Economic Foundations for Entertainment and Media

1
Economic Foundations for Entertainment and Media

• Production, Cost and Organization of
• Firms in EM Industries

2
Technology and Production

• Conventional aspects of cost and production for a
  commodity
• Similarities to and differences from
  entertainment and experience goods

3
Classical microeconomics apply to the production
of toasters and books
Brand Cuisinart Price About 80
1,200 pages. Retail About 200 Marginal
Cost? Fixed Cost? Total Cost?

• Behind the price How much does it cost to make
  a Cuisinart toaster?
• Costs of production
• Variable vs. fixed costs
• Marginal cost
• Prices, costs and profits

4
Does it apply to Spotify?
5
Classical microeconomics apply to the market
structure for toasters
Brand Cuisinart Price About 80
There are many brands Lots of competition Probably
not unusually profitable

• Behind the market structure
• Economies of scale can small firms
  survive? Examples Breweries, Car
  makers Counterexamples Paper, Books, Toys,
  Small appliances
• In the middle Movie studios
• Economies of scope is there a competitive
  advantage in producing more than one product?

6
There are many movie studiosThis looks like a
competitive market
7
Familiar Market Outcomes in Commodity Markets

• Market power
• Monopoly (Branding)
• Market segmentation(Low and high end toasters)
• Does the idea of branding extend to movie
  studies or TV networks? To the products they
  produce?

8
Producing Experiences

• Most of the interesting differences are on the
  demand side. (We examined in Part 1.)
• Features of Entertainment and Media Firms
• Conventional economics explains much of
  production
• There are a few special features of some EM
  production

9
Producing Experiences

• Economic Foundations for Production
• Production functions the technology
• Costs of production an element of competition
• Economies of scale and scope produce market
  advantages
• Technological change markets evolve as
  technology changes (e.g., movie theaters)

10
Production Function Making movies has a well
established production technology.
11
Spotify Production Function
Output(s)? What does Spotify produce/sell Inputs?
What resources do they use?
12
Characteristics of the Creative Industries

• What do we mean by the creative industries?
• Not synonymous with experience goods E.g.,
  amusement park vs. art
• There are distinguishing features of creative
  industries
• These features have implications for the
  organization of market activities
• Contracts among producers
• Market organizations for distribution

13
Staging in Production

• Creating experience goods
• Music Composition, Creation
• Books Authorship
• Delivering experience goods
• Pandora, Spotify, etc.
• Prentice Hall Publisher, Amazon Distributor
• Different production processes at work in
  different stages.
• Contrast this to car manufacturers vs. dealerships

14
Creative Industries

• Some characteristics of production in creative
  industries that are unlike more conventional
  production
• Producers emotional connection to the output
  e.g., art, music, performances of many types
  not toasters
• Assembly of widely diverse skills for production
  - movies, sports
• Durable products and durable rent streams.
  Contrast to one-off sale of the toaster.

15
Caves on Creative Industries

• Some characteristics of demand in creative
  industries that are unlike more conventional
  goods
• Uncertainty of demand difficult to resolve
  using market research
• Differentiated products different consumers
  have very different interests in the same
  product.
• The role of time in consumption

16
Noteworthy Features of Production in
Entertainment and Media

• Multiple stages of production
• Outputs are often downstream inputs Think
  movies
• Creation, Distribution, Exhibition
• Creation stage is often very labor intensive
• Little substitution between labor and capital
• Less technologically oriented
• Not always - animation is a major exception
• Delivery (exhibition) may be very capital
  intensive
• May allow substitution away from labor
• Technological advance
• Applications Books, Movies, TV, Newspapers,
  Radio, Recorded Music, Live Performance (Theater,
  Concerts)

17
Production Processes Sometimes Allow Substitution

• Substitution of Factors
• Live theater the cost disease results
  from little opportunity to substitute capital
  for labor
• The trend toward animated movies is an
  example of substituting capital for labor.

