce profits by limiting its suppliers' choices.

This is because Apple is a hardware company, and Ipods provide a major part of its revenue. Ipods are useless without videos or music, so Apple created Itunes to offer downloads at uniform, relatively low, prices. This encourages consumers to buy more videos and music than they might otherwise be willing to buy.

However, Itunes only works with Ipods. The more downloads that a customer buys, the more expensive it becomes to switch from Apple's Ipod to a rival's video and music player, even if the rival is cheaper.

This leaves producers and distributors like NBC almost no leverage to negotiate with Apple. An estimated 40 percent of downloads on Itunes come from NBC. But NBC must accept whatever wholesale price Apple offers, even if that price is below NBC's costs, or below what NBC thinks it could earn if it wasn't forced to sell programs through Itunes.

How NBC Hopes to Earn a Profit

So the network will instead turn itself into a rival to Itunes. At first, it will only offer the free version of its videos. A service that allows customers to buy programs for PCs and portable players, including Ipods, should be available by the middle of 2008.

By offering free videos, NBC is using a classic strategy for entering markets by selling a product below cost. NBC expects to build demand for its new service this way, then begin offering the versions that viewers must pay for. (This strategy is frequently used with new software products).

But I expect NBC will not stop offering the free, self-destructing versions of its programs. These versions will be downloaded by viewers who are not willing to pay, or are not interested in repeatedly watching the same episode over long periods. NBC will earn revenue from the commercials.

Viewers who place a higher value on repeatedly watching programs over long periods will pay for the commercial-free versions. Even if the new price is higher than Itunes, NBC can increase its total revenues if the Itunes price was below the range where most viewers are sensitive to price increases.

Formally, changing different consumers different prices for versions of the same product is called price discrimination. Economist Hal Varian argues the low cost of digital reproduction makes what he calls "versioning" to allow price discrimination increasingly important to the Web.

Other scholars criticized media companies in an article in the International Journal on Media Management ¹ for not taking advantage of digitization to adopt price-discrimination strategies that can increase the profitable distribution of their products.

NBC has now decided to try just that. The network's experiment will test the theoretical arguments in demanding market conditions. If NBC succeeds, the dynamics of Internet competition will once again change in dramatic and interesting ways.
¹ Chang, B.H., Lee, S.E., & Lee, Y.H. (2004). Devising video distribution strategies via the Internet: Focusing on the economic properties of video products. The International Journal on Media Management, 6(1 & 2), 36-45.

Ownership Matters: Murdoch, Dow Jones and the Importance of Family

The Bancroft family meets Monday, July 23, to finally decide if they will sell Dow Jones & Co. to News Corp., the company that is Rupert Murdoch's global media behemoth. This may be the last of four separate deals involving seven companies with journalistic reputations that were established over decades.

Dow Jones owns the Wall Street Journal, respected for prize-winning news coverage viewed as independent of the newspaper's ardently conservative editorial page, and of the Bancroft family interests. News Corp. owns companies like the New York Post and Fox News, viewed as spiking journalism with sensation and conservative politics that reflect Mr. Murdoch's views. Much coverage of the pending sale has therefore focused on whether News Corp. will remake the journalism at Dow Jones to conform with Mr. Murdoch's desires.

As of this post, it seems likely the sale will go through. Directors at Dow Jones voted for the deal last week. The Bancrofts control almost two-thirds of the shareholder votes needed for final approval. The International Herald Tribune reports the family's stock generates about $20.6 million in dividends each year that must be divided among more than 30 people. The newspaper reports a sale could give the family enough cash to generate $52 million a year if the cash were invested conservatively.

The family is divided about the sale, but even members who regard Mr. Murdoch as a threat to good journalism have searched for alternate buyers or investors . Newspapers in markets with high-speed wireless and Internet connections are taking stiff financial blows as advertisers move online. Mr. Murdoch is offering a premium for Dow Jones stock, making a vote to reject his offer a vote against the best financial interests of other company stockholders. Journalistic principles, alas, cannot generate enough immediate revenue to overcome this financial imperative.

Family Influences

If the deal goes through, the sale of Dow Jones to News Corp. will join the sale of Knight Ridder to The McClatchy Co., the sale of The Tribune Co. to real-estate investor Sam Zell , and the sale of Reuters to The Thomson Corp. on a list of acquisitions involving companies deeply involved in the production of news. In each case, at least one of the companies is also known for its founding family, or families.

