Sunday, July 18, 2010

More choice is less choice: The strange economics of a-la-carte cable

I've rarely seen an abuse of economic logic as dramatic as the push for a-la-carte cable. The economics of zero-marginal-cost services like additional cable channels are extraordinarily unintuitive, and otherwise sensible prescriptions like "more choice" do not necessarily improve consumers' actual options. In fact, debundling of cable is quite likely to lead to worse choices for a similar amount of money.

To see why, let's forget about cable for a moment and imagine a city with 20 parks, strewn throughout various neighborhoods. Suppose congestion isn't an issue; each park is large enough that an additional visitor doesn't materially diminish the experience of the others. The city park system is required to recoup its costs by selling yearly passes.

At first, the park system sells yearly passes to all 20 parks in a single package, for $100. All 100,000 residents purchase the passes, allowing the parks to cover $10 million in annual expenses. Life is good.

But residents start to grumble—after all, they don't visit all the parks. Why should they have to pay for the maintenance of parks they don't visit? In response to this eminently reasonable complaint, the park board offers a new pricing scheme, where passes are sold for each park individually. At first it sets a low price for each pass: $20 a year. Sadly, after a year—and an unpleasant report from the county treasurer—the price for each park is increased to $100. Residents pay the same amount of money for access to only a single park.

Horrors! What happened? As it happens, each family was mainly interested in visiting the park nearest to its neighborhood; although occasionally it might want to visit parks elsewhere in the city, few other parks were worth the $20 annual pass. On average, families purchased only two passes: one to the park closest by, and one to another popular park across the city. Needless to say, this wasn't enough to cover the annual expenses of the park board: its revenues declined by 60 percent!

To compensate, the board initially voted to raise the price for a pass to $50 a year. Its consultants, however, ran several surveys and discovered that at a price of $50, the average resident would only buy passes to 1.5 parks. This, of course, forced a further price increase to increase revenue, leading to another drop in estimated demand. After several excruciating meetings with the consultants, the board realized that the minimal price sufficient to balance its budget was $100. At this point, the average resident would purchase only one pass: the sole worthwhile investment was a pass to the nearest neighborhood park.

This outcome was unambiguously worse for city residents. After all, they derived some benefit from being able to visit other parks—just not enough to justify an extra $100 for any one pass. They now paid the same amount of money but received far fewer choices in return. A policy that purported to promote choice actually destroyed it.

Substitute "niche programming" for "neighborhood parks" and you have the essence of cable economics. I hardly care about MTV; take away Comedy Central, however, and I'll be steamed. Many viewers feel the opposite. In an a-la-carte world, we'd each choose to buy only our favorite channels. Their prices would skyrocket on a thinner subscriber base, to the point we'd be paying nearly as much as we did before. I'd be just as poor financially, and I wouldn't even be able to indulge myself with Jersey Shore—surely a bad deal all around.

Is this analysis of cable economics a little one-sided? Of course. There are legitimate arguments for why a-la-carte cable might be beneficial; maybe it would make content providers more responsive to viewer interests, or shake up some cozy monopolies. But the typical argument for a-la-carte cable is still dreadfully wrong. In a world where additional content has zero marginal cost, the freedom to choose the content you buy has a good chance of leaving you with less choice in the end.

13 comments:

Anonymous said...

Most parks are public services that are run as not-for-profit centers (so, that $100 collected in taxes was going to be used for $100 worth of maintenance of the parks).

TV stations are run as profit centers (so, that $100 collected in fees from consumers is used for $50 worth of programming and $50 worth of filling the pockets of rich people).

Your comparison is flawed and the a-la-carte pricing of cable will not lead to such ridiculous increases.

By the by, who really watches cable TV anyway? This discussion is better suited for 1990 than 2010 when there was no Internet.

Anonymous said...

Two problems with the above counter-argument. First, I disagree with the opinion that $50 of every $100 spent on cable TV is somehow flexible. If there are no high-paid execs involved, there's no channel. In fact, a-la-carte programming will hurt consumer pricing as well as choices in the long run.

Second, without cable TV networks to bankroll projects, there's no programming (good or bad) available on the Internet. So, don't go wishing it away so quickly.

Go Go Chinchilla! said...

Mr. Rognlie, I think you're forgetting a couple of salient facts. In the case of the parks, the parks are all owned by the city government, and the city government has the authority to compel people to contribute to the parks' support by any means it deems necessary. It has both a monopoly and the power to compel people to purchase its product. If people aren't interested in paying a fee, the city can simply levy a tax instead, and earmark the monies obtained by the park tax for park maintenance.

