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Programming in a competitive broadcasting market: entry, welfare and regulation
Information Economics and Policy 10 (1998) 23–39
Programming in a competitive broadcasting market: entry, welfare and regulation Chris Doyle* London Business School, Sussex Place, Regent’ s Park, London NW1 4 SA, UK
Abstract It is shown how regulation might be needed in a competitive broadcasting industry to ensure a desirable mix of programming. A model building on the tradition of the existing literature illustrates how different regulatory instruments can be deployed to provide, where necessary, TV firms with appropriate incentives to choose certain programme types. Direct instructions and the use of a tax on profits are two such instruments. The model also considers the effect of entry and there is a brief discussion on regulatory risks. The paper contributes towards the public policy issues connected with broadcasting markets where extensive liberalisation is imminent. Key words: Broadcasting; Programming; Regulation JEL Classification: L5; L8
1. Introduction Television and radio broadcasters are typically subject to an array of license conditions which include to a greater or lesser extent terms governing the content of programming. For example, in the United States the Mass Media Bureau at the FCC protects the public by ensuring that broadcasters do not broadcast obscene programmes and limits the number of commercials aired during programming aimed at children. In the United Kingdom the licenses held by terrestrial television broadcasters contain inter alia the following three regulatory requirements (see Collins et al. (1988)): * Corresponding author. E-mail: [email protected] 0167-6245 / 98 / $19.00 1998 Elsevier Science B.V. All rights reserved. PII S0167-6245( 97 )00027-9
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1. Programming and scheduling should have a mix that operators must produce for themselves, including programmes for schools, news, current affairs and local interest programmes. 2. Limits on the amount of programming acquired from outside of the European Union. 3. Operators should provide comprehensive production facilities in order to comply with the first requirement and to originate a wide range of programmes besides. It can be seen that the programming subject to regulation in the United Kingdom includes that which is likely to have a relatively low demand and which may be relatively costly to produce. In some cases programmes in these categories may confer social benefits because of alleged cultural content and because they may satisfy the tastes of important minorities in a population (such as ethnic and religious groups). For these reasons welfare arguments can be used to justify the regulation of programming, particularly if it is felt that private unregulated firms would be unlikely to deliver certain desirable programmes. However, the relatively interventionist position taken by the authorities in the United Kingdom differs sharply from that taken in the United States. The FCC, see FCC (1980), believes that in general the selection of programming is best left to those operating in the market who are more likely to be aware of the needs of consumers. Krattenmaker and Powe (1995) have argued content decisions should not be determined by government at all and that a competitive market will deliver a socially desirable mix of programming. This view is questioned by Collins et al. (1988) in a discussion regarding the merits of introducing Pay or subscription TV. ‘‘Obviously more channels will provide more choice between channels but not necessarily between programmes. Whereas monopolies and duopolies can pursue complementary scheduling strategies, Pay TV channels may provide very similar fare. The attractiveness of Pay TV therefore depends on the quality of choice and the costs of achieving choice’’.1 It is useful from a public policy perspective therefore to develop an understanding of how competing broadcasting firms choose programming. This is particularly of great concern today as consumers in many countries will soon be able to receive digital television which promises a choice of hundreds of channels including many Pay TV options. These developments are arising because of moves towards greater liberalization in markets like the United Kingdom (see Oftel (1996) and the Peacock Report (Peacock, 1986)), and because of technological change which is lowering both the costs of transmission and programme production. If we have a reasonably good understanding of the factors which are likely to determine the mix of programming in competitive broadcasting market, this will enable us to design better any necessary regulatory safeguards. 1
See Collins et al. (1988) page 107.
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At a general level the issues addressed in this paper fall into the domain of product variety and location theory, for example see Greenhut et al. (1987). In the field of Media and Multimedia economics there is a rich literature which addresses the issue of programme schedules or diversity and competition. The seminal works are those of Steiner (1954); Beebe (1977); Spence and Owen (1977). More recent contributions include Holden (1993); Waterman (1990); Wildman and Owen (1985). An excellent overview of the literature can be found in Owen and Wildman (1992). The early literature inspired by Steiner (1954) concentrated on the relationship between market structure and programme diversity. For example, it was shown in a variety of settings that under advertising funded TV social welfare is likely to be higher with monopoly provision of broadcasting programmes. This arises because under competition Hotelling-like bunching occurs as rival firms each try to extract rents by broadcasting more popular type of programmes. However, Beebe (1977) emphasizes that the outcome in Steiner’s model was influenced considerably by the use of a specific set of assumptions. Relaxing some of these assumptions enabled Beebe to show that competition need not do worse than monopoly provision, which is also shown in the model presented in this paper. Spence and Owen (1977) developed further the enquiry focussing on market structure and presented a model of monopolistic competition in which they make welfare comparisons between Pay TV and advertising funded TV. Using this framework they looked at how the different methods of funding TV affected welfare and then compared the outcomes to those which would arise in a monopolistic setting. Their main conclusion showed that Pay TV if supplemented with advertising revenue would result in higher welfare than TV supported only by advertising revenues, a result echoed in this paper. The conclusions of the analysis examining market structure shows that advertising TV typically leads to more bunching than Pay TV, and that competition typically generates more programming diversity than monopoly. However, to conduct welfare rankings of the different market structures and the different funding mechanisms requires detailed information about preferences (demand) and costs.2 In this paper we focus only on a competitive market structure. This is because the question of monopoly versus competitive provision of TV programming is largely redundant today. It is clear that in most advanced economies there is extensive and growing competition in the TV broadcasting industry. This is due largely to technological progress which has lowered production programming costs and lowered the costs and improved the quality of TV sets which has therefore increased demand for TV programmes. Faced with increasing competition in the broadcasting industry the relevant questions to pose regarding programme 2
For a clear discussion on welfare for different market structures and funding mechanisms, see chapter four in Owen and Wildman (1992).
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diversity relate to the degree of competition and the role of regulation. In this paper we deal with both of these aspects. We develop a model in the spirit of the traditional literature while incorporating a more plausible characterization of the investment process. We suppose that broadcasting firms face a two-stage decision process where the type of programing is decided in an initial stage. By modelling firms as facing a two-stage decision process enables us to allow for the presence of sunk costs, which in the broadcasting industry are often considerable. Much of the literature that has focused on market structure largely uses static models, although notable exceptions include Wildman and Lee (1989) who look at programme repetition. We highlight how competition in the absence of regulation may not deliver a social optimum. For example, if a certain amount of programme diversity is optimal this may not emerge in an unregulated competitive broadcasting market: private unregulated firms may concentrate on broadcasting more popular programmes. In this setting we show that there is scope for welfare enhancing regulation. There are two main forms such regulation may take. First, it could involve direct instructions: a regulator instructs a TV company about the type of programming content it should broadcast. This is particularly prevalent in Europe where licenses are often drafted to contain provisions ensuring certain types of programming are shown, as discussed above. Secondly, regulation may seek to complement the price mechanism through the use of tax instruments and price controls. In the United Kingdom industry specific taxes have been levied in ways which are designed to promote certain forms of programming. Spitzer (1991) discusses how differential taxes are used in the United States to influence the content of programming, for example by providing tax breaks for broadcasters delivering certain types of minority programmes. In the model here we show how both forms of regulation can achieve outcomes which are socially desirable when otherwise the market might fail to achieve these outcomes. We also extend the analysis to examine the effect of entry and increased competition, a phenomenon occurring in most competitive broadcasting markets. Typically entry into broadcasting markets takes place where the market is thickest: that is in the more popular domain of programming. Noam (1987) has shown in the context of government owned minority broadcasting such entry might jeopardize programme diversity by undermining the finances of the minority channel. We also show how greater competition in popular broadcasting can undermine programme diversity, especially where revenues are raised using subscription charges. Nevertheless, in this case we show how regulation can be designed to accommodate entry and promote increased diversity in programming.3 Although the principal aim of the paper is to show how regulation can be designed to benefit society, we also discuss informally how regulation, or the fear of changes to regulatory rules, so-called ‘‘regulatory risk’’, might in fact have an 3
Park (1980) presents a different model dealing with the effects of new entry.
