My earlier analysis simply was assuming that we will not make this policy shift and then asking how worried we should be about the resulting semi-monopoly power in that market. If you would like to see the pro-case, here is a UK study (pdf) showing unbundling improves quality. Here is French evidence for higher penetration, often through quality rather than just price effects. Here is Tom Hazlett on related issues (pdf) and Vernon Smith is a long-time proponent of related ideas.
I don’t, however, agree with Felix’s presumption that all we need do is refine the current infrastructure, or his claim that there are no other effective forms of competition at current margins. Penetration rates could be a few percentage points higher, and that is an economic cost from the status quo, but in Felix and some of the other commentators I am seeing a black and white version of a monopoly story that simply does not correspond to the facts. Furthermore the current monopoly power of cable means that infrastructure will be laid down more quickly next time around, and moving to local loop unbundling would weaken this incentive by confiscating some of the rents from the infrastructure investments of the cable companies. I probably would make this trade-off, but that further blunts any estimate of the net costs from the U.S. status quo.
Note also that Netflix has turned out to be worth a lot of money as a company, a reality which those who pushed the “cable as extreme monopoly” view denied could happen, out of a belief the cable companies would simply confiscate any Netflix rents.
And here is Peter Huber on how deregulation — yes the dreaded “D word” — can improve cable competitiveness.
From my email:
My name is Max Grozovsky. I’m an economics student at the University of Delaware (until I finish a few more papers and can start my life) and a fan of your blog/column.
Thanks a lot for using your platform to elevate disability rights. I hope you’ll write more on the topic going forward, perhaps mentioning supported decision-making mechanisms which have been touted by the National Council on Disability as alternatives to guardianship that actually help people rather than bundle and strip their rights wholesale based on the canard that incapacity in one area implies incapacity in an unrelated one.
Also, since you (or is it someone else?) sporadically post on Islamic architecture/history, here’s my favorite nonficiton book, unsolicited.
In my MRUniversity video on the economics of bundling I argue that bundling raises total surplus and that requiring the Cable TV companies to price by the channel is unlikely to reduce most people’s cable bill (see also Does Cable TV Ripoff People Who Don’t Like Sports?). Pragmatarianism offers an excellent critique. Here is one bit from a longer post worth reading in full:
The flaw in Tabarrok’s logic is that it completely ignores the necessity of determining what the actual demand is for the individual components in the bundle. For example, when I subscribed to cable…Charter had no idea how much I valued the Discovery Channel. Neither did the Discovery Channel. But is my valuation relevant? According to Tabarrok…it really isn’t. Uh, what?
How could the Discovery Channel and Charter and Tabarrok not care what the actual demand is for the Discovery Channel? In the absence of consumer valuation…how could society’s limited resources be put to their most valuable uses?
Tabarrok is basically arguing that we don’t need accurate information in order to efficiently allocate resources. Except, does he really believe that? Let me consult my magic database…
The most valuable public goods are constantly changing, just as the most valuable private goods are constantly changing. The signal provided by prices and mobility is therefore of great importance. – Alexander Tabarrok, in The Voluntary City
Huh. Hmmm. Is the Discovery Channel a private good? Yes. Is its value constantly changing? Yes. So…according to Tabarrok…it’s of great importance that the Discovery Channel should have its own price. But this sure wasn’t what he said in his video.
An excellent point that was made most forcefully by Ronald Coase in The Marginal Cost Controversy. Coase argued that pricing goods with high fixed cost at marginal cost would generate static efficiency but at the price of dynamic efficiency because we would not be able to say with assurance that the total value of the product exceeded total cost. Similarly we lose some information with bundling, perhaps especially so because marginal cost in this case is zero. With bundling, we know that the total value of the bundle exceeds the total cost but we are less certain that the total value of each bundle component (channel) exceeds the total cost of each component.
But this cannot be the whole story because in another paper, The Nature of the Firm, Coase pointed out that sometimes we choose not to use prices. Firms, for example, are islands of central planning in a market ocean (see Yglesias for a good discussion).
A channel such as HBO is itself a bundle of dramas, comedies and documentaries. Should Girls and Game of Thrones always be priced and sold separately and not through the HBO bundle? HBO certainly learns something from individually priced downloads on iTunes and that information helps HBO to improve its service. But how much is this information worth?