Cable TV operates under different conditions. While Comcast has a monopoly guaranteed by local and state governments in the areas in which it operates (this monopoly being euphemistically called a "franchise"), Comcast cannot compel anybody to purchase its services. Comcast can't levy a tax if the majority of the people decide that they don't want to pay Comcast, and instead opt for getting TV via Verizon FIOS, settle for watching broadcast TV, watching TV via Hulu, Netflix, and bootlegs off of BitTorrent -- or simply giving up TV altogether.

As more people obtain broadband internet access and see how good a job the Internet does at catering to niche interests, cable TV providers will find themselves becoming more and more irrelevant. Why should anybody settle for paying a hundred dollars a month for 666 channels they're not going to watch when they can get an internet connection for fifty bucks, pay ten bucks a month to either Netflix or Hulu Plus, and have the ability to watch what they want, when they want.

The traditional media is on Death Row. They just weren't paying attention when we the people read the verdict: guilty of providing a shoddy product at extortionate prices. They weren't paying attention when we sentenced them to a slow, lingering death.

Anonymous said...

Your little theory is great, how come TWC doesn't have the NFL network again?

Be great if cable companies applied the same logic in this article to broadband speeds and caps.

Travis said...

Well, I'd be a subscriber if they did ala carte. They won't, so I'm not. Seems like it would be more economical of them to offer it, then, huh?

They could keep package deals, and offer ala carte as well.

Matt Rognlie said...

Travis:

My argument applies even if the cable companies still offer a package deal, unless they make the prices for each a la carte channel extremely high (which, I'm sure, is not what you're after). People will desert the package deal for cheaper a la carte rates until the a la carte rates rise to be barely economical compared with the package deal.

Take a look at my more recent post on Microsoft Office and bundling -- the main point is that while Microsoft offers an a la carte option, it's completely irrelevant for home users and doesn't save money for any business users except those who only need a single program.

By the way, you might not be a cable subscriber, but most people are: around 90% of Americans subscribe to some kind of cable or satellite service. Providers aren't going to kill their existing business model to go after the few remaining holdouts.

Anonymous said...

The point, guys is that there is no unit cost in the city parks example. Pay CLOSE attention to this sentence: Suppose congestion isn't an issue; each park is large enough that an additional visitor doesn't materially diminish the experience of the others.

What that means is that everybody can "have as much" of the park experience as they want; there is no per-unit cost as there would be for a hot dog.

When you buy a hot dog, nearly ALL of the purchase price is in unit cost - it took feed to raise the cow and machines to grind up the cow parts and trucks that cost fuel to ship the hot dog and so on.

But in cable, as with the parks example, there is no effective unit cost at all. It costs the cable companies virtually nothing extra to include 50 channels as one.

So the a-la-carte model falls flat on it's fast. You aren't paying for this channel or that channel; you are paying for access to channels and subdividing it a la carte decreases revenue that must be made up somehow and that means you have fewer choices at dramatically higher costs per channel.

End result: you either have:

1) the SAME BILL you have now but just a few channels to show for it, or

2) Much cheaper bill and very few, low quality choices.

Read up on "Long Tail Economics" http://www.wired.com/wired/archive/12.10/tail.html

upintheclouds said...

I don't think the analogy is very good because cable channels are not real property like parks. They can be destroyed and replaced with relative ease for the content producers, compared to building or selling a park for a city. Also, as some others pointed out, most city dwellers do not pay for access to their parks. They do, however, pay for access to hospitals.

There is no part of our entertainment culture which would have its availability to potential customers encumbered to the degree that our health system already is. What's more, the access to healthcare is restricted in exactly the way that you have described for parks. Anyone who has experienced bad insurance policies from companies like HealthNet understands that healthcare is the only part of the daily American experience that such obstructions have become commonplace as a result of this form of backwards economic reasoning.

When it comes to television channels, most people will want to choose far, far than just one or two. This is because there is no marginal cost for changing the channel, where there is a marginal cost for going to a park (or a hospital) across town. Based on the popular desire for variety in entertainment, there is no reason that these companies will not make more money while charging less for their products if they understand the realities of the costs of supply and demand in the digital age, and give people what they actually want.

There is also no way that the quality of the programming offered will not improve, even if channel selection is reduced. Quality programming is necessary to retain veiwership on a per-channel basis.