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adverse effect on programming diversity and welfare. The argument about regulatory risk is intended to introduce some balance into the discussion by highlighting that regulation, like a competitive market, is susceptible to failings. The paper is organized as follows. In Section 2 a benchmark two-stage duopoly model is characterized. In Section 3 the outcome in an advertising supported industry is constructed, and in Section 4 the same is done for the case of a subscription supported industry. In Section 5 we examine the industry structure in which firms are free to choose both advertising and subscription fees. Section 6 looks at the outcomes that might emerge in an unregulated industry. By contrast Section 7 looks at the role for regulatory intervention. In Section 8 the issue of greater competition through entry and the effect on programme diversity is considered. In Section 9 there is a brief discussion on regulatory risk and Section 10 concludes.
2. The benchmark model: duopoly We examine a game theoretic model in which initially the industry structure is assumed to be duopolistic. Three forms of revenue support are considered: (i) where revenues derive solely from advertising, (ii) where revenues derive exclusively from subscription fees levied on viewers, and (iii) where revenues derive from both advertising and subscription charges. Subscription or Pay TV, where a consumer pays a fixed fee for the rights to view a channel, is the most prevalent alternative to advertising supported TV. However, it is usual in practice for broadcasters to generate revenue both through advertising and subscription charges. In the model presented here pay-per-view television is equivalent to subscription TV. In all scenarios considered firms face a two-stage decision process. In the first stage each firm chooses a programme type that it intends to broadcast in the second stage. Revenues in the second stage are collected through advertising and / or via the levying of subscription charges. The firms may be free to choose in the second stage the way in which revenues are raised.
2.1. Preferences and demand Consider two broadcasting firms (alternatively stations or channels) 1 and 2 where each station i can choose to broadcast one of two types of programme. Let Pij denote that programme j is shown on the ith station. Assume there exists a population of consumers (alternatively viewers) normalized at unity. Without loss of generality assume that a fraction a [ (1 / 2,1) (the majority) of consumers hold the lexicographic preference relations Pi 1 s Pi 2 , P11 | P21 , and P12 | P22 and the remaining fraction 1 2 a (the minority) have the preference relations Pi 2 s Pi 1 , P11 | P21 , and P12 | P22 . In words these mean that the majority prefer to view programme type 1 (PT1) and are indifferent about the choice of channel when
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both stations are showing PT1, and the minority prefer to view PT2 and are indifferent about the choice of channel when both stations show PT2. In practice it may be the case that PT1 is a sports programme and PT2 is an arts programme. In addition to viewing TV suppose that all consumers have an outside option denoted S. In other words a viewer can consume S by turning off the television; S is a substitute for television viewing. Assume that a fraction g [ (0,1) of the majority a who prefer PT1 hold the preference relation S s Pi 2 if both channels show PT2.4 However, for all the other viewers (1 2 g )a 1 (1 2 a ) PT2 is preferred; S a Pi 2 . Similarly, for the minority 1 2 a who prefer PT2 assume that if both channels offer PT1, a fraction g [ (0,1) of these consumers hold the preference relation S s Pi 1 . For all the other viewers (1 2 g )(1 2 a ) 1 a PT1 is preferred; S a Pi 1 . Note symmetry is assumed with respect to the outside option. If the programme mix is hP11 , P21 j then (1 2 g )(1 2 a ) 1 a 5 u , 1 prefer to watch television, and if the mix is hP12 , P22 j a fraction (1 2 g )a 1 (1 2 a ) 5 b , 1 of consumers watch television. As a . 1 / 2 it is always the case that u . b and u / 2 , a. Where programming is bunched, i.e. both channels show the same programme type, a fraction (1 2 u ) or (1 2 b ) of the population prefer to consume the outside option. The assumptions about preferences mean that when variety is absent aggregate demand for TV consumption is lower.5 When each channel offers the same type of programming, those who prefer to view are indifferent about which channel to watch and it is assumed that each viewer selects a channel at random. If the programme mix is hP11 , P22 j, then a prefer to watch channel 1 and (1 2 a ) prefer channel 2. Let the viewing figures for each channel i be defined by the function V i (P1j , P2j ) for i, j 5 1 or 2. Given the above assumptions, if TV programming is broadcast at a zero price by both channels, then each channel will have one of four possible viewing figures as follows: V 1 (P11 , P21 ) 1
V (P11 , P22 ) V 1 (P12 , P21 ) V 1 (P12 , P22 )
65 5
u /2
V 2 (P11 , P21 )
a
V 2 (P11 , P22 )
12a
b /2
;
V 2 (P12 , P21 ) V 2 (P12 , P22 )
65 5
u /2
12a
a
(2.1)
b /2.
Following Spence and Owen (1977) we also place valuations on the goods in the choice set of consumers. The following valuations are based on uninterrupted programming, ie programmes are shown in the absence of advertising. Suppose that the a majority who prefer PT1 value it at $1 and that they attach a value $w,$1 to PT2. Furthermore, assume that ga of the majority value the outside ¯ option S at $s¯ and the remaining (12g )a value it at $s, ] where 1.s .w.s. ] 4
In Steiner (1954) preferences are said to be exclusive which is the case where g 51. Goodhart et al. (1987); Barwise and Ehrenberg (1988) provide evidence for this kind of viewing pattern. 5
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Similarly, let the 12 a minority value PT1 at $w, PT2 at $1 and a fraction g (12 a ) value the outside option at s¯ and the remaining (12g )(12 a ) value it at $s. ] Finally, without loss of generality assume that the outside option has a zero price and $s50. ] We suppose that consumers prefer to watch programmes with fewer adverts rather than with more adverts.6 Where a consumer places a value of $x on a programme in the absence of advertising, this falls to $ax for $a$0 if the same programme is shown together with advertising. Note that the disutility effect due to advertising is multiplicative which means consumers suffer a greater absolute loss in utility when advertising appears on programmes which they value relatively highly. For simplicity we assume where programmes are shown together with advertising all channels display the same amount of advertising.
2.2. Technology, supply and costs The underlying technology and costs for each firm is symmetric. Each channel is confronted with a two-stage decision process. First a programme type is selected and this is followed by the levying of advertising fees or subscription fees, or possibly both. We allow the marginal costs of subscription TV to differ from those of advertising supported TV. Let superscript d51 refer to advertising funded TV and d52 denote subscription TV. In the first stage, where a programme type is selected, a firm incurs a fixed cost Fj $0 which is treated as sunk and independent of the funding mechanisms when the firms enter the second stage. Having selected a programme type in the first stage, each firm will broadcast to viewers in the second stage. In this stage each firm i incurs a linear variable cost c j dV i , where c j d [[0,1) is the marginal cost of production. The total cost function for each firm i is Cij 5 c dj V i 1 Fj , where d, j51 or 2. In practice c j d for d, j51 and 2 are likely to be relatively small, but it seems reasonable to suppose programmes involving the direct billing 6
The dislike of greater advertising has recently been reflected in discussions regarding UK terrestrial commercial TV. Under regulatory rules set by the Independent Television Commission UK terrestrial TV channels are allowed to show an average of 7 ]12 min / h between 6pm and 11pm and 7 min for the rest of the day. It is currently being discussed whether to increase this to 9 min to bring terrestrial television in line with satellite and the rest of Europe. These proposals have been criticized by viewers’ groups and consumer representatives. Benet Middleton of the Consumers’ Association has stated ‘‘These proposals offer no benefit to consumers. More or longer breaks would just make consumers worse off.’’ (The Times newspaper, 6th August, 1997.) The regulated approach in Europe contrasts sharply with US practice where since 1981 broadcasters have been free of timing constraints over advertising, see Owen and Wildman (1992, p.125).
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of consumers, ie subscription or pay TV, are likely to have higher marginal costs and therefore we assume c j 1 ,c j 2 . For simplicity and without loss of generality assume c j 1 50 for j51 and 2.
