Economic Foundations for Entertainment, Media, and Technology

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Economic Foundations for Entertainment, Media,
and Technology

• Production and Cost in EM Industries
• Spring 2001 (4)
• Professor W. Greene

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Production and Cost

• Production Functions
• Costs of Production
• Economies of Scale and Scope
• Technological Change
• Integration Horizontal and Vertical
• Economic Profits

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The Production Function

• Output
• Inputs The factors of production
• The process

Labor Capital Materials
?
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About Production Functions

• Factors and Factor Intensity
• Higher education
• Broadway Theater Labor intensive
• Major League Baseball - ???
• Casino Capital intensive
• Multiple stages of production
• Outputs as downstream inputs

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Multiple Stages in Production
The TV broadcast
Capital Equipment Labor
The game
The viewer
Players Capital Equipment
TV Sports
F(x)
F(x)
Whats better for this process, one firm or two?
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Production Functions

• Managing a multiplex
• Casino
• Making movies (indies vs. studios)
• Professional sports
• Delivery of professional sports
• Music
• Publishing

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The Costs of Production

• Fixed cost Not a function of output. Capital
• Sunk cost One time, nonrecoverable costs
• (very significant in the movie business)
• Variable cost Variable with respect to output
• Labor
• Materials
• Marginal cost Avoidable cost of one more (less)
  unit

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Economies of Scale

• Working definition Declining average cost
• Market based definition Competitive advantage of
  large size
• Sources
• Supply based Technical,
• Demand based Networks
• Indivisibilities Lumpiness

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Economies of Scale in EMT

• Cablevision
• Professional sports
• Publishing/Movies Backlists of titles
• Casinos
• Movies
• Television
• Telecommunications
• Web based businesses

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Economies of Scope

• Cost effect
• C(Q1,Q2)
• Not the effect behind vertical integration
• Applications?
• Cable TV, Internet (convergence?)
• Basketball, Hockey

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Technical Advance
Average total cost

• Cost Reduction
• Digital setup
• in newspapers
• Product innovation Adult orthodontics
• Rapid, disruptive product innovation
• Seagate disk drives
• Satellite delivery of electronic content
  (Cablevision?)

t1
t2
t3
Output
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Digitizing Entertainment Technical Advance in
Delivery of Existing Forms

• Music
• MP3 - affects distribution, not creation
• Pop music without musicians. (Britney Spears)
• Literature
• E-books?? (Maybe not yet)
• E-zines (Slate.com)
• Web based news services (NYTimes.com)
• Movies
• Creation digital equipment
• Distribution transmission without film
• Exhibition digital projection (expensive)

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Multistage Production

• Financial Services Professional Sports
  Publishing
• Back office Team sports Author
• Large scale Advertising and Publisher
• content assembly
• Retail banking Broadcast to homes Retail
  distribution

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New Football LeagueNFL XFL

Labor Pool
Labor Pool
Other inputs
NFL Draft
WWF/NBC
LA
CLE
NY
CHI
Homes
ABC
NBC
CBS
FOX
Is it vertical integration? Is it a cartel in the
labor market? Why are salaries so low compared to
NFL? What does WWF bring to the party?
Homes
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Integration of Firms

• Markets
• Financial Services Professional Sports
  Traditional Publishing

Final Consumers
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Theoretical Departure Pointon Firm Integration

• Perfectly Competitive Markets
• All firms atomistic price takers
• All firms fully informed and efficient
• Reasons for firm integration None
• Reasons against integration None
• Reasons we observe integration
• Reaction to market failure of some sort
• Creation of a market failure

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Conglomerate Mergers

• Markets
• Financial Services Professional Sports
  Traditional Publishing

Why do this? Why do we observe this?
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Economies of Scope?

• Markets
• Financial Services Professional Sports
  Traditional Publishing

Sports broadcasting and newspaper
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Synergistic Mergers

• Firms in related industries
• Not a conglomerate merger
• Exploitation of commonalities
• Are there economies of scope?
• Applications?
• Hockey and basketball?
• Newspapers and book publishing?
• Others?

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Horizontal Integration

• Markets
• Financial Services Professional Sports
  Traditional Publishing

What objective?
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Horizontal Mergers

• Increases market share
• Extends market power forward
• Monopolization
• Hirfindahl index ?firms (market shares)
• (S1S2) S1 S2 2 S1 S2
• May extend market power backward
• What justifies horizontal integration?
• Economies of scale
• Synergies? (What is this?)
• Capture market power
• Application The media mogul

2
2
2
2
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Vertical Integration

• Markets
• Financial Services Professional Sports
  Traditional Publishing

Final Consumers
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Benefits of Vertical Integration

• All arise from some market failure
• Lower transaction costs Firm organizational
  limitations
• Transactions involving information
• Avoidance of government restrictions, taxes, or
  regulations.
• Extension of market power (forward or backward)
• Avoidance of upstream market power
• Assurance of steady or reliable input supply
• Murdochs (alleged) attempt to influence staffing
  decision of a baseball field manager before a
  broadcast
• Internalization of market failures
• Franchising reduces problems of free riding

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Costs of Vertical Integration

• Private costs
• Loss of economies of scale
• Organizational complexity
• Assumption of risk
• Social costs
• Creation or extension of market power
• Possible cartelization

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Vertical Integration in EMT

• Analysis
• Where is it observed?
• What are the benefits / motivation?
• What are the costs?
• Applications
• Seagram and Vivendi
• Cablevision and home delivery of cable generally
• End to end production
• Internet service providers and cable operators
• The movie business (at several stages)

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AOL Time Warner

• AOL
• Internet service provider
• Instant messaging
• Time Warner
• Time Warner Cable Time Inc. (Magazines)
• HBO Turner Broadcasting
• The WB Network New Line Cinema
• Warner Music Time Warner Publishing
• Warner Brothers Studio
• Horizontal vs. vertical integration
• What kind of merger is this?

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Cablevision

CSC Holdings and Optimum TV The cable system
Optimum Online
Knicks Rangers Liberty
Homes
Radio City Enter.
Lightpath
Rainbow Media
Businesses
The Wiz
Madison Square Garden
Clearview Cinemas
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Rupert Murdoch

• Markets
• Financial Services Professional Sports
  Traditional Publishing

Mogul take all?
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Profits and Losses

• Simple Cases Electronic Commerce

Average Total Cost
Amazon
Average Variable Cost
EToys
Average Fixed Cost
Amazon P AVC, P (RIP, April 6, 2001)
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Profits in Multistage and Multiple Output
Processes

• Allocation of revenues to activities
• Multiple revenue sources (outputs)
• Allocation of costs to activities
• Fixed costs in multiple output firms
• Net vs. gross in Hollywood
• A Miami Fish Story

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Economic Profits and Losses

• Opportunity cost of capital
• Valuing an investment?
• ?tyears
• Economic value of a business
• How to do this? (Offer the business for sale.)
• When is a business losing money?

Profits in year t (1 r)
t