Family ownership has cachet in the newspaper business. The New York Times Co. and the Washington Post Co. are controlled by families that place a high value on journalistic excellence, sometimes at the expense of their short-term economic interests. There is also systematic evidence that control by families or executives at public companies increases the financial commitment to those companies' newspapers.¹

However, the four deals show family influence varies. A significant number of Bancrofts want to sell Dow Jones. Mr. Murdoch's father was a journalist.

The Chandler family, best known for owning the Los Angeles Times, had a significant minority stake after their company merged with the Tribune Co. The Chandlers pushed hard to sell the Tribune Co. when Mr. Zell offered a deal that would maximize their financial returns and minimize the taxes they owed.

Knight Ridder was known for distinguished journalism, and its last CEO was a member of one of the founding families. However, Anthony Ridder was unable to fend off stockholder pressure to sell the company's 32 newspapers. McClatchy is also controlled by a family that values journalism, but it did not keep 12 Knight Ridder papers, including some with national reputations, because they weren't in growing markets.

Roy Thomson said money, not news, drove his ambitions, and he built Thomson into a multinational company. The company owned dozens of dailies in the United States, but their news coverage was considered mediocre. Thomson sold its U.S. newspapers around 2000 as it reinvented itself as a provider of specialized information. Reuters, which began as a news service in 1851, is heavily invested in financial services. The acquisition by Thomson will merge established news companies that refocused their operations to take full advantage of new media technologies.

These four cases show the relationship between good journalism and family ownership varies, particularly at companies facing enormous economic pressure. There are other variables that probably play an important role in determining the outcome of such deals. Those variables will be examined in my next post.

¹ Lacy, S., Shaver, M.A., & St. Cyr, C. (1996). The Effects of Public Ownership and Newspaper Competition on the Financial Performance of Newspaper Corporations: A Replication and Extension. Journalism & Mass Communication Quarterly 73,(2): 332-41.

Of Search Engines, Ad Prices, and Blind Sales

A report that Google and Yahoo are losing ad sales to an upstart might, at first glance, raise doubts about the search giants’ understanding of the advertising business. However, a closer look suggests the famously smart people at Google and Yahoo know exactly what they are doing.
The article in Monday’s New York Times reports a new company, Quigo Technologies, convinced Fox, ESPN, and Cox Enterprises to abandon the search giants as providers of text advertising. These ads appear beside your search results in response to the words you are searching for.
Quigo, unlike Yahoo and Google, tells advertisers where ads appear on the web and allows advertisers to buy ads on specific sites, the Times reports.
It may seem odd for search giants to conceal this information because advertisers target people likely to buy their products. So most advertisers want to appear on websites with content that attracts large numbers of people potentially interested in their products – if you sell sporting goods, you want to be on the big sports sites.

How Search Advertising Works

According to Advertising Age, the search giants make most of their money from these text ads.
Advertisers buy key words, and their ad appears when those words are typed in a search engine. The advertiser only pays if someone clicks on an ad. Advertisers bid a certain amount for each click, and that determines how often and where their ads appear.
The search giants display the ads on their pages and on innumerable other web sites participating in their advertising programs. The advertiser knows how many clicks it paid for, but not where the clicks came from.
If advertisers knew ads were appearing on sites they want to target, wouldn't they buy even more ads? So why is this information concealed?

Concealing Information Increases Ad Revenues

I am indebted to Roy W. Kenney and Benjamin Klein , authors of a 1983 article in the Journal of Law and Economics (cite below), for this explanation:

Advertisers consider some web sites to be better than others. They may be attracted by the large number of sites available through Google and Yahoo, but most advertisers would probably like to select some sites and ignore the rest.
But advertisers cannot select sites, so they must instead estimate the average value of a click from all sites, desired or not. Many people who click on an ad will not buy anything. And sites with small amounts of traffic probably have smaller proportions of buyers among those who do click on ads.
So the best sites will generate large numbers of clicks and many more likely buyers. Another way to think of this is that average sales per click will be much higher on the desirable sites.
If advertisers could identify the desirable sites they would bid more for those, and advertising would be concentrated there. But Google and Yahoo would be forced to sell ads for much less on the undesirable sites, and their total advertising revenue would decline.

Two Alternatives

What if Google and Yahoo instead offered to sell advertisers web sites in groups -- or bundles -- and included some less desirable sites in each bundle? Buyers would look for bundles they considered bargains, and only bid for those. The search giants would be forced to sell ads on the remaining bundles for less than buyers would pay if they did not know what bundle they were getting.
Another alternative would allow buyers to experiment, buying ads on a variety of sites to see which sites produced the best results. Advertisers would make adjustments after their initial purchase, asking the search giants to redirect ads to sites generating the most sales. But this would be costly for the search giants. It would also have the same effects on ad prices and revenues as the other alternatives.