3. Equilibrium in an advertising supported industry In this case programmes are broadcast to consumers free of charge and revenues for each firm are derived solely from advertising. It is assumed that advertising revenues increase in the viewing figures given in Eq. (2.1). The revenue function for each firm i is described as R i (V i ) and if all viewers were equally valuable to advertisers this function would be homogeneous of degree one. In order to depart from this restrictive assumption we assume instead that advertising per capita revenues derived from broadcasting to the minority are not necessarily equal to the per capita revenues from broadcasting to the majority. To capture this we suppose advertising revenues from the minority are scaled up or down by l [[0, `) so that if channel 1 broadcasts PT2 and channel 2 shows PT1, advertising revenues for channel 1 are l(12 a ) whereas revenues are a for channel 2.7 If the minority group is relatively poor (rich), this is likely to be associated with l ,1 ( l .1). Note that firms are price takers in the advertising market which means the market for advertising is presumed to be perfectly competitive. This assumption is widely deployed in the literature, for example see Spence and Owen (1977); Waterman (1990). The profits for each firm i showing programme type j are defined as follows,
Pij 5 R i 2 Fj
for i, j 5 1, 2.
(3.1)
Although the game extends over two stages, only the first stage is strategic because profits are affected only by the choices made in the first stage. If advertising were not perfectly competitive, then the second stage of the game would also be strategic. In the first stage each firm i chooses a programme type Pij , where j51 or 2. A Nash equilibrium is a pair of programme types hP 1*j , P 2*k j for j, k51, 2 where these yield for each firm a profit at least as great as that which could be achieved by choosing the other programme type given the choice made by the other firm. Given Eq. (3.1) the Nash equilibrium of the game can be solved. As consumers are not necessarily equally valuable for advertisers, it is useful to define u 95(12 g )l(12 a )1 a and b 95(12g )a 1 l(12 a ). Given these definitions it also helps ˆ where l˜ , l( l˜ . l) if l .1 ( l ,1) and lˆ , l ( lˆ . l) ˜ and b 95 lb to define u 95 lu if l .1 ( l ,1). The payoff matrix for the game is given below in (3.2) where the amount obtained by channel 1 is shown as the upper figure in each cell.
7
Where l 51 this is the case of equally valuable consumers.
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Channel 1
Channel 2
PT1
PT2
PT1
˜ /22F1 lu ˜ /22F1 lu
PT2
a 2F1 (12 a )l 2F2
(12 a )l 2F2 a 2F1 ˜ /22F2 lb ˜ /22F2 lb
(3.2)
Symmetry means that hP11 , P21 j (equivalently hPT1, PT1j) is a Nash equilibrium if ˜ / 22F1 .(12 a )l 2F2 holds and hP12 , P22 j (equivalently hPT2, PT2j) is a Nash lu ˆ / 22F2 . a 2F1 is satisfied. These inequalities can be rewritten equilibrium if lb respectively as
l˜ 2(F2 2 F1 ) 2(1 2 a ) ] 1 ]]] . ]]], l ul u
(3.3)
1 F2 2 F1 b ] 1 ]]] , ]. 2a l˜ al˜
(3.4)
Where both the inequalities in Eq. (3.3) and Eq. (3.4) are reversed, then hP11 , P22 j (equivalently hPT1, PT2j) or hP12 , P21 j (equivalently hPT2, PT1j) are both Nash equilibria. Thus under advertising supported TV programming can be diverse or bunched and the outcome depends on the relative size of the parameters. For example, the larger (smaller) the difference between fixed costs F2 2F1 , it is more likely that hP11 , P21 j (hP12 , P22 j) will be the equilibrium. Where advertising is highly valuable when shown to the minority, i.e. l is relatively large, the equilibrium is more likely to be hP12 , P22 j. Although programming may be diverse under advertising, there is a tendency for programming to bunch when l is relatively small and a is relatively high. Where both l and a are relatively high, diversity may constitute an equilibrium. The bunching effect of advertising supported TV will become apparent when we analyse the solution of the subscription TV game next.
4. Equilibrium in a subscription supported industry An alternative form of revenue generation is subscription TV: the consumer pays an amount for the right to view a channel. The decisions made by the firms’ follows a sequence where the programme type is chosen in the first stage and competition over subscription fees takes place in the second stage. Unlike the advertising game, the solution here requires backwards induction to solve for a perfect equilibrium because the final subgame is strategic.
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In the second stage each firm competes by choosing a subscription fee pi to levy on consumers. If a consumer pays a subscription fee pi it enables him or her to receive the programming shown by channel i in the second stage. In the second stage the fixed costs incurred in the first stage are sunk and therefore do not influence profit maximization choices in this stage. There are four possible scenarios in the second stage: (i) both channels offer PT1, (ii) both channels offer PT2, (iii) channel 1 (2 ) offers PT1(PT2) or (iv) channel 1 (2 ) offers PT2(PT1). Consider first cases (i) and (ii) where both channels offer the same programme type. In this setting Bertrand competition will drive subscription fees to a level where expected second stage profits are zero. Consider the case where both channels show PT1 and each levies the same subscription fee p1 5p2 .c 12 . If demand is non-zero, then profits at channel i can be increased by undercutting infinitesimally the price set by channel j. Hence p1 5p2 5c 12 is the only equilibrium in this stage. Similarly if both channels show PT2 the unique equilibrium in the second stage is p1 5p2 5c 22 . Next consider the case where channel 1 offers PT1 and channel 2 offers PT2. (Symmetry means that the case where channel 1 shows PT2 and channel 2 shows PT1 is identical.) Assume that firm 2 sets a price p2 $0. The number of consumers viewing channel 1 depends on the size of p2 and w. When the price for channel 2 is relatively high such that p2 .12w, demand at channel 1 is as follows: V 1 5 0 for p1 . 1 2 w 1 p2 ,
(4.1)
¯ 1 2 w 1 p2 ], V 1 5 (1 2 g )a for p1 [ (1 2 s,
(4.2)
V1 ¯ w 2 1 1 p2 ] and min[w 2 1 1 p2 , 1 2 s¯ ] 5 1 2 s, ¯ 1 2 g if p1 [ (1 2 s, 5 a if p1 [ (w 2 1 1 p2 , 1 2 s¯ ] and min[w 2 1 1 p2 , 1 2 s¯ ] 5 w 2 1 1 p2 , (1 2 g )(1 2 a ) 1 a if p1 [ [0, min[w 2 1 1 p2 , 1 2 s¯ ]].
5
(4.3) If the price set by channel 2 is relatively low such that p2 ,12w, demand at channel 1 is as follows: V 1 5 0 for p1 . 1 2 w 1 p2 ,
(4.4)
¯ 1 2 w 1 p2 ], V 1 5 (1 2 g )a for p1 [ (1 2 s,
(4.5)
V 1 5 a if p1 [ [0, 1 2 s¯ ] and p2 , 1 2 w.
(4.6)
Where each channel has its own programme type, i.e. there is diversity, it follows that there is ex post monopoly power or in other words the market structure in the second stage is monopolistically competitive. Channel 1 obtains the largest
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audience (12g )(12 a )1 a when channel 2 sets a relatively high price and its own price is relatively low, as is to be expected. The discrete nature of demand and the linearity of marginal costs mean that each firm only considers setting one of at most three prices: pi 512w1pk , pi 512s¯ or pi 5w211pk . It is clear that the price combinations: p1 5w211p2 and p2 5w211p1 ; p1 512w1p2 and p2 512w1p1 ; and pi 5w211pk and pk 512s¯ cannot hold in equilibrium. There are therefore five possible candidate equilibrium price structures in the final subgame: p1 5 1 2 w 1 p2 , p2 5 w 2 1 1 p1 ; p2 5 1 2 w 1 p1 , p1 5 w 2 1 1 p2 ; p1 ¯ p2 5 1 2 s; ¯ p1 5 1 2 s, ¯ p2 5 1 2 w 1 p1 ; p1 5 1 2 w 1 p2 ; p2 5 1 2 s, ¯ 5 1 2 s.
(4.7)
Each pair in Eq. (4.7) is a potential equilibrium in the second stage if the following inequalities hold c 21 #p1 and c 22 #p2 . Having solved the second stage of the game, this can be used to evaluate the choices made in the first stage. Each firm aware of the equilibrium in the final stage can compute the profit associated with choosing programme type j given the choice of programme type made by the competitor. Consider the programme type choice of firm 1. If channel 2 chooses PT2(PT1), then positive profit is feasible only when channel 1 chooses PT1(PT2). If channel 1 were to select the same programme type as channel 2, the zero profit second stage equilibrium would imply an overall negative profit. Thus in a subscription supported TV industry the equilibrium exclusively features diversity. If the disutility effect a due to advertising is relatively small and the equilibrium price under subscription TV is relatively high, it is likely that consumers of popular programming would obtain a lower consumer surplus than is enjoyed under advertising funded TV. In a more general setting Holden (1993) has shown that pay-per-view TV enables third degree price discrimination and that this typically lowers consumer surplus. However, where the disutility effect of advertising is high and the price under subscription TV is low, consumers are likely to better off under subscription TV.