In 2002 should HBO have individually priced episodes of the Sopranos and sold them through AOL? Individual pricing generates value but it also has costs. Tradeoffs are everywhere. And, to the crux of the issue, if a law had been passed in 2002 requiring HBO to sell The Sopranos on an episode by episode basis would that have resulted in better and more programming at lower prices? I think not. Similarly, I see few reasons to think that welfare would be improved by a law requiring cable TV companies to price by channel.
More generally, the price system is embedded in the larger field of the market economy which includes non-price institutions such as firms; and the market economy is embedded in the larger field of civil society which includes non-profits and non-market institutions such as the family. Economists often focus on the virtues of the price system but that should not blind us to the many virtues and many margins on which a free society operates.
John McCain has introduced a bill to “encourage the wholesale and retail unbundling of programming by distributors and programmers.” Would a la carte pricing result in lower prices and greater consumer welfare or would it raise prices and result in less investment in television media? Time to take a look at the economics of bundling. In this video from our MRUniversity course on media economics I review the theory of bundling and then apply it to cable TV.
Recently the LATimes ignited a firestorm of anti-sports commentary by arguing that people who don’t watch sports are being ripped off by Cable TV.
A key concern is that the higher bills driven by sports are being shouldered by subscribers whether they watch sports or not.
…”I pay $98 a month for cable and half of that is for sports?” said Vincent Castellanos, 51, a fashion stylist who lives inLos Feliz. “I’ve never once gone to a single sports channel. I wasn’t even aware I was paying for it. I want my money back. Who do I call?”
Derek Thompson at The Atlantic corrected some of the numbers but agreed with the analysis:
If you watch sports, millions of pay-TV households who never click on their ESPN channels are subsidizing your habit. If you don’t watch sports, you’re one of the suckers paying an extra $100 a year for a product you don’t consume.
Kevin Drum demanded a la carte pricing so that:
“sports fans would be forced to pay the actual cost of their sports programming without being subsidized by the rest of us.”
I don’t watch sports very often but I think the commentators have misunderstood the economics of Cable TV and the math of content provision. Let’s consider a simple model, there are content providers such as ESPN and Bravo, distributors such as the cable company and consumers. Let’s assume that there are 4 consumers, 3 of them value football at $10 and Top Chef at $0 and one vice-versa so the model looks like this:
How much will ESPN and Bravo charge the distributors? Bilateral bargaining between content sellers and distributors can be complex but for the point I want to make we can assume that the distributors simple pass on their input costs to consumers. In this case, ESPN will charge the distributor $30 and Bravo will charge $10, the maximum that they can get.
Here is where the LA Times and the others go very wrong – they reason that $30 of the $40 charged is due to sports so each person is paying $7.50 for football ($7.50*4=$30) and $2.50 for Top Chef ($2.50*4=$10) and, therefore, the Top Chef viewer is being ripped off because 3/4 of their bill is going to support programming they never watch! Mathematically this is as true as any other division of total cost but conceptually it makes little sense. Consider, for example, what happens if we add football viewers. With 9 football viewers, ESPN will charge $90 and Bravo $10 and thus the LA Times would conclude that the Top Chef viewer is even more ripped off than before–90% of their bill is going to football! It’s very odd, however, that the ripoff of the Top Chef viewer gets bigger even as the price that they are charged and their viewing habits aren’t changing! Also as we add more football viewers the per-subscriber charge for Bravo gets smaller and smaller, with 10 viewers it’s only $1. Implicitly the LA Times is suggesting that this number represents what a la carte price would be or could be but that’s nonsense–whatever Bravo’s a la carte price would be it doesn’t get lower as we add more football viewers.
Conceptually it’s much clearer to say that each person is being charged $10 for the programming that they most want to watch. Moreover, the reason that Cable TV firms bundle is precisely because by making the demand for their product more homogeneous they can increase profits. In other words, the best bundle for the Cable TV firm is one in which everyone does in fact value the bundle equally.
The bottom line is that there is no reason to think that Top Chef viewers are subsidizing football.
