Cable TV: Socialism that Works?

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We’re frequently told that if cable companies would allow us to buy channels à la carte, we could save lots of money by not having to pay for all those hundreds of channels we never watch. As the following numerical example illustrates, however, channel bundling may actually enable cable companies to provide offerings that many of us like better than what we’d get under an à-la-carte system.

The key feature of the example is one that also figures prominently in other digital content markets—namely, that the costs of production are mostly fixed: Once content is in hand, the marginal cost of serving additional consumers is essentially zero. Normal intuitions about pricing often break down under these conditions, and that’s what happens here.

For simplicity, suppose there is one premium channel that everyone would like to have (call it HBO) and 100 fringe channels, none of which is valued by more than a small proportion of potential viewers. Suppose there are 120 million potential subscribers in total, that their maximum monthly willingness to pay for access to HBO and the 100 fringe channels is as summarized in this table:

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If the cable company sold HBO separately, their best bet would be to gouge the rich TV fans, selling 10 million subscriptions at a price of $70 each, for $700 million in monthly revenue. They’d also sell 120 million subscriptions to the bundle of 100 fringe channels at a price of $5 each, for another $600 million in revenue. Total monthly revenue: $1,300 million.

Now suppose they can offer a premium bundle consisting of the 100 fringe channels plus HBO. Their best bet would then be to charge $20 a month for that package, at which price they’d sell 50 million units, for monthly revenue of $1,000 million. They’d also sell another 70 million monthly subscriptions to the 100 fringe channels at $5 each, for another $350 million in revenue. So total revenue would be $1,350 million, or $50 million more than before. Yet no subscriber would end up with a package that’s worse than before, and 10 million former HBO à-la-carte subscribers would be paying $55 a month less than before for the combination of HBO and the fringe channels.

This is obviously just a hypothetical example. But it captures the basic idea that when the marginal cost of serving additional subscribers is zero, the average cost of serving each one necessarily goes down whenever sellers can price their offerings in ways that result in increased numbers of units sold.

Tech industry analyst Ben Thompson has described the current cable bundling system as “socialism that works,” offering data suggesting that the implications of my numerical example are hardly farfetched. No one should be surprised, then, if prices for channels like HBO and ESPN go up sharply if cable providers are forced to offer them as stand-alones. That wouldn’t be a good thing for the people who now get those channels as part of a cheaper cable bundle, nor would it help those subscribers who don’t care about the channels.

 

Author: Robert Frank

Robert H. Frank is the Henrietta Johnson Louis Professor of Management and Professor of Economics at Cornell's Johnson Graduate School of Management and the co-director of the Paduano Seminar in business ethics at NYU’s Stern School of Business. His “Economic View” column appears monthly in The New York Times. He is a Distinguished Senior Fellow at Demos. He received his B.S. in mathematics from Georgia Tech, then taught math and science for two years as a Peace Corps Volunteer in rural Nepal. He holds an M.A. in statistics and a Ph.D. in economics, both from the University of California at Berkeley. His papers have appeared in the American Economic Review, Econometrica, Journal of Political Economy, and other leading professional journals. His books, which include Choosing the Right Pond, Passions Within Reason, Microeconomics and Behavior, Principles of Economics (with Ben Bernanke), Luxury Fever, What Price the Moral High Ground?, Falling Behind, The Economic Naturalist, and The Darwin Economy, have been translated into 22 languages. The Winner-Take-All Society, co-authored with Philip Cook, received a Critic's Choice Award, was named a Notable Book of the Year by The New York Times, and was included in Business Week's list of the ten best books of 1995. He is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought. He was awarded the Johnson School’s Stephen Russell Distinguished teaching award in 2004, 2010, and 2012, and its Apple Distinguished Teaching Award in 2005.

13 thoughts on “Cable TV: Socialism that Works?”

  1. Among Bob's pricing schemes, some are less bad than others, but do not leave this post without realizing that all are selling content far above marginal cost, and are therefore wasteful compared to providing content efficiently. The right price to customers for digital content is free = $0 = zip = nada , just like the right price for walking on the sidewalk.

    1. Michael, I'm not sure I understand your point about marginal cost.

      Suppose it costs $20 million to produce a season of The Sopranos. The marginal cost of delivering it to me, and every subscriber after the first, is $zero. Are you supposing that the first subscriber should pay $20 million (plus a reasonable profit markup) and I (and everybody else after Subscriber Number 1) should get it free?

      The right price for walking on the sidewalk is zero because even Republicans recognize the efficiency as well as the necessity of using taxes to pay for sidewalks. I.e., you just can't find a way to collect tolls, and even if you could, a Republican administration putting tolls on the sidewalks would spell the end of the Republican Party for the rest of the century. The right price for driving across the Golden Gate Bridge might be zero, as well, if everybody agreed the bridge should be paid for by taxes, but that's not the general view of people who live in Vermont, or people who live in Los Angeles, or even people who live in San Francisco if they never drive north.

      1. There's a set of people that confuse the market clearing price of a good with the "right" price of that good. In general, the market clearing price is the one at which the cost to produce an additional unit of the good equals what the next consumer is willing to pay for it. That's the price at which the supply and demand curves intersect, and thus the price at which Econ 101 tells you the good will be available.

        The real world is more complicated than that, and the behavior of goods in which the fixed costs are large and the marginal cost of every unit after the first is effectively zero is one situation in which the above concept breaks down. That does not prevent those people from asserting that the "right" price is zero, although a working definition of "right" proves to be slippery when you try to pin it down, because those pesky fixed costs and the equally pesky profit margin do not fit at all well into the assertion. Nevertheless, you end up with people insisting that they ought to be able to have that good at the "right" price, no matter what the producer thinks.