5. Advertising and subscription charges An extension of the above yields the industry structure in which the firms are allowed to set both subscription charges and advertising. We assume that the marginal cost of broadcasting in the second stage is c i 2 for firm i if it sets a subscription charge, reflecting the higher cost of billing customers. If both channels show the same programme type, then in the second stage prices are driven down either to zero or to a level above zero but below c i 2 and where second stage profit is zero. For simplicity we assume that the second stage equilibrium
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price is zero.8 In this case the outcome is identical to that shown in the advertising supported equilibrium above. When the channels select different programme types, monopolistic competition in the second stage means that positive subscription charges can be set in equilibrium. However, the presence of the disutility effect a means that equilibrium prices are in general lower than in the pure subscription game above. Modifying Eq. (4.7) leads to the following possible price equilibria: p1 5 (1 2 a)(1 2 w) 1 p2 , p2 5 p1 2 (1 2 a)(1 2 w); p1 5 p2 2 (1 2 a)(1 2 w), p2 5 (1 2 a)(1 2 w) 1 p1 ; p1 5 1 2 s¯ 2 a, p2 5 1 2 s¯ 2 a; p1 5 1 2 s¯ 2 a, p2 5 (1 2 a)(1 2 w) 1 p1 ; p1 5 (1 2 a)(1 2 w) 1 p2 , p2 5 1 2 s¯ 2 a.
(5.1)
Although the prices shown in Eq. (5.1) are lower than in the pure subscription TV game, consumers are no better off because the lower prices exactly offset the disutility effect of advertising.
6. Outcomes in the absence of regulation Having established the strategies and equilibria for three distinct market structures, we now assess what may emerge in a competitive market in the absence of regulation. Recall that the firms are free to choose whether they set subscription charges and / or carry advertising. If programme bunching can be supported as an equilibrium in the advertising game, the ability to set a subscription charge in the second stage would make no difference to the profit of each firm. On the other hand, if programme diversity is sustained as an equilibrium in the advertising game, the ability to set a subscription fee would further increase the profits of the firms at the expense of consumer surplus, although total welfare (consumer surplus plus profits) would be unaffected. Hence, the payoffs shown in the upper right hand corner in the matrix (3.2) would be modified as follows: (1 2 a )l[1 1 p1 2 c 22 ] 2 F2 , a [1 1 p2 2 c 12 ] 2 F1 .
(6.1)
By substituting Eq. (6.1) into (3.2) and assuming that p1 .c 22 and p2 .c 21 it follows that the set of parameters supporting a bunching equilibrium is smaller than that in the case where firms generate revenues solely through advertising. In other words, assuming the marginal costs of subscription TV are sufficiently small then allowing firms to choose both advertising and subscription fees increases the chance of programme diversity in equilibrium, a point shown more generally by Spence and Owen (1977). 8
It is conceivable for a negative price to be set by the firms in the second stage, where the firms pay consumers to view. However, we do not consider this here.
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Next consider the case of subscription TV in which diversity was shown to characterize the outcome in any price equilibrium. Whether it is profitable to show advertising depends on the relative size of the disutility effect a. Advertising can certainly generate revenue in the second stage but this is at the cost of a lower subscription fee and hence lower subscription revenues. Where a is relatively small, it is likely that the firms would show advertising. On the other hand, where the disutility of advertising is relatively high the firms may choose not to advertise because total revenue and hence profits would decline. It is possible in equilibrium for one firm to set a subscription fee and advertise and for the other firm to set only a subscription fee; or for one firm to show advertising and for the other to set a subscription fee and advertise; or even for one firm to show advertising and for the other to levy a subscription fee. Such funding combinations are increasingly being observed in competitive broadcasting markets.
7. Welfare and regulation Suppose the parameters are such that society would maximize welfare by having programme diversity. In this case subscription TV would certainly generate programming consistent with the preferred outcome, whereas advertising supported TV may not yield this outcome. It might be suggested therefore that to safeguard public interest a regulatory rule would require broadcasters to set a subscription fee. However, if the marginal costs of subscription TV are relatively high, maximum welfare may be achieved when diverse programming is shown on advertising TV. In the absence of any regulation an equilibrium under advertising TV is more likely to support bunching. If bunching does characterize the equilibrium under advertising supported TV, this means that one or both of the inequalities in Eq. (3.3) and Eq. (3.4) hold. Suppose that both these inequalities are satisfied and that advertising funded TV is the most efficient way to broadcast programming. There are two regulatory instruments which could achieve programme diversity in this setting. First, a regulator could instruct each firm to choose a particular form of programming. This could be achieved in practice through the appropriate design of license conditions. The discussion in the introduction illustrates how this direct approach is used in the United Kingdom. An alternative regulatory instrument is taxation which is less direct as it works by changing market incentives rather than by dictating strategies. Programme diversity can be achieved by implementing a tax on second stage operating profits.9 For a profits tax to be effective it would need to be set so that both inequalities Eq. (3.4) and Eq. (3.4) are reversed. This could be achieved by setting taxes t and t 9 9 Inspection of Eq. (3.3) and Eq. (3.4) shows that it is not possible to use only lump-sum taxes, say through adjustments to a license fee, in the first stage to change incentives in a way that gurarantees programme diversity for all parameter values.
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˜ /22 F1 ,(12a)l2 F2 and t9lb ˜ /22 F2 , such that following inequalities hold: lut a2 F1 . These inequalities imply the following tax rates: 2[(1 2 a )l 2 F2 1 F1 ] t # ]]]]]]], ul˜
(7.1)
2[a 1 F2 2 F1 ] t 9 # ]]]]]. blˆ
(7.2)
Hence, if a regulator is as informed as the firms about the underlying parameters it could set taxes in a way that ensures welfare is maximized.10 For the above scheme to work the regulator needs to announce in stage 1 what the tax rates would be in stage 2. Note that the setting of individual tax rates is contingent on the programme type and mix. The setting of taxes to be levied in the second stage enables the payoff matrix to be changed in a way that guarantees the social welfare maximum can be attained. The important feature of using tax rates to change incentives is to ensure the appropriate design of the contingent tax rates.
8. Entry and welfare As broadcasting technology advances conditions are changing in the industry enabling more firms to enter the market. This is occurring throughout the world and especially in more advanced economies. In this section we illustrate how entry might have an adverse effect on welfare by undermining minority programming. Suppose that programme diversity is consistent with attaining a social welfare maximum and that there are two channels offering different programme types as above. Assume that this outcome can be supported under subscription TV or advertising TV. We now modify the analysis in the following way. Suppose that the majority group of consumers can be sub-divided into two equal groups holding preferences over two different but similar popular programme types, PT1 and PT19. Assume that the cost of producing a popular TV programme falls to a level below that used above, say F 19 ,F1 . This is intended to reflect technological progress which typically leads to lower programme making costs. (It may also be the case that the cost of producing a minority programme is also lower.) Assume that social welfare now attains a maximum with two slightly different popular programme channels and one minority channel. If the industry is supported entirely through advertising the effect of entry would be to diminish the profits obtained by popular programming. Nevertheless, social 10
In imperfect information environments the revelation mechanism could be deployed to establish separating equilibria. This is not examined here.
