Market Failure in Media Industries

CHAPTER FOUR

Media markets operate in unusual ways and it would be surprising if laissez faire always resulted in the best possible outcome.  Various market failures, which give rise to a prima facie case for intervention, are among the important considerations of media policy.  These are related to three features of media industries:  public good characteristics of many media products where a particular consumer's use does not detract from that of others;  natural monopoly stemming from one or both of economies of scale and scope;  and the absence of an established link between demand and supply for some media.  In this chapter these three categories of market failure are considered.

PUBLIC GOOD

In common with other intellectual property products, media products and services have public good characteristics.  Generally, all the cost of producing the content element of a media product like a television programme or newspaper article is incurred in making the first copy.  Once the first copy is produced, the level of consumption has no effect on production costs, but, depending on the vehicle used to deliver it to consumers, has varying degrees of impact on distribution costs.  Whether one or one million individuals consume a news story has no impact on its production costs, but its distribution cost, for example, depends on whether it is delivered to consumers via a newspaper or a broadcasting medium.

Distribution may also have public good characteristics.  The public good characteristics of physical media products, such as books, newspapers and videotapes are limited but nonetheless exist.  For example, a book or a newspaper may be read once or many times by the same or different readers without any loss of content and their price is not related to the number of readers.  The public good characteristics of electronically distributed products are more pervasive.  Once a free-to-air or cable distribution system is established, the cost of distribution within the signal coverage area does not change with the number of consumers accessing the product.

The public good characteristics of media products have important implications for efficient levels of consumption and supply.  For broadcasting services where the marginal cost of supplying additional consumers within the reception area is zero, efficiency requires free access.  Obviously, private suppliers would not enter such an activity as a business unless they were able to recover their costs directly or indirectly.  To overcome this problem, three different financing arrangements have been developed.

First, broadcasting services are funded from the public purse and are supplied free of charge to consumers (sometimes after payment of a levy or receiver licence fee).

Second, services are funded by the sale of advertising and are supplied free of charge to consumers.

Third, consumers pay an up-front charge for exclusive access to the signal (via cable or encrypted broadcast) and then pay nothing for actual consumption.

Actual funding schemes may involve combinations of these three arrangements.  For example, SBS is funded from the public purse as well as advertising and pay television may be funded from subscription fees and advertising.

The capacity to restrict access to those who purchase them facilitates the private production of print media products.  But efficiency considerations also affect their pricing.  As noted above, suburban newspapers are usually supplied free of charge to consumers and are fully funded from advertising.  For other print products, cover prices to consumers are kept low by the sale of advertising.  Cover prices and advertising are inextricably linked.  The lower the cover price, the larger is the readership and, in turn, the higher is the advertising revenue from advertisements sold on the basis of circulation.  Consequently, in setting cover prices publishers will take account of their effects on circulation and will attempt to set prices that maximise the combined revenue from copy sales and advertising.

For broadcasting, in particular, where the supply of programmes to audiences is restricted through licensing of stations, funding through the sale of advertising may not maximise welfare.  Advertising is sold in the form of airtime and its price reflects both the amount of airtime and the size and characteristics of the potential audience for the advertising messages.  For any given programme cost, therefore, broadcasters have an incentive to maximise the size of the audience.  Because programmes generate different audiences, in terms of both size and composition, programme selection usually involves a trade-off between programme costs and the advertising value of the expected audience.  Generally, the choice between two programmes to fill an available slot on a programming schedule is determined by the combination of cost and expected audience likely to generate the larger profit.  A high-cost programme, therefore, would be preferable to a lower-cost alternative whenever its audience is likely to generate sufficient advertising revenue to outweigh the higher cost.

In a system where the number of broadcasting stations is not limited by either technical or regulatory constraints, all programmes capable of generating advertising revenue at least equal to their cost would be broadcast.  If, however, the number of stations is limited, then the available slots on programming schedules may not be sufficient to accommodate all the available profitable programmes.  In such a situation, broadcasters have a tendency to supply programmes that appeal to large audiences in preference to those that may be highly desirable to smaller audiences.

Intensity of demand for a service is usually measured by the price a person is prepared to pay for it.  The total price is a combination of both the monetary cost and the opportunity cost of forgoing the next best available activity.  Where no direct payment is incurred to consume a service (e.g., television), benefits to consumers cannot be assessed directly.  However, it may be possible to assess them indirectly by valuing the activities that are given up to consume the service.

The intensity of demand, and consequently willingness to pay, varies from one individual to another.  For example, individuals with a very high intensity of demand for a particular programme may be prepared to give up some other highly desirable activity in order to watch it.  Others may be happy to record the programme and watch it later rather than give up the alternative activity, while a third group may be prepared to give up watching the programme altogether.  In this sense, viewers may be thought of as having an implicit reserve price for a programme at least equal to the value of the benefits that would have been derived from the alternative activity.  This reserve price is different for different individuals and for different programmes.  Because of these differences in willingness to pay among individuals, it is possible that a programme with a small audience may be valued more than one with a larger audience.  The possibility is illustrated in Figure 4.1.