I don’t ever watch Bravo but still I must pay for it:
In the dream world of some television viewers, they would pay their cable or satellite companies only for the channels they want. Some might not pay for MTV, because they don’t want their 8-year-olds watching it. Others would turn down ESPN Classic, because they’ve already seen the 1975 World Series. Others would eschew TeleFutura, because they don’t speak Spanish.
Reality is far different.
No U.S. cable or satellite company offers what are called “a la carte” plans. In order to get the Discovery Channel from Comcast Corp. cable company, for instance, Washington viewers have to pay for an “expanded basic” package that includes MTV, FX, MSNBC and 33 other channels.
Here is one relevant article.
Why are consumers forced to buy a bundle? Cable companies claim that choice would require expensive boxes, but few observers believe this claim.
More plausibly, price discrimination is at work. Consider a simple example with two individuals. John values Disney at $100 a year and FoxNews at $10 a year; Sally has the reverse valuations. Without bundling, the cable company will offer each channel for about $99, and sell a channel to each consumer, reaping $198 in revenue (N.B.: I am assuming that the cable company has a good idea of demand in general, although it cannot identify which consumer is willing to pay how much for what.)
In lieu of this set up, sell the bundle for $109 to each consumer, reaping a greater revenue of $218. The company makes greater profit.
More importantly, aggregate welfare is higher. In this case each consumer receives two channels instead of one.
Monopolies, regulated or otherwise, tend to bundle commodities when demands are scattered and the marginal cost of additional service is low. In this context, once the program is made, you can sell it cheaply to additional customers. So why not try to get the entire package into everyone’s hands?
You can spin your own numbers, with varying results, but the overall lesson is clear. While there is a general problem with monopoly in the cable market, bundling can make that problem better rather than worse. So don’t complain next time you have to “click-remote” through those Farsi and exercise channels.
David Pogue (via Kottke) asks:
Why doesn’t someone start a cellphone company that bills you only for
what you use? That model works O.K. for the electricity, gas and water
companies — and people would beat a path to its door.
Of course many companies will charge you by the minute. Overseas, per minute plans are more common yet. The puzzle I think is why the standard American plan is per month, with perhaps a non-convex minutes cap, rather than per minute.
The most likely answer combines price discrimination with consumer misjudgment. If the company puts a very high marginal per minute price right at the cap, some consumers will, in self-deceiving fashion, think they are getting a good deal but then chat themselves into near-bankruptcy. For the other consumers, you are forcing them to buy minutes as part of a bundle. It is well know this can be an efficient means of price discrimination across high-value and low-value demanders; see my earlier post on cable bundling for a full explanation of the economics.
Why doesn’t competition break down such schemes? First, cell phone competition has become more intense only with number portability in the last few years; we can expect pricing schemes to continue to evolve. Second, the cost structure of the company may have more to do with marketing than with the cost of supplying extra miniutes. So "marginal cost pricing," or the nearest approximation thereof, may involve "per customer" charges (a fixed monthly fee) rather than "per minute" charges.
Of course they’ll let you opt out of all of this if you pay a high enough per minute charge, thereby reimbursing them for the fixed cost they paid upfront to recruit you. That all said, if you go to Western Union and buy one of those cards with minutes to Sierra Leone, it seems that true marginal cost pricing reigns, subject of course to some probability of a fraudulent or difficult-to-use card.
…BMW is planning to move some features of its new cars to a subscription model, something it announced on Wednesday during a briefing for the press on the company’s digital plans.
…now the Bavarian carmaker has plans to apply that model to features like heated seats. BMW says that owners can “benefit in advance from the opportunity to try out the products for a trial period of one month, after which they can book the respective service for one or three years.” The company also says that it could allow the second owner of a BMW to activate features that the original purchaser declined.
In fact, BMW has already started implementing this idea in some markets, allowing software unlocking of features like adaptive cruise control or high-beam assist (in the United States, those options are usually standard equipment). Other features are more whimsical, like having a Hans Zimmer-designed sound package for your electric BMW or adaptive suspension for your M-car. Indeed, the company says that its forthcoming iNext will “expand the opportunities for personalization.” I’m sure y’all can’t wait.
Here is the full story, via the excellent Samir Varma. In the standard theory of bundling, bundling enables more price discrimination, as for instance with the cable TV bundle. But if most consumers really don’t value the add-ons at all, which perhaps is the case here, a’la carte may maximize revenue after all.