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welfare would be higher as the majority would face a choice over two similar programmes and the profit obtained by the channel offering the minority programme would be unaffected. However, where the industry relies on subscription charges the outcome is different. Here entry does effect the profitability of the minority channel. This can be seen by inspecting the prices in Eq. (4.7) and Eq. (5.1). The entry of an additional popular programme channel would lower subscription charges for customers purchasing popular programmes, and the effect of this would be to lower the subscription fee for the minority channel. If the minority channel obtains a positive profit following entry, then entry and increased competition is unambiguously desirable. On the other hand, if greater competition in the popular sector leads to the exit of the channel broadcasting the minority programme, then social welfare is adversely affected. If entry were to result in exit and lower welfare, this suggests that there might be scope for regulation. One solution to the possible problem of entry and programming diversity in the context of subscription TV is the imposition of price controls. If a regulator were to impose a price floor on the subscription fees levied by popular channels, this would shelter the minority channel from the effects of competition. The imposition of a price floor, however, is itself unlikely to be popular. Another mechanism that could achieve the same end is a tax levied on the second stage profits of the popular channels. (Alternatively a subsidy could be levied on the minority channel.) The effect of the tax would be to raise subscription fees for popular programming above what would otherwise be the case, and therefore enable the minority channel to set a higher subscription fee. Furthermore, tax revenues could be transferred to the minority channel in the form of a subsidy. A mechanism which in principle is similar to this, although in practice is rather more complicated, has been used in the United Kingdom to support the minority programming offered by the terrestrial station Channel 4.
9. Regulatory risks In the above discussion regulation has been introduced in ways to demonstrate how it can enhance welfare. The traditional public economics approach contrasts with the political economy approach to regulation which suggests that regulation need not always be benefical. Suppose that in stage 1 it is not possible for a regulator to commit credibly to tax rates or to the number of licenses that may be awarded in stage 2 and beyond. Although a regulator might set tax rates to promote programme diversity in stage 1, once a firm has sunk resources the regulator might change the rules in stage 2. This is more likely to occur in instances where a regulatory body is insufficiently independent of government. If a firm that is considering the placing of investments into minority programming believes that regulatory risks are considerably high, it may choose to withdraw its investment altogether or it might require a much greater subsidy to reflect a higher
38
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cost of capital. In an extension to the above analysis the adverse effect of regulatory risk could be considered. The informal discussion here is intended to show that regulation is not necessarily a panacea for all ills, like a competitive market it is subject to deficiencies.
10. Conclusions The regulation of firms in a competitive broadcasting market is undertaken primarily to promote diversity of programming content or to prevent monopoly abuse. We have concentrated on the issue of programme content and shown that two instruments can be used to achieve goals which might not be attained in an unregulated setting. One solution proposed that a regulator could instruct TV firms about the nature of material to be broadcast by individual firms. In practice this is undertaken through terms inserted into a firm’s operating license. However, there is a danger with this approach: it can lead to undesirable censorship. An alternative mechanism is the use of taxation. By setting appropriate profit taxes we showed that firms can retain discretion over programme choice. Importantly we showed that a profit tax can be designed to be conditional on programme type and that this can effectively deliver diversity. In practice regulators use both instruments to achieve the desired target of programme diversity. Furthermore, the declining cost of supplying subscription TV is raising concerns about exclusion, particularly in the area of live sports broadcasting, and future regulation is also likely to include measures which oversee subscription fees. The regulation of subscription fees was also touched upon in this paper.
Acknowledgements I should like to thank Steve Wildman for providing very helpful comments and the European Commission Phare-ACE programme for funding this research through the project ‘‘The Economics of the Media’’ (grant number P95-2166-R).
References Barwise, P., Ehrenberg, A., 1988. Television and its Audience. Sage Communications in Society Series, London. Beebe, J.H., 1977. Institutional structure and program choices in television markets. Quarterly Journal of Economics XCI, 15–37. Collins, R., Nicholas, G., Locksley, G., 1988. The Economics of Television: The UK Case. Sage Publications. FCC, 1980. New Television Networks: Entry, Jurisdiction, Ownership and Regulation, vol. I, Final Report by the Network Inquiry Special Staff. FCC, Washington DC.
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Goodhart, G.J., Ehrenberg, A.S.C., Collins, M.A., 1987. The Television Audience: Patterns of Viewing an Update. Gower Publishing. Greenhut, M.L., Norman, G., Hung, C.-S., 1987. The Economics of Imperfect Competition: A Spatial Approach. Cambridge University Press. Holden, S., 1993. Network or pay-per-view. Economics Letters 43, 59–64. Krattenmaker, T.G., Powe L.A., 1995. Regulating Broadcasting Programming. AEI Studies in Telecommunications Deregulation. MIT Press. Noam, E., 1987. A publice and private choice model of broadcasting. Public Choice 55, 163–187. Oftel, 1996. Competition Issues in Terrestrial Broadcast Transmission. Oftel Consultative Document, October 1996, London. Owen, B.M., Wildman, S.S., 1992. Video Economics. Harvard University Press. Park, R.E., 1980. New Television Networks: An Update. N-1526-FCC in FCC. Peacock, A. (Chairman), 1986. Report for the Committee on Financing the BBC. Cmnd 9824. HMSO, London. Spence, M., Owen, B., 1977. Television programming, monopolistic competition, and welfare. Quarterly Journal of Economics XCI, 103–126. Spitzer, M.L., 1991. Justifying minority preferences in broadcasting. Southern California Law Review, 64(2), 293–361. Steiner, P.O., 1954. Program patterns and preferences and the workability of competition in radio broadcasting. Quarterly Journal of Economics 1, 194–223. Waterman, D., 1990. Diversity and quality of information products in a monopolistically competitive industry. Information Economics and Policy 4, 291–303. Wildman, S., Owen, B., 1985. Program competition, diversity, and multichannel bundling in the new video industry. In: Noam, E. (ed.), Video Media Competition: Regulation, Economics and Technology. Columbia University Press, New York. Wildman, S.S., Lee, N.Y., 1989. Program Choice in a Broadband Environment. Program presented at Integrated Broadband Networks Conference. Columbia University.
Programming in a competitive broadcasting market: entry, welfare and regulation Chris Doyle* London Business School, Sussex Place, Regent’ s Park, London NW1 4 SA, UK
Abstract It is shown how regulation might be needed in a competitive broadcasting industry to ensure a desirable mix of programming. A model building on the tradition of the existing literature illustrates how different regulatory instruments can be deployed to provide, where necessary, TV firms with appropriate incentives to choose certain programme types. Direct instructions and the use of a tax on profits are two such instruments. The model also considers the effect of entry and there is a brief discussion on regulatory risks. The paper contributes towards the public policy issues connected with broadcasting markets where extensive liberalisation is imminent. Key words: Broadcasting; Programming; Regulation JEL Classification: L5; L8
1. Introduction Television and radio broadcasters are typically subject to an array of license conditions which include to a greater or lesser extent terms governing the content of programming. For example, in the United States the Mass Media Bureau at the FCC protects the public by ensuring that broadcasters do not broadcast obscene programmes and limits the number of commercials aired during programming aimed at children. In the United Kingdom the licenses held by terrestrial television broadcasters contain inter alia the following three regulatory requirements (see Collins et al. (1988)): * Corresponding author. E-mail: [email protected] 0167-6245 / 98 / $19.00 1998 Elsevier Science B.V. All rights reserved. PII S0167-6245( 97 )00027-9
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1. Programming and scheduling should have a mix that operators must produce for themselves, including programmes for schools, news, current affairs and local interest programmes. 2. Limits on the amount of programming acquired from outside of the European Union. 3. Operators should provide comprehensive production facilities in order to comply with the first requirement and to originate a wide range of programmes besides. It can be seen that the programming subject to regulation in the United Kingdom includes that which is likely to have a relatively low demand and which may be relatively costly to produce. In some cases programmes in these categories may confer social benefits because of alleged cultural content and because they may satisfy the tastes of important minorities in a population (such as ethnic and religious groups). For these reasons welfare arguments can be used to justify the regulation of programming, particularly if it is felt that private unregulated firms would be unlikely to deliver certain desirable programmes. However, the relatively interventionist position taken by the authorities in the United Kingdom differs sharply from that taken in the United States. The FCC, see FCC (1980), believes that in general the selection of programming is best left to those operating in the market who are more likely to be aware of the needs of consumers. Krattenmaker and Powe (1995) have argued content decisions should not be determined by government at all and that a competitive market will deliver a socially desirable mix of programming. This view is questioned by Collins et al. (1988) in a discussion regarding the merits of introducing Pay or subscription TV. ‘‘Obviously more channels will provide more choice between channels but not necessarily between programmes. Whereas monopolies and duopolies can pursue complementary scheduling strategies, Pay TV channels may provide very similar fare. The attractiveness of Pay TV therefore depends on the quality of choice and the costs of achieving choice’’.1 It is useful from a public policy perspective therefore to develop an understanding of how competing broadcasting firms choose programming. This is particularly of great concern today as consumers in many countries will soon be able to receive digital television which promises a choice of hundreds of channels including many Pay TV options. These developments are arising because of moves towards greater liberalization in markets like the United Kingdom (see Oftel (1996) and the Peacock Report (Peacock, 1986)), and because of technological change which is lowering both the costs of transmission and programme production. If we have a reasonably good understanding of the factors which are likely to determine the mix of programming in competitive broadcasting market, this will enable us to design better any necessary regulatory safeguards. 1
See Collins et al. (1988) page 107.