In Figure 4.1 it is assumed that two programmes A and B are available to a broadcaster at the same cost.  The two programmes are provided free of charge (advertiser-financed) to the viewers and valued differently by their different size audiences.  As shown by the respective demand curves, Programme A is highly valued by a small audience, whereas Programme B is less valuable to a larger audience.  The consumer surplus derived from each of the programmes is represented by the shaded area under the respective demand curves (the area under the "Programme A" curve is larger than the area under the "Programme B" curve).

Figure 4.1:  Consumer Welfare and Audience Preferences

While one programme may generate a higher level of consumer surplus than another, it does not necessarily follow that economic welfare is maximised by that programme.  Economic welfare derived from broadcasting is maximised if the sum of the surplus accruing to producers and to consumers from the consumption of a given set of programmes is greater than that which could be derived from any alternative set of programmes.  If in Figure 4.1 equal costs for both programmes are assumed, the larger audience (and thus larger advertising revenue) of Programme B would generate a larger producer surplus than that of Programme A.  Because the broadcaster does not benefit from the larger consumer surplus of Programme A, it will always prefer Programme B.  However, because of its much larger consumer surplus, Programme A may generate a total surplus that exceeds that of Programme B.  Consequently, from a welfare perspective, Programme A may be preferable to Programme B.

NATURAL MONOPOLY

Natural monopoly is the situation where the total cost of providing a particular level of service (or bundle of services) is greater with more than one provider than with just one.  Natural monopoly elements in media industries can be either or both of economies of scope or economies of scale.

Economies of Scale

Economies of scale arise where there are fixed costs (i.e. costs that do not vary with output) in producing a particular good or service.  When fixed costs are present, the average cost of producing each unit of output declines with the number produced.  Where they are large relative to variable costs, the impact of scale on unit costs can be very important.  The extent of economies of scale has a significant impact on the structure of an industry.  Their presence in the media industries has been influential in determining their structure.

All media content products, whether produced in large or small quantities, have a common feature in that all the costs of producing the content are incurred in the making of the first copy.  So even a small circulation newsletter displays some economies of scale in the sense that the average cost per copy declines with the production of the second and subsequent copies.

First-unit costs are a major feature of television and radio programmes.  The cost of purchasing or producing a programme will be the same irrespective of the ultimate size of the audience.  Thus the larger the audience, the lower the programme cost per unit of audience.  Economies of scale are particularly evident in the distribution (broadcasting) of a programme.  Regulation requires the broadcast of a signal of a given strength throughout the licence area irrespective of the number of people who choose to tune into the signal.  That is, the transmission costs are independent of the size of the audience, or the larger the audience the lower the per-unit cost.

Economies of scale give large newspapers clear advantages over smaller circulation rivals.  Not only does the production of a high-volume daily newspaper involve high capital investment and start-up costs, but all costs of news collection, specialist columns, editorial, composition, layout, set-up and other pre-printing functions are incurred before the presses are turned on.  Once printing has begun, the overall cost of the print-run does not change greatly.  The marginal cost of additional copies is only a little more than the material cost of additional paper and ink.  Also, as the print run increases, the average cost per copy declines rapidly as the large first-copy costs, print set-up costs and overheads are spread over the copies printed.  A large print run enables a producer to undercut the price of a smaller rival newspaper.  Alternatively, it enables the producer to improve the quality of the newspaper by increasing expenditure on desirable input factors which the smaller rival will not have the capacity to sustain.

A high circulation or a large audience also generates economies of scale in the sale of advertising.  Advertisers pay a premium for single advertisements reaching a large audience because they are preferable to multiple advertisements in two or more publications or programmes reaching an aggregate audience of the same size.  Multiple advertisements do not necessarily have the same reach, nor are they necessarily as effective as a single advertisement even though their aggregate audiences might be the same.  This arises because of potential duplication of at least part of the smaller audiences and potential variations in audience demographics.  Planning and administrative costs of multiple advertisements are also likely to exceed those of single advertisements.  For the newspaper or broadcaster, the lower cost per unit of generating a larger readership or audience for sale to advertisers results in larger profits.

Another scale advantage of a large circulation newspaper arises from distribution.  Because of the larger circulation, bundles delivered to distribution points will be larger so packaging costs per unit will be smaller.  Also, transport costs on a given distribution round are likely to be related to the number of bundles rather than their size.

Economies of scale are also the main driving force for the formation of media groups.  A television or radio network allows the spreading of the largely fixed cost of producing a programme across the aggregated audience of all the stations in a network.  Management economies are likely to be present as well.  In advertising a single sales force may be able to represent all the stations in the network.  Benefits also accrue to buyers of advertising.  For them, there may be considerable benefits in dealing with a single supplier for a number of markets rather than with different suppliers in each market.

Production of more than one newspaper using the same presses can lower overheads for each of the newspapers produced.  Copy costs can be lowered by sharing news stories and other content material among the related newspapers.  Similarly, distribution costs may be lowered by using the same resources to distribute the related newspapers.  Both buyers and sellers can benefit from the joint selling of advertising on related newspapers.  In addition, newspaper groups may have improved purchasing power for key inputs such as newsprint.