The figure shows different combinations of
capital and labor that can be used to produce
100,000 units. E.g., the USPS can use people or
machines to sort 100,000 pounds of mail.
18
The cost disease.
Now, after 500 performances, our producers have
told us and our union that in order to cut costs
they will chop our string section in half,
releasing five musicians and replacing them
with a synthesizer piped in from another room.
19
Production Functions

• Output
• Inputs the factors of production
• The process

The amount producted, Q, depends on inputs or
factors of production. Conventional inputs
Capital, labor, materials used in making
movies Unconventional inputs Music used in
distribution and production in stores and
offices.The crowd used to create big sporting
events.
Labor Capital Materials
20
Industrial Production Function
21
BBB Production Function

• Output Distribution of things to consumers
• Inputs
• Capital Physical, Financial
• Labor
• Energy
• Materials
• Music
• How do they use music?
• Why do they use music?
• How do they pay for it?

22
Live Performance Production is Unconventional

• Production function One stage
• Simultaneous production and consumption
• Feedback between consumers and producers
• Concerts
• Big Sports
• eBay watchers

23
About Production Functions

• Factors and Factor Intensity
• Higher education is very labor intensive, but
  less so over time.
• Broadway (legitimate) theater very labor labor
  intensive and there is almost no opportunity to
  substitute capital for labor
• Creating Music labor intensive, but some
  opportunities to substitute capital for labor.
• Major League Baseball only the game on the
  field is labor intensive. Most of the rest of the
  process is very capital intensive.
• Casino capital intensive. It takes relatively
  few people to keep a casino working, and fewer
  over time.

24
Multiple Output Processes

• Managing a multiplex Two outputs from one
  production facility
• Concessions (the primary source of profits)
• Movies (the secondary profit center)
• Casino
• Gambling
• Food and entertainment
• One capital intensive output, one labor intensive

25
Multiple Output Processes

• Professional sports performance
• The sport Outcome on the field and the signal
  for broadcasting
• Concessions including food and merchandise
• Sky boxes in stadiums
• Music Distribution Many products many
  distribution channels
• Performances (public) that also distribute
  recorded versions plus t shirts and souvenirs
• Music videos
• Music for private consumption
• Music input to other entertainment
• Music blended into advertisements

26
A Mathematical Model for a Movie Theater
Marberger, D., Optimal Pricing for Performance
Goods, Managerial and Decision Economics, 1997,
18, 5, 375-381.

• (1) Movie theaters sell two products
  Tickets, T the number of movie goers who come
  to the theater
• Food (concessions), F amount of food
  sold that night
• (2) Mathematical statements for the two products
• Tickets Demand for movie tix
  T(Pt,W). Marginal cost Ct
• Depends on factors like
  weather (W), the movie, and
• ticket price, Pt
• Food Demand for food
  F(Pf,T,O). Marginal cost Cf
  Depends on the price of food, Pf, the
  number of movie
• goers, T, and other things
  (O) including the movie.
• (3) Central (and intuitively reasonable) result
  dF/dT gt 0
• More movie goers buy more food. Selling
  more tickets will result in selling more
  food.

27
Mathematical Model for a Movie Theater

• The manager must decide on the ticket price
• (1) Ignore the relationship between tickets sold
  and food sold or
• (2) Figure out both tickets and food at the same
  time.
• Ignoring the connection to food
• The theater owner acts like a ticket
  monopolist Profit TPt
  - TCt - fixed costs
• Maximize by equating marginal revenue to marginal
  cost Pt T(dPt/dT) Ct
• The resulting price is a monopoly outcome.
• Pt Ct (marginal cost) plus a
  monopoly effect

28
Mathematical Model for a Movie Theater

• Considering the connection of movie tickets and
  food
• The theater owner tries to maximize profits from
  tickets and food at the same time. Recognizes
  the ticket price will affect the amount of food
  they sell.
• Total Profit Tickets profit food
  profit
• (TPt - TCt )
  (FPf FCf)
• They must equate MR to MC in both parts. For
  the tickets part, now
• Pt T(dPt/dT) Pf(dF/dT) Ct
• The ticket price is lower than if the food
  is ignored
• Pt Ct - T(dPt/dT) - Pf(dF/dT) the
  second minus part is positive.