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At a general level the issues addressed in this paper fall into the domain of product variety and location theory, for example see Greenhut et al. (1987). In the field of Media and Multimedia economics there is a rich literature which addresses the issue of programme schedules or diversity and competition. The seminal works are those of Steiner (1954); Beebe (1977); Spence and Owen (1977). More recent contributions include Holden (1993); Waterman (1990); Wildman and Owen (1985). An excellent overview of the literature can be found in Owen and Wildman (1992). The early literature inspired by Steiner (1954) concentrated on the relationship between market structure and programme diversity. For example, it was shown in a variety of settings that under advertising funded TV social welfare is likely to be higher with monopoly provision of broadcasting programmes. This arises because under competition Hotelling-like bunching occurs as rival firms each try to extract rents by broadcasting more popular type of programmes. However, Beebe (1977) emphasizes that the outcome in Steiner’s model was influenced considerably by the use of a specific set of assumptions. Relaxing some of these assumptions enabled Beebe to show that competition need not do worse than monopoly provision, which is also shown in the model presented in this paper. Spence and Owen (1977) developed further the enquiry focussing on market structure and presented a model of monopolistic competition in which they make welfare comparisons between Pay TV and advertising funded TV. Using this framework they looked at how the different methods of funding TV affected welfare and then compared the outcomes to those which would arise in a monopolistic setting. Their main conclusion showed that Pay TV if supplemented with advertising revenue would result in higher welfare than TV supported only by advertising revenues, a result echoed in this paper. The conclusions of the analysis examining market structure shows that advertising TV typically leads to more bunching than Pay TV, and that competition typically generates more programming diversity than monopoly. However, to conduct welfare rankings of the different market structures and the different funding mechanisms requires detailed information about preferences (demand) and costs.2 In this paper we focus only on a competitive market structure. This is because the question of monopoly versus competitive provision of TV programming is largely redundant today. It is clear that in most advanced economies there is extensive and growing competition in the TV broadcasting industry. This is due largely to technological progress which has lowered production programming costs and lowered the costs and improved the quality of TV sets which has therefore increased demand for TV programmes. Faced with increasing competition in the broadcasting industry the relevant questions to pose regarding programme 2
For a clear discussion on welfare for different market structures and funding mechanisms, see chapter four in Owen and Wildman (1992).
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diversity relate to the degree of competition and the role of regulation. In this paper we deal with both of these aspects. We develop a model in the spirit of the traditional literature while incorporating a more plausible characterization of the investment process. We suppose that broadcasting firms face a two-stage decision process where the type of programing is decided in an initial stage. By modelling firms as facing a two-stage decision process enables us to allow for the presence of sunk costs, which in the broadcasting industry are often considerable. Much of the literature that has focused on market structure largely uses static models, although notable exceptions include Wildman and Lee (1989) who look at programme repetition. We highlight how competition in the absence of regulation may not deliver a social optimum. For example, if a certain amount of programme diversity is optimal this may not emerge in an unregulated competitive broadcasting market: private unregulated firms may concentrate on broadcasting more popular programmes. In this setting we show that there is scope for welfare enhancing regulation. There are two main forms such regulation may take. First, it could involve direct instructions: a regulator instructs a TV company about the type of programming content it should broadcast. This is particularly prevalent in Europe where licenses are often drafted to contain provisions ensuring certain types of programming are shown, as discussed above. Secondly, regulation may seek to complement the price mechanism through the use of tax instruments and price controls. In the United Kingdom industry specific taxes have been levied in ways which are designed to promote certain forms of programming. Spitzer (1991) discusses how differential taxes are used in the United States to influence the content of programming, for example by providing tax breaks for broadcasters delivering certain types of minority programmes. In the model here we show how both forms of regulation can achieve outcomes which are socially desirable when otherwise the market might fail to achieve these outcomes. We also extend the analysis to examine the effect of entry and increased competition, a phenomenon occurring in most competitive broadcasting markets. Typically entry into broadcasting markets takes place where the market is thickest: that is in the more popular domain of programming. Noam (1987) has shown in the context of government owned minority broadcasting such entry might jeopardize programme diversity by undermining the finances of the minority channel. We also show how greater competition in popular broadcasting can undermine programme diversity, especially where revenues are raised using subscription charges. Nevertheless, in this case we show how regulation can be designed to accommodate entry and promote increased diversity in programming.3 Although the principal aim of the paper is to show how regulation can be designed to benefit society, we also discuss informally how regulation, or the fear of changes to regulatory rules, so-called ‘‘regulatory risk’’, might in fact have an 3
Park (1980) presents a different model dealing with the effects of new entry.
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adverse effect on programming diversity and welfare. The argument about regulatory risk is intended to introduce some balance into the discussion by highlighting that regulation, like a competitive market, is susceptible to failings. The paper is organized as follows. In Section 2 a benchmark two-stage duopoly model is characterized. In Section 3 the outcome in an advertising supported industry is constructed, and in Section 4 the same is done for the case of a subscription supported industry. In Section 5 we examine the industry structure in which firms are free to choose both advertising and subscription fees. Section 6 looks at the outcomes that might emerge in an unregulated industry. By contrast Section 7 looks at the role for regulatory intervention. In Section 8 the issue of greater competition through entry and the effect on programme diversity is considered. In Section 9 there is a brief discussion on regulatory risk and Section 10 concludes.
2. The benchmark model: duopoly We examine a game theoretic model in which initially the industry structure is assumed to be duopolistic. Three forms of revenue support are considered: (i) where revenues derive solely from advertising, (ii) where revenues derive exclusively from subscription fees levied on viewers, and (iii) where revenues derive from both advertising and subscription charges. Subscription or Pay TV, where a consumer pays a fixed fee for the rights to view a channel, is the most prevalent alternative to advertising supported TV. However, it is usual in practice for broadcasters to generate revenue both through advertising and subscription charges. In the model presented here pay-per-view television is equivalent to subscription TV. In all scenarios considered firms face a two-stage decision process. In the first stage each firm chooses a programme type that it intends to broadcast in the second stage. Revenues in the second stage are collected through advertising and / or via the levying of subscription charges. The firms may be free to choose in the second stage the way in which revenues are raised.