Writing about economics for a large audience at Marginal Revolution taught Tyler and me to get to the point quickly, use vivid examples, and avoid unnecessary math and other jargon. We brought all these lessons to our textbook, Modern Principles of Economics. We wanted to teach modern topics such as tying and bundling–pricing schemes familiar to students from cell phone plans, Cable TV and software sales yet not discussed in most principles textbooks–while recognizing that most students who take a principles course will never take another economics course. The most complicated math function in our book is the square root function.
Fortunately, judging by the reception of MP, we have succeeded in our goals. Modern Principles is used in a wide-range of universities and colleges throughout the United States, at places like the University of Pennsylvania, UCLA, and Minnesota and also Henry Ford College, Rock Valley College and the SUNY Colleges. Here are a few reactions from users of Modern Principles.
I can’t tell you how many people I have met who took economics in college, and who hated it. If only they had started with Cowen and Tabarrok. Modern Principles is one of the few books that will immerse students into the elegance and beauty of our science, and which will create a lifelong love of economics.
Lee E. Ohanian,
Professor of Economics, UCLA
and Senior Fellow, Hoover Institution
Cowen and Tabarrok’s Modern Principles and the accompanying videos make for an unbeatable combination for both students and instructors. The intuition is clear and the examples—both contemporary and interesting—draw students into the material. This text is a fantastic tool for showing students how economics impacts their daily lives in choices great and small. My students come to class with questions, eager to discuss in more detail the concepts covered in the videos and text.
Department of Economics,
University of Tampa
I have tried multiple textbooks over the last ten years. None of them engage my students as well as Modern Principles by Cowen and Tabarrok. The writing is fresh and lively. The videos are clear and entertaining. It is a book that attracts students who will never take another economics course and excites economics majors.
Randy T. Simmons,
Professor of Political Economy,
Utah State University
Here’s a cool video explaining some of the features of Modern Principles.
Should economists shy away from teaching hard topics for fear of offending someone’s moral sensibilities? Should we restrict ourselves to the market for ice cream? The tagline of our textbook, Modern Principles, is See the Invisible Hand: Understand Your World. We take understand your world seriously and we teach topics that other textbooks do not such as the economics of network goods like Facebook or the economics of tying and bundling which students see regularly when they purchase cell phones and minutes and Cable TV.
The world, however, is not always a pleasant place and so we also discuss modern slavery and how the concept of the elasticity of supply can help us to evaluate programs like slave redemption. It’s important to teach this material with seriousness, it’s not an idle exercise in “freakonomics,” and it’s possible to misstep but we think students need to see economics as a vital discipline that can be used to make the world a better place, even if only one small step at a time.
Here is Tyler on elasticity and the economics of slave redemption. This is from the elasticity section of our course at MRUniversity, released today along with taxes and subsidies. You can also find a lengthier treatment with more details in Modern Principles.
1. HBO will be letting you watch their shows on-line without buying cable (the great unbundling).
4. “I don’t really know if they love me, or if they love my height.” (markets in everything, and do we need more Amazons?)
I say no (for background read here, and Dan Rayburn has very useful coverage, dispelling a variety of myths). To be sure, one may believe there are monopoly problems at the retail level in the cable sector. We could alleviate those with local loop unbundling and/or deregulation, as I discussed yesterday. But within that setting, Netflix paying Comcast won’t make that monopoly worse.
In support of this conclusion, I would cite two literatures. The first is Ronald Coase’s analysis of payola. If a gatekeeper can extract payments from input suppliers, the end result of that process need not be bad for consumer welfare and very often is positively good for consumers. In a nutshell, the gatekeeper won’t want to exclude the programs which consumers really want. Those programs contribute to the profits of the gatekeeper.
The second literature is that on double marginalization. This literature considers settings where you have a retailer with market power and an input supplier with market power, and the input supplier needs the retailer for access to consumers. In those cases either integration or Coasean bargaining is usually in the interests of consumers, as it minimizes the double mark-up and thus lowers the costs of the market power. To put this more concretely, the two parties will deal so that the marginal cost of the input to the monopolist is lowered, the monopolist expands output (and profit), and those gains are shared between the two institutions with market power.