        I, of course, say this as someone who is a producer of a zero marginal cost good as well as a consumer of them. At some point, you people had better pay me for my novel.

      2. For goods like this (declining marginal cost=public goods), we have a few basic options. We can have government buy it with tax money, presumably the government of the jurisdiction where the consumers mainly live, and give it away free. That's what we do with sidewalks, police, the army, etc. We can wait to see if anyone can charge enough to cover its fixed costs (what we do with cable and are trying to do with music, newspapers, etc.) knowing that everyone who would pay more than nothing but less than that price will go without, leaving value on the table (waste). We can hope someone really rich will buy it and give it away. Or we can just go without.
        The last of these is good choice if the area under the demand curve is less than that big fixed cost: we don't build many parks, sidewalks, etc. that we could and obviously this isn't always wrong (cf: bridge to nowhere, the other type of waste).

        This has one further complication when (unlike watching a TV show but like driving on the GG bridge) the good is congested, so if I use it there's less of it for you. In this case not rationing access somehow is wasteful, and some means of rationing, like waiting in line, are also wasteful. The best solution is (still respecting the price = marginal cost rule) probably going to be a non-zero price.

        1. Please explain how you do this with music or writing. Are you going to pay everyone who writes a wage for it? Is the government going to buy every work of fiction that is produced? Or are you going to have the government picking and choosing which works it should buy?

          The thing about sidewalks and freeways is that you can figure out how much of them you're going to need and, once you do, asphalt and concrete are fungible. So it is plausible for the government to just go ahead and purchase them. This does not translate to art.

          1. This is a really important question (that I've posted about in the past; search "non-rival goods" or, e.g., http://www.samefacts.com/2010/05/everything-else/… ). For digital content — not just art, but news and almost all public deliberation — technology almost certainly provides a solution, whereby consumers pick and choose what they want to engage with and pay for it with taxes. Not having a bureaucrat choose content, and preserving privacy so the government knows someone listened to the "Down with everything blues" but not who did, are important design constraints, but not fatal.

          2. I can't find anything that actually lays out this policy, other than a full book that I don't intend to add to the large stack of books I'm still waiting to getting around to reading. (There are also some academic papers, but they tend to be more expensive than the book, plus suffering from the problem that academics seem to choose paper titles with the intent of making it impossible to tell quite what that paper is about.)

            So, without reading any of the details, I have some issues. For one, it would mandate that the government collect the data and have access to a list of everything that you purchase or read. The privacy implications here are not good. That's especially true if the payment scheme is based upon what people actually read, rather than the large pile of stuff they'll never get around to but downloaded anyway because it's free. Amazon is currently dealing with this headache as it changes the way that it pays authors for works that are borrowed rather than purchased.

            I also don't think it gets around the problem of the government deciding what content is valuable. It is going to have to decide what each individual work is worth in tax payment per engagement, which entails all of the problems of picking which works to pay for. You could get around this by having a flat rate per work or per word, but that would be manifestly unfair, as some books are much more time and labor intensive, even on a per word basis. If the choice is per word, I suspect it would also encourage even more bloat in books that really ought to be edited down.

            So, I'm still completely unconvinced by this whole concept.

  2. Part of the problem with this argument is that it is a false dilemma: Either "there shall be no bundling of any channels at all" or "the provider shall lump dozens or hundreds of channels together (for purported administrative simplicity)." As a specific example, consider the subset of religious-broadcast channels frequently lumped into one's "basic cable" subscription. I would just as soon not pay for them; one of the first things I do is to block all of them on my remote and channel listing when I set up a new TV subscription. (And the less said about the "shopping channels," the better.) There's room for compromise here: Allowing "sub-bundles" of a dozen or so actually related (either in substance or in ownership) channels, rather than one by one. That way I can have my sub-bundle of "basic-equivalent" arts channels without being annoyed by the "basic-equivalent" religious channels (or vice versa)… or, more to the point, subsidizing commercial speech that I find offensive. And, if the sub-bundle is assembled with any care at all, it will probably include some stuff I might not have thought of, and allow limited and appropriate subsidy and discovery.

  3. You set up a false alternative. The real alternative is the Internet.

    Assume that true high speed Internet (both up and down) is available to everyone. Cable, as presently structured, would collapse. The reason is quite simple: Cable providers and larger content suppliers (e.g, HBO) would have to sell their products via a true open and free market. Currently, the cable companies survive on rent profits due to the limited competition that they face. The suppliers are only one-step removed since they compete with a larger number of suppliers. Yet, the universe of suppliers is much more limited than a true open market would allow.

    High speed Internet opens the market. Rather than choose from the limited fare offered by my cable company, I would have access to a vast array of content.

    Let me illustrate: If the Internet is fast and wide-spread, I could choose between watching the talking heads on MSNBC or those from the Reality-Based Community "TV" channel. So, who would you like to watch give political commentary: the MSNBC evening hosts or Kleiman, Pollack, Humprheys, et al.

  4. I imagine this can be fixed by adjusting the numbers, but your chosen values don't work as stated. If the cable companies are forced to sell a la carte, it is better to sell to 50 million customers at $15 then to 10 million at $70. They would also sell fringe subscriptions at $5. This produces $750 M + $600 M = $1350 M in revenue for the a la carte model, tying the bundled model.

  5. On further reflection, it will be tricky to tweak the numbers. As long as your entire population is marginally willing to pay $5 for the fringe channels, the following pricing models are equivalent:

    Model 1: $x for HBO and $5 for the fringe

    Model 2: $(x+5) for both, or $5 for just the fringe.

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