2.1. Preferences and demand Consider two broadcasting firms (alternatively stations or channels) 1 and 2 where each station i can choose to broadcast one of two types of programme. Let Pij denote that programme j is shown on the ith station. Assume there exists a population of consumers (alternatively viewers) normalized at unity. Without loss of generality assume that a fraction a [ (1 / 2,1) (the majority) of consumers hold the lexicographic preference relations Pi 1 s Pi 2 , P11 | P21 , and P12 | P22 and the remaining fraction 1 2 a (the minority) have the preference relations Pi 2 s Pi 1 , P11 | P21 , and P12 | P22 . In words these mean that the majority prefer to view programme type 1 (PT1) and are indifferent about the choice of channel when
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both stations are showing PT1, and the minority prefer to view PT2 and are indifferent about the choice of channel when both stations show PT2. In practice it may be the case that PT1 is a sports programme and PT2 is an arts programme. In addition to viewing TV suppose that all consumers have an outside option denoted S. In other words a viewer can consume S by turning off the television; S is a substitute for television viewing. Assume that a fraction g [ (0,1) of the majority a who prefer PT1 hold the preference relation S s Pi 2 if both channels show PT2.4 However, for all the other viewers (1 2 g )a 1 (1 2 a ) PT2 is preferred; S a Pi 2 . Similarly, for the minority 1 2 a who prefer PT2 assume that if both channels offer PT1, a fraction g [ (0,1) of these consumers hold the preference relation S s Pi 1 . For all the other viewers (1 2 g )(1 2 a ) 1 a PT1 is preferred; S a Pi 1 . Note symmetry is assumed with respect to the outside option. If the programme mix is hP11 , P21 j then (1 2 g )(1 2 a ) 1 a 5 u , 1 prefer to watch television, and if the mix is hP12 , P22 j a fraction (1 2 g )a 1 (1 2 a ) 5 b , 1 of consumers watch television. As a . 1 / 2 it is always the case that u . b and u / 2 , a. Where programming is bunched, i.e. both channels show the same programme type, a fraction (1 2 u ) or (1 2 b ) of the population prefer to consume the outside option. The assumptions about preferences mean that when variety is absent aggregate demand for TV consumption is lower.5 When each channel offers the same type of programming, those who prefer to view are indifferent about which channel to watch and it is assumed that each viewer selects a channel at random. If the programme mix is hP11 , P22 j, then a prefer to watch channel 1 and (1 2 a ) prefer channel 2. Let the viewing figures for each channel i be defined by the function V i (P1j , P2j ) for i, j 5 1 or 2. Given the above assumptions, if TV programming is broadcast at a zero price by both channels, then each channel will have one of four possible viewing figures as follows: V 1 (P11 , P21 ) 1
V (P11 , P22 ) V 1 (P12 , P21 ) V 1 (P12 , P22 )
65 5
u /2
V 2 (P11 , P21 )
a
V 2 (P11 , P22 )
12a
b /2
;
V 2 (P12 , P21 ) V 2 (P12 , P22 )
65 5
u /2
12a
a
(2.1)
b /2.
Following Spence and Owen (1977) we also place valuations on the goods in the choice set of consumers. The following valuations are based on uninterrupted programming, ie programmes are shown in the absence of advertising. Suppose that the a majority who prefer PT1 value it at $1 and that they attach a value $w,$1 to PT2. Furthermore, assume that ga of the majority value the outside ¯ option S at $s¯ and the remaining (12g )a value it at $s, ] where 1.s .w.s. ] 4
In Steiner (1954) preferences are said to be exclusive which is the case where g 51. Goodhart et al. (1987); Barwise and Ehrenberg (1988) provide evidence for this kind of viewing pattern. 5
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Similarly, let the 12 a minority value PT1 at $w, PT2 at $1 and a fraction g (12 a ) value the outside option at s¯ and the remaining (12g )(12 a ) value it at $s. ] Finally, without loss of generality assume that the outside option has a zero price and $s50. ] We suppose that consumers prefer to watch programmes with fewer adverts rather than with more adverts.6 Where a consumer places a value of $x on a programme in the absence of advertising, this falls to $ax for $a$0 if the same programme is shown together with advertising. Note that the disutility effect due to advertising is multiplicative which means consumers suffer a greater absolute loss in utility when advertising appears on programmes which they value relatively highly. For simplicity we assume where programmes are shown together with advertising all channels display the same amount of advertising.
2.2. Technology, supply and costs The underlying technology and costs for each firm is symmetric. Each channel is confronted with a two-stage decision process. First a programme type is selected and this is followed by the levying of advertising fees or subscription fees, or possibly both. We allow the marginal costs of subscription TV to differ from those of advertising supported TV. Let superscript d51 refer to advertising funded TV and d52 denote subscription TV. In the first stage, where a programme type is selected, a firm incurs a fixed cost Fj $0 which is treated as sunk and independent of the funding mechanisms when the firms enter the second stage. Having selected a programme type in the first stage, each firm will broadcast to viewers in the second stage. In this stage each firm i incurs a linear variable cost c j dV i , where c j d [[0,1) is the marginal cost of production. The total cost function for each firm i is Cij 5 c dj V i 1 Fj , where d, j51 or 2. In practice c j d for d, j51 and 2 are likely to be relatively small, but it seems reasonable to suppose programmes involving the direct billing 6
The dislike of greater advertising has recently been reflected in discussions regarding UK terrestrial commercial TV. Under regulatory rules set by the Independent Television Commission UK terrestrial TV channels are allowed to show an average of 7 ]12 min / h between 6pm and 11pm and 7 min for the rest of the day. It is currently being discussed whether to increase this to 9 min to bring terrestrial television in line with satellite and the rest of Europe. These proposals have been criticized by viewers’ groups and consumer representatives. Benet Middleton of the Consumers’ Association has stated ‘‘These proposals offer no benefit to consumers. More or longer breaks would just make consumers worse off.’’ (The Times newspaper, 6th August, 1997.) The regulated approach in Europe contrasts sharply with US practice where since 1981 broadcasters have been free of timing constraints over advertising, see Owen and Wildman (1992, p.125).
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of consumers, ie subscription or pay TV, are likely to have higher marginal costs and therefore we assume c j 1 ,c j 2 . For simplicity and without loss of generality assume c j 1 50 for j51 and 2.
3. Equilibrium in an advertising supported industry In this case programmes are broadcast to consumers free of charge and revenues for each firm are derived solely from advertising. It is assumed that advertising revenues increase in the viewing figures given in Eq. (2.1). The revenue function for each firm i is described as R i (V i ) and if all viewers were equally valuable to advertisers this function would be homogeneous of degree one. In order to depart from this restrictive assumption we assume instead that advertising per capita revenues derived from broadcasting to the minority are not necessarily equal to the per capita revenues from broadcasting to the majority. To capture this we suppose advertising revenues from the minority are scaled up or down by l [[0, `) so that if channel 1 broadcasts PT2 and channel 2 shows PT1, advertising revenues for channel 1 are l(12 a ) whereas revenues are a for channel 2.7 If the minority group is relatively poor (rich), this is likely to be associated with l ,1 ( l .1). Note that firms are price takers in the advertising market which means the market for advertising is presumed to be perfectly competitive. This assumption is widely deployed in the literature, for example see Spence and Owen (1977); Waterman (1990). The profits for each firm i showing programme type j are defined as follows,
Pij 5 R i 2 Fj
for i, j 5 1, 2.
(3.1)
Although the game extends over two stages, only the first stage is strategic because profits are affected only by the choices made in the first stage. If advertising were not perfectly competitive, then the second stage of the game would also be strategic. In the first stage each firm i chooses a programme type Pij , where j51 or 2. A Nash equilibrium is a pair of programme types hP 1*j , P 2*k j for j, k51, 2 where these yield for each firm a profit at least as great as that which could be achieved by choosing the other programme type given the choice made by the other firm. Given Eq. (3.1) the Nash equilibrium of the game can be solved. As consumers are not necessarily equally valuable for advertisers, it is useful to define u 95(12 g )l(12 a )1 a and b 95(12g )a 1 l(12 a ). Given these definitions it also helps ˆ where l˜ , l( l˜ . l) if l .1 ( l ,1) and lˆ , l ( lˆ . l) ˜ and b 95 lb to define u 95 lu if l .1 ( l ,1). The payoff matrix for the game is given below in (3.2) where the amount obtained by channel 1 is shown as the upper figure in each cell.
7
Where l 51 this is the case of equally valuable consumers.
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Channel 1
Channel 2
PT1
PT2
PT1
˜ /22F1 lu ˜ /22F1 lu
PT2
a 2F1 (12 a )l 2F2
(12 a )l 2F2 a 2F1 ˜ /22F2 lb ˜ /22F2 lb
(3.2)
Symmetry means that hP11 , P21 j (equivalently hPT1, PT1j) is a Nash equilibrium if ˜ / 22F1 .(12 a )l 2F2 holds and hP12 , P22 j (equivalently hPT2, PT2j) is a Nash lu ˆ / 22F2 . a 2F1 is satisfied. These inequalities can be rewritten equilibrium if lb respectively as
l˜ 2(F2 2 F1 ) 2(1 2 a ) ] 1 ]]] . ]]], l ul u
(3.3)
1 F2 2 F1 b ] 1 ]]] , ]. 2a l˜ al˜
(3.4)
Where both the inequalities in Eq. (3.3) and Eq. (3.4) are reversed, then hP11 , P22 j (equivalently hPT1, PT2j) or hP12 , P21 j (equivalently hPT2, PT1j) are both Nash equilibria. Thus under advertising supported TV programming can be diverse or bunched and the outcome depends on the relative size of the parameters. For example, the larger (smaller) the difference between fixed costs F2 2F1 , it is more likely that hP11 , P21 j (hP12 , P22 j) will be the equilibrium. Where advertising is highly valuable when shown to the minority, i.e. l is relatively large, the equilibrium is more likely to be hP12 , P22 j. Although programming may be diverse under advertising, there is a tendency for programming to bunch when l is relatively small and a is relatively high. Where both l and a are relatively high, diversity may constitute an equilibrium. The bunching effect of advertising supported TV will become apparent when we analyse the solution of the subscription TV game next.