29
Movies and Food
Ticket Price
Pt is the monopoly price if the owner ignores the
effect of tickets on sales of food.
Ptf is the ticket price if the owner also
considers the effect of tickets sold on sales of
food.
Pt
Ptf
Marginal Cost
Food Effect
Marginal Cost minus food effect
Demand
Tickets
Conclusion To account for the effect of ticket
prices on the demand for the main profit center
(food), the theater owner drives down the ticket
price.
Marginal Revenue
30
Two Product Monopolist
31
Multistage Production Is Common
This is not the same as joint production of more
than one product. Early stages are inputs to
later ones.
32
Multiple Stages in Production
? The TV broadcastNetwork
The game on the field Team
? The viewerCable Operator
Capital Equipment Labor
Players Capital Equipment
F(x)
F(x)
TV Sports
Whats better for this process, one firm or
two? Disney ? Pixar, or Disney/Pixar?
33
The Costs of Production

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

Multimillion model of Titanic
34
Box Office Revenue 1997-2013
35
Production Costs
36
2003

• (2003)
• Marketing Costs 85M
• U.S. Box Office 150M
• World incl. US 417M
• (113 all time on a list that does not correct
  for inflation, currency, or anything else.)
• Rights WB 50M
• Sony 75M

http//www.slideshare.net/MissConnell/film-distrib
ution-costs http//www.edwardjayepstein.com/x-rar1
.htm
37
(No Transcript)
38
Changing Economics for Stars

• Before 2010 10M, 15M, 20M,
• Trend since about 2010
• Small or no up front
• Except for Angelina Jolie first choice for
  Gravity but could not agree on a deal. Sandra
  Bullock got 20M for signing. Unusual now.
• CB 0 contract (Cash-Break zero percentage after
  break even)
• Far smaller total compensation for start
• Why?
• Economics of film making
• Falling demand for star power in movies

39
Production cost 100M Exhibitors
At least 300M Sandra Bullock
77M 20M 15 x Studio net (45 )

Misc TV, DVD, etc. George
Clooney ? Net so far
231M - ? Promotion and
advertising ? Probably 50M - 100M Other
distribution ?
Such first dollar guaranteed box office deals
for actors are becoming rare, the Hollywood
Reporter said, because studios now want to recoup
all the costs for expensive productions before
sharing the profits with talent. Bullocks
co-star George Clooney, Gravity director Alfonso
Cuarón and producer David Heyman are also
believed to have back end pay
deals. http//www.independent.co.uk/arts-entertai
nment/films/news/gravity-star-sandra-bullock-set-t
o-earn-70m-windfall-for-oscarnominated-film-915744
8.html
40
Budgets and Box Office Revenues
41
CD Costs and Profits
Breaking Down Music Costs
Consumer
Retailer 6.20
Record Label 10.80
.75 1.40 2.15 .86 1.08 1.29
.70 1.94 .59 1.36 1.36
2.55 .97
Marketing and Promotion
Sales and Distribution
Overhead and Distribution
CD and Booklet Manufacturing
Cooperative advt. and Discounts
Artist Development
Royalty to Recording Artist
Royalty to Composer and Lyricist
Operating Profit
Labor
Distribution
Rent (Shopping Mall)
Operating Profit
Fixed CostsVariable CostsSunk CostsOperating
Profit
42
Production and Cost Functions?
Most of the marginal cost of something sold for
download from iTunes is the royalty. E.g., the 99
cent single track triggers about 70 cents in
royalties.
43
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

44
Economies of Scale in EM

• Cablevision
• Professional sports
• Publishing/Movies Backlists of titles
• Casinos
• Movies
• Television

45
Economies of Scope

• Cost effect
• Cost(Q1,Q2) lt Cost(Q1,0) Cost(0,Q2)
• Cablevision and Newsday
• Applications
• Cable TV, Internet
• Mobile phone network
• Basketball, Hockey teams
• Not the effect behind vertical integration
• News media owning the sports team?Sky News
  motivation for owning Manchester United

46
Technological Advance

• (Marginal) Cost Reduction
• Digital setup in newspapers
• Synthesized instruments in Broadway Musical
  Orchestras
• Digital distribution of movies
• Less Cost Reduction in Performance Industries
  Baumols Cost Disease of the service sector
• Live theater, Orchestra, Education

47
Search Technology - The Long Tail

• Reduces the marginal cost of distribution and
  promotion.
• Locate the world market for small or obscure
  goods books - information
• A result of the Internet and search technology.