When you put those two theories together, Netflix buying transit rights from Comcast is likely fine. Don’t translate your opposition to cable monopoly into opposition to this agreement. Seton Motley asks a good question:
Should we worry Amazon (Prime) buys transit rights from UPS & USPS?
So, if someone criticizes this new deal, but cannot put the argument in Coasean language, they probably have not thought it through carefully enough.
Moving beyond that, can we think of reasons why the basic Coasean results may not hold?
1. Expected joint profit doesn’t map perfectly well into consumer surplus.
2. The status quo ex ante was based on some amount of queuing of Netflix access, rather than a dollar-based marginal cost for selling the input, as in basic Coasean models.
3. None of these transactions are purely Coasean when regulatory threats beckon and thus a wider range of outcomes is possible.
4. Comcast has read Doug Bernheim and can now construct a scheme to preempt Netflix from this market altogether,
I’ve pondered those long and hard, but the standard Coasean results still seem reasonably likely. And if they are not, it would be for reasons so convoluted it is unlikely to represent anyone’s actual worry. From that list only #4 seems to have any bite, but I don’t see that #4 applies empirically. Netflix has risen greatly in value over the last year, this new development is hardly a surprise, and the fees to Comcast, while secret, have been described as “de minimis.” There is quite a good chance that Netflix benefits from this deal and this is more of a “we are here for good” statement than Netflix falling off a cliff.
You also could try this argument:
5. By agreeing to pay a price for transit rights, Netflix imposes a negative pecuniary externality on smaller streaming services and content providers, which in the longer run will mean a negative non-pecuniary externality for variety-seeking consumers.
Maybe, maybe so. I do take that argument seriously. But it’s also unconfirmed, Coase on payola implies it won’t be so bad, and furthermore the Netflix transaction, in stand-alone terms, still would seem to be welfare-improving. Besides, what happens if Netflix expands by 5x or 10x, should the company never have to pay anything? Is it so terrible if tomorrow’s necessary equilibrium shows up today?
Addendum: Timothy Lee offers a different perspective. Perhaps I am failing to understand his argument, but I don’t see why having a cluster of mid-level intermediaries should make the market as a whole more competitive.
Or you may be tempted to write a screed about the dangers of moving away from net neutrality, and associate this development with that movement. I say you would do better to stick to the specific economics of this particular issue and explain, in terms related to the Coasean model, exactly what will go wrong.
Further addendum: Joshua Gans offers comment.
That is the current rage in the DC dining scene, namely that you can more easily order lots of “small plates” rather than a big plate with steak and spinach. Neil Irwin makes the case against that practice here, Matt Yglesias responds and defends small plates.
Neither mentions price discrimination or for that matter does much analysis of price. You will recall Glazer’s Law: “It’s either taxes or price discrimination.” And usually it is price discrimination.
Here is Alex on bundling cable channels as a form of (possibly) welfare-improving price discrimination. Read through that stuff if you don’t already know it, but the punchline is that big plates are like a “take it or leave it” cable contract, and small plates are like the a’la carte cable pricing schemes. The bundled contract gets some marginal channels to people who wouldn’t otherwise be willing to pay for them if those channels were sold on a stand-alone basis. In the TV context some of us browse reality TV, Farsi news, and women’s roller derby, even if we wouldn’t pay for those transmissions per se. In the restaurant context, the big plate gets some of us to eat more vegetables and munch on more parsley. Who would pay much for coleslaw? Output goes up under many of the most basic scenarios and consumer welfare goes up too.
In a more competitive market, as indeed the DC restaurant scene has become, bundling breaks down somewhat. We move toward a system of “small plates.” So the increasing competitiveness is good for consumers but the breakdown of bundling can be bad for them, with indeterminate welfare results, which means either Neil or Matt can be correct (but do lay out the whole story, and never ever ever reason from a plate size change!)
Those who have a relatively low marginal value for the add-on items of a meal (vegetables?) will be the ones who eat less under a regime of small plates. How their consumer surplus fares, a priori, is more complex and is not easily settled by theory alone. But, using some typical numbers, very often those who value the vegetables inelastically are worse off under a regime of small plates.
I wonder whether Neil Irwin or Matt Yglesias likes vegetables more?