4. Equilibrium in a subscription supported industry An alternative form of revenue generation is subscription TV: the consumer pays an amount for the right to view a channel. The decisions made by the firms’ follows a sequence where the programme type is chosen in the first stage and competition over subscription fees takes place in the second stage. Unlike the advertising game, the solution here requires backwards induction to solve for a perfect equilibrium because the final subgame is strategic.
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In the second stage each firm competes by choosing a subscription fee pi to levy on consumers. If a consumer pays a subscription fee pi it enables him or her to receive the programming shown by channel i in the second stage. In the second stage the fixed costs incurred in the first stage are sunk and therefore do not influence profit maximization choices in this stage. There are four possible scenarios in the second stage: (i) both channels offer PT1, (ii) both channels offer PT2, (iii) channel 1 (2 ) offers PT1(PT2) or (iv) channel 1 (2 ) offers PT2(PT1). Consider first cases (i) and (ii) where both channels offer the same programme type. In this setting Bertrand competition will drive subscription fees to a level where expected second stage profits are zero. Consider the case where both channels show PT1 and each levies the same subscription fee p1 5p2 .c 12 . If demand is non-zero, then profits at channel i can be increased by undercutting infinitesimally the price set by channel j. Hence p1 5p2 5c 12 is the only equilibrium in this stage. Similarly if both channels show PT2 the unique equilibrium in the second stage is p1 5p2 5c 22 . Next consider the case where channel 1 offers PT1 and channel 2 offers PT2. (Symmetry means that the case where channel 1 shows PT2 and channel 2 shows PT1 is identical.) Assume that firm 2 sets a price p2 $0. The number of consumers viewing channel 1 depends on the size of p2 and w. When the price for channel 2 is relatively high such that p2 .12w, demand at channel 1 is as follows: V 1 5 0 for p1 . 1 2 w 1 p2 ,
(4.1)
¯ 1 2 w 1 p2 ], V 1 5 (1 2 g )a for p1 [ (1 2 s,
(4.2)
V1 ¯ w 2 1 1 p2 ] and min[w 2 1 1 p2 , 1 2 s¯ ] 5 1 2 s, ¯ 1 2 g if p1 [ (1 2 s, 5 a if p1 [ (w 2 1 1 p2 , 1 2 s¯ ] and min[w 2 1 1 p2 , 1 2 s¯ ] 5 w 2 1 1 p2 , (1 2 g )(1 2 a ) 1 a if p1 [ [0, min[w 2 1 1 p2 , 1 2 s¯ ]].
5
(4.3) If the price set by channel 2 is relatively low such that p2 ,12w, demand at channel 1 is as follows: V 1 5 0 for p1 . 1 2 w 1 p2 ,
(4.4)
¯ 1 2 w 1 p2 ], V 1 5 (1 2 g )a for p1 [ (1 2 s,
(4.5)
V 1 5 a if p1 [ [0, 1 2 s¯ ] and p2 , 1 2 w.
(4.6)
Where each channel has its own programme type, i.e. there is diversity, it follows that there is ex post monopoly power or in other words the market structure in the second stage is monopolistically competitive. Channel 1 obtains the largest
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audience (12g )(12 a )1 a when channel 2 sets a relatively high price and its own price is relatively low, as is to be expected. The discrete nature of demand and the linearity of marginal costs mean that each firm only considers setting one of at most three prices: pi 512w1pk , pi 512s¯ or pi 5w211pk . It is clear that the price combinations: p1 5w211p2 and p2 5w211p1 ; p1 512w1p2 and p2 512w1p1 ; and pi 5w211pk and pk 512s¯ cannot hold in equilibrium. There are therefore five possible candidate equilibrium price structures in the final subgame: p1 5 1 2 w 1 p2 , p2 5 w 2 1 1 p1 ; p2 5 1 2 w 1 p1 , p1 5 w 2 1 1 p2 ; p1 ¯ p2 5 1 2 s; ¯ p1 5 1 2 s, ¯ p2 5 1 2 w 1 p1 ; p1 5 1 2 w 1 p2 ; p2 5 1 2 s, ¯ 5 1 2 s.
(4.7)
Each pair in Eq. (4.7) is a potential equilibrium in the second stage if the following inequalities hold c 21 #p1 and c 22 #p2 . Having solved the second stage of the game, this can be used to evaluate the choices made in the first stage. Each firm aware of the equilibrium in the final stage can compute the profit associated with choosing programme type j given the choice of programme type made by the competitor. Consider the programme type choice of firm 1. If channel 2 chooses PT2(PT1), then positive profit is feasible only when channel 1 chooses PT1(PT2). If channel 1 were to select the same programme type as channel 2, the zero profit second stage equilibrium would imply an overall negative profit. Thus in a subscription supported TV industry the equilibrium exclusively features diversity. If the disutility effect a due to advertising is relatively small and the equilibrium price under subscription TV is relatively high, it is likely that consumers of popular programming would obtain a lower consumer surplus than is enjoyed under advertising funded TV. In a more general setting Holden (1993) has shown that pay-per-view TV enables third degree price discrimination and that this typically lowers consumer surplus. However, where the disutility effect of advertising is high and the price under subscription TV is low, consumers are likely to better off under subscription TV.
5. Advertising and subscription charges An extension of the above yields the industry structure in which the firms are allowed to set both subscription charges and advertising. We assume that the marginal cost of broadcasting in the second stage is c i 2 for firm i if it sets a subscription charge, reflecting the higher cost of billing customers. If both channels show the same programme type, then in the second stage prices are driven down either to zero or to a level above zero but below c i 2 and where second stage profit is zero. For simplicity we assume that the second stage equilibrium
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price is zero.8 In this case the outcome is identical to that shown in the advertising supported equilibrium above. When the channels select different programme types, monopolistic competition in the second stage means that positive subscription charges can be set in equilibrium. However, the presence of the disutility effect a means that equilibrium prices are in general lower than in the pure subscription game above. Modifying Eq. (4.7) leads to the following possible price equilibria: p1 5 (1 2 a)(1 2 w) 1 p2 , p2 5 p1 2 (1 2 a)(1 2 w); p1 5 p2 2 (1 2 a)(1 2 w), p2 5 (1 2 a)(1 2 w) 1 p1 ; p1 5 1 2 s¯ 2 a, p2 5 1 2 s¯ 2 a; p1 5 1 2 s¯ 2 a, p2 5 (1 2 a)(1 2 w) 1 p1 ; p1 5 (1 2 a)(1 2 w) 1 p2 , p2 5 1 2 s¯ 2 a.
(5.1)
Although the prices shown in Eq. (5.1) are lower than in the pure subscription TV game, consumers are no better off because the lower prices exactly offset the disutility effect of advertising.
6. Outcomes in the absence of regulation Having established the strategies and equilibria for three distinct market structures, we now assess what may emerge in a competitive market in the absence of regulation. Recall that the firms are free to choose whether they set subscription charges and / or carry advertising. If programme bunching can be supported as an equilibrium in the advertising game, the ability to set a subscription charge in the second stage would make no difference to the profit of each firm. On the other hand, if programme diversity is sustained as an equilibrium in the advertising game, the ability to set a subscription fee would further increase the profits of the firms at the expense of consumer surplus, although total welfare (consumer surplus plus profits) would be unaffected. Hence, the payoffs shown in the upper right hand corner in the matrix (3.2) would be modified as follows: (1 2 a )l[1 1 p1 2 c 22 ] 2 F2 , a [1 1 p2 2 c 12 ] 2 F1 .
(6.1)
By substituting Eq. (6.1) into (