Although ownership control limits prevent enterprises from growing beyond a certain size in television and to a much less extent in radio, large successful enterprises are a feature in each of these media industries.  These indicate the likely presence of substantial economies of scale.  They also suggest that ownership controls may be preventing full utilisation of some economies of scale.  For example, limits preventing the ownership of more than one television station or more than two radio stations in the same licence area would clearly limit the potential to benefit from some scale economies.

Economies of Scope

Economies of scope occur where a single facility contributes to the production of more than one good or service.  Economies of scope give rise to reductions in unit costs for particular outputs both through improved utilisation of production facilities and through the addition of complementary outputs in the range of products produced by a firm.  The use of common facilities to produce different products is prevalent in media industries.  Major media groups engaged in diverse media activities include News Limited with interest in free-to-air television, subscription television, newspapers and magazines;  Publishing and Broadcasting Limited with interests in free-to-air and subscription television and magazines;  and APN Limited and Rural Press Limited both with substantial interests in radio, newspapers and magazines.  The likely presence of scope economies is also suggested by examples of co-operative arrangements for sharing facilities and production of programmes, such as news, between commercial radio and television services in the same licence area.

Scope economies are also present within each of the media industries.  Newspaper groups, for example, produce different types of newspapers (national daily, capital city daily, Sunday newspapers, regional newspapers and suburban newspapers) each different in some important attributes.  Evidence presented by major newspaper groups to the House of Representatives Select Committee on the Print Media (1992) indicates that economies of scope can arise from the sharing of operating and overhead costs, and from the sharing of premises, computers, facsimile, library, newsgathering, editorial resources, syndication of articles by staff writers etc., and from higher utilisation of presses.

In television, economies of scope may arise from programme-sharing arrangements such as co-operative agreements between independent stations for shared subscriptions to overseas news agencies, sharing of studio facilities with programme producers and production of programmes for own use as well as for sale to other enterprises (e.g. news programmes for airlines and corporate videos).

Economies of scope may be realisable in the advertising market as well.  Major advertising campaigns usually involve co-ordinated advertisements on radio, television and print media.  A group able to offer all these outlets in one package to advertisers may have substantial advantages over competitors operating in a single medium.  Advertisers may also gain by dealing with one group rather than having to negotiate separate purchases of advertising on different media.

The extent to which regulation hinders utilisation of economies of scope is potentially more substantial than is the case with economies of scale.  For example, prior to the introduction of cross-media ownership restrictions in 1987, common ownership of major capital city newspapers and television stations was a feature of Australian media industries.  This is no longer possible, because cross-media ownership restrictions prevent control of different media in the same licence area.  Thus, by preventing the common ownership of diverse co-located media, cross-media rules may be limiting the extent to which economies of scope can be pursued by media industries.

LACK OF NEXUS BETWEEN SUPPLY AND DEMAND

In free-to-air television and radio, where audiences do not pay to consume the programmes, consumers are unable to use the market mechanism to express their intensity of preference for particular programmes and thus exert a direct influence on the programming decisions of broadcasters.  The options available to audiences are limited to choosing a programme presented by one of the competing services, or alternatively, choosing some other activity in preference to the reception of broadcasting programmes.  The inability of audiences to influence directly the range and composition of the programming of advertiser-financed broadcasters manifests itself in the often-expressed community dissatisfaction with the programme mix delivered by the broadcasters.  Government has responded by regulating the programming of broadcasters, establishing its own broadcasting facilities, and (most recently) by allowing pay television.  Conversely, some government actions appear to have exacerbated the problem by being too restrictive in licensing and by holding back new technologies too long.

CATERING FOR THE DIVERSITY OF TASTES In 1929 Harold Hotelling analysed the operation of spatial competition.  This analysis has been applied to a number of spatial situations, including the political spectrum, scheduling of airline and other transport services, and the diversity of tastes for media products.  A popular illustration of Hotelling's analysis is the example of two ice-cream vendors on a beach selling identical items at identical prices.  Customers are equally dispersed along the beach, and seek out the nearest supplier.  He showed how spatial competition would lead the two vendors to locate next to each other in the middle of the beach.  When applied to the media in the circumstance where tastes are normally distributed, it suggests that if there is only a small number of profit-maximising service providers they will tend to locate their programming so as to cater for mainstream tastes.  One way of achieving greater diversity would be to allow more services, but this would eventually (perhaps quite quickly in smaller markets) run up against the natural monopoly constraint.  Other ways of catering for minority tastes are through direct government provision, regulation of programming and allowing the ownership of multiple channels.

CONCLUSION

The standard justification of intervention in the market is that the market fails in some respect and that the benefits of intervention exceed the costs.  As discussed above, a free-market approach to media is likely to lead to three principal kinds of market failure:  public good, natural monopoly (economies of scale and scope) and a "gap" between consumers and producers.  Each of those market failures provides a necessary condition for potential intervention in the market, but it is not clear that interventions based on these failures have always led to improved social outcomes.  Furthermore, the extent to which these market failures are a cause for regulatory concern has been lessened by technological developments.  For example, broadcast signals can be encrypted and made available only to those prepared to pay to consume them.  Similarly, cable technology prevents those who do not pay from accessing programmes.