Eventually, channel variety would expand under a-la-carte, as niches of higher quality programming are much more likely to survive when supported directly by a small pool of viewers who will not pay for crap, than when fighting for resources with much more popular low quality programming. This could also allow smaller players to potentially enter the cable market, which would undoubtedly improve variety and quality.

J Louis said...

Your entire analogy is absolutely pointless because it is based upon the even distribution of park visitors by location. Cable subscribers do not 'navigate to the channel nearest them' as they would a park, they watch the GOOD shows while simultaneously forced to pay for shows that feature grade school scumbags berating each other in poorly spoken English while they bake cakes.

Most of the garbage 'networks' that make up the cable company fluff are owned by the giant cable conglomerates.... like Time Warner. This is why they force you to buy that crap.

A-la-Carte pricing will clearly decimate most of the crap nothing networks, which is the entire point! Subscribers are sick of paying for MULTIPLE shows about midgets!

The best part is, even though a network may die, that one hit show out of the other 80 'midget covered in chocolate' shows at each dying network will be picked up by the surviving networks!

The end result is a lower cable bill, better selections, and the ability for a subscriber to ensure none of his/her pennies to go to those phucking morons on Jersey Shore. We consumers do not care if our bill is slashed by only 20% as long as we're not supporting this stream of ignoramuses. Get it?

The bottom line is, if something is worth having, people will pay for it. The strange economics is actually the CURRENT method of providing cable TV.

In fact, this little post of mine is moot. The internet will obliterate the cable companies when content providers can directly reach their audience. It is already happening. Drip....drip.....drip. Goodbye Comcast. Goodbye Time Warner.

P.S. You're obviously employed by the cable industry, and it shows. It's almost embarrassing to read your article.

Matt Rognlie said...

J Louis,

I was under the impression that I was employed by MIT (via funding from the National Science Foundation) and the National Bureau of Economic Research (via a grant from the National Institute on Aging), not the cable industry. I guess I was mistaken.

Although physical neighborhoods and clusters of content may not seem alike at first, I think that my (admittedly imperfect) analogy holds up pretty well upon closer inspection. Within the vast selection offered by modern cable television, most people have fairly particular, localized preferences. If cable was offered a-la-carte, they would generally opt for only their "local" channels. ("local" in content-space, not geographic space)

Since the content providers would be trying to fund the same content production on a smaller base of subscribers, they would jack up the price for each channel until most viewers would be paying nearly as much as before. The only difference would be that viewers could no longer venture outside of their "local" set of favorite channels -- much as the families in my example can no longer go to parks outside their neighborhood.

Now, it's possible that a cozy oligopoly of content providers would use this system to exploit consumers by charging them extra for lousy programming (although depending on the economic circumstances, it's not clear that you could call this "exploitation"). But I don't see this actually happening. Your "garbage networks" are daily viewing for a lot of other people. Can you provide an actual example of a cable channel with a high affiliate fee that isn't matched by high ratings and viewer interest?

Anonymous said...

The people who pay for passes most certainly do benefit from their entire $100 being dedicated to the closest park to them. Areas that value parks can then have nicer parks and areas that don't value parks can use their space for something else.

All natural monopolies like roads and cable systems should be co-ops anyway. When the government grants monopoly rights over utilities it's corrupt crony capitalism.

Put it to a vote and net people will vote for more bandwidth and TV people will vote for on-demand TV. Almost nobody will vote for more dedicated infomercial channels. The only reason cable companies can force those on people is because our corrupt government gave monopoly rights over a communications utility to private companies.

Armil@cable tv said...

I am really grateful to know this kind of information just like :TV stations are run as profit centers (so, that $100 collected in fees from consumers is used for $50 worth of programming and $50 worth of filling the pockets of rich people).
Thanks!

Anonymous said...

Yeah that doesn't make a whole lot of sense. First, people who don't currently purchase cable tv due to the price may decide to if they can purchase just a few channels.
Secondly, the park example is a bit flawed. You assume that no new parks will be built. If one of the far away parks(the sci-fi channel) was shut down, and new park that was also in your neighborhood(insert channel you'd like), you may end up paying the same $100, but just getting more services that you actually enjoy.
The majority of us don't necessarily have a problem with the price. We have a problem with 550 of 600 channels being total crap. We want 600 GOOD channels. I don't like the fact that cable companies get the same revenue whether shows on the CW network suck or not.