48
(No Transcript)
49
Labor Saving Technological Change in Card Games
in Casinos
50
Digitizing Entertainment Technical Advance in
Delivery of Existing Forms

• Music
• MP3 - affects distribution, not creation
• Pop music without musicians.
• Literature
• E-books Kindle (Amazon), Nook (BN)
• E-zines (Slate.com)
• Web based news services (NYTimes.com)
• Movies
• Creation digital equipment, Pixar animation
• Distribution digital transmission without film
• Distribution mode Netflix
• Exhibition digital projection (expensive)

51
Book Production Costs
52

• Music Production and Distribution Costs
• Studio quality recording with free software and
  without studio or graphic design. (XBloome X
  Marks the Spot.
• Distribution, bypassing the labels. iTunes,
  SoundCloud

From XBloome's X Marks The Spot website As maybe
the first album ever, 'X marks the spot' was
produced exclusively using Free Software (Open
Source) and without a professional studio or
graphic designers. With this 'proof of concept'
album, XBloome have debunked several prejudices
about feasibility, professionality and quality of
free and self-made productions. (www.xbloome.com)

53
(No Transcript)
54
SoundClouds Conventional Entry into the Music
Streaming Market
55
Who should bear the cost?(About
75,000/screen) Film makers? Distributors?
Exhibitors? Equipment makers? New York
State? The conversion is over 80 complete in the
U.S.
56
http//www.rollingstone.com/movies/news/how-digita
l-conversion-is-killing-independent-movie-theaters
-20130904
57
U.S. Movie Screens Source National Association
of Theater Owners
58
(No Transcript)
59
Theater owners cannot price digital.
PRICING MOVIE TECHNOLOGY General Seniors
Children Cabin in the Woods (Georgetown) 12
11 9 Cabin in the Woods (7th
H)(Not digital) 12 9.25 9 Loews
on 84th St. New York 13 9.50
9.50 Titanic Imax 18 17
15 Titanic Real 3D 16 15
13 Wrath of the Titans in Real 3D 16
15 13
60
(No Transcript)
61
3D
2D Format Existing projecting systems 20 new
movies in 2008-2010. 3D Format About 1000
existing projection systems plus 250 IMAX.
Requires digital projection. Its not always as
good as they say it isIm not so sure our
customers even know we have it Theater owner,
New Mexico. Can it be priced?
62
(No Transcript)
63
http//www.marketplace.org/topics/business/movie-t
heaters-move-beyond-ticket-price
The simple explanation is that fewer people are
going to the movies, but they are paying more for
their tickets. Mostly we're talking about 3-D
movies, which are more expensive. But higher
ticket prices aren't necessarily great news for
theater owners. Theaters have to share box office
revenue with studios, says business professor
William Greene of the Stern School of Business at
NYU.
64
3D Economics

• 30 3D Movies
• Avatar - 250M
• Benefit Net addition to profit 80M (Dreamworks)
• Obstacle Digital Projection
• Insufficient screens (3000 needed for an opening)
• Uncertain financing for theater digital
  projection (financial crisis)
• Pricing the Upgrade (25 tickets)

65
3D can be priced. Digital cannot.
3D
2D
66
4D can be priced.
A subsidiary of a distribution and exhibition
company, CJ 4DPlex provides the technology for
112 4D theaters in more than 20 countries
throughout Asia, Europe and the Americas. Tickets
Stateside cost 22 on average, but for that
premium price, moviegoers get to kick back in
motion-based seating in a theater that spays
water, emits odors and jerks visitors around, all
synchronized to the on-screen action. Moviegoers
seem interested in taking this particular ride.
Over its 13-day 4D engagement, for example,
Transformers Age of Extinction generated
105,016 in ticket sales compared to a U.S.
average of 44,054 during the same period. Thats
an 138 improvement. Likewise, Dawn of the
Planet of the Apes capitalized on its
action-heavy plot to deliver 94,247 in ticket
sales in one 4DX location over its first 13 days
compared to an industry average of 38,404.
Thats 145 better.