A Change is (Probably) Gonna Come

The existing arrangements also make it possible for Google and Yahoo to distribute ads differently than expected. For example, an ad on 1,000 blogs might generate 1,000 clicks, but few buyers. The same ad on a few big news sites might generate the same 1,000 clicks and deliver far more potential buyers. Google and Yahoo are asking buyers to trust that this is not happening.
The Times article also reports some buyers are worried about click fraud. This happens when people click on ads just to generate revenue for the sites where they appear (Google and Yahoo share some of the revenue with the site).
The article says Google is planning to give advertisers more information about where ads appear. The search giant is feeling competitive heat from companies like Quigo. It will be interesting to see what happens next.

(The cite for the Kenney and Klein article, "The Economics of Block Booking," is Journal of Law and Economics, Vol. 26, No. 3. (Oct., 1983), pp. 497-540.)

Competition and the satellite radio merger

Prof. Stephen Lacy of Michigan State University is this blog's first guest commentator. He has this response to my Feb. 21 suggestion that prices will be higher if the two satellite radio companies are allowed to merge:

"The particular blog prompted an idea about substitutes. Satellite really has two submarkets -- in the home and in the car.
In the home, Sirius and XM compete with the three-dozen or so music channels on digital cable, iPods and with specialized Web sites such as Pandora.com. In the car, the companies compete with iPods, books on tape and CDs.
These are all pretty good substitutes for music, which suggests satellite will differentiate itself with programming other than music. In other words, the potential price increase might be acceptable because of programming that might not otherwise be available."

(Full disclosure: Prof. Lacy was my dissertation advisor.)

Things to consider about satellite radio

The proposed merger of the satellite radio companies, XM and Sirius, is getting a lot of attention because of the size of the deal (Bloomberg reports its worth $4.84 billion), because of uncertainty about how federal regulators will view the deal, and because consumers might be hurt by the reduction in competition.
The companies have about 14 million subscribers between them, each paying about $13 a month or more. A rough estimate suggests the merger would result in a company with subscriber revenues of at least $2.18 billion a year. However, the Chicago Tribune says the companies lost a combined $7 billion getting started, and the new company would have about $1.6 billion in debt. The companies argue the merger is critical to their survival because of intense competition from programming on the Internet, cell phones, and broadcast radio.

Some questions for regulators

Regulators at the Federal Communications Commission must approve the deal, or it won't happen. It won't be easy for the FCC to evaluate the arguments that consumers are substituting all of those alternatives for satellite radio.
First, consumers pay to receive satellite radio, but not for advertiser supported radio or Internet programming. But the best way to tell if goods are substitutes is by measuring the relationship between the price of one good (satellite radio) and the demand for other goods (everything else). How do you measure the influence of price if consumers can get the substitute goods for free?
Second, the market for earthbound broadcasters is defined by the reach of their radio signal, but the market reached by a satellite is not limited this way. And there is no good way to define the geographic extent of a market on the Internet.
I'm skeptical that all of the other media being cited by the companies are substitutes -- many people who consume free radio would not be willing to pay for the same programming. This does not mean the companies' arguments lack merit, but it's in their interest to push their definition of the market to the limit.

What about consumers?

There are two possible ways consumers could be hurt. First, the merger probably will result in higher prices. Second, the range of programming might be reduced.
The second point first. Phil Rosenthal at the Chicago Tribune points out that XM and Sirius offer different programming -- one has Howard Stern, and the other Oprah, one has football, and the other has baseball. So customers who like particular genres, such as sports, have to subscribe to both XM and Sirius to get all of the programming they want. However, it's unlikely many people are actually willing to pay for both services, not to mention impractical.
Customers who want programs on the service they don't subscribe to would be better off if the merger goes through. The new company will probably offer all the programs now offered separately because elminating programming means the new company would lose customers.
As a general rule, increasing the range of programming at a merged company would increase the number of subscribers. For instance, sports fans and opera fans would subscribe if they could both find programs they liked for a price they were willing to pay.
This goes back to the first point. Prices will probably increase, but subscribers will probably get more programming. Customers should pay more if they are getting more.
But will the new prices be so high that they cannot be justified by the increased programming?
This might be the outcome if the new company can monopolize its segment of the radio market. And that is why the market definition that the FCC adopts will be so important to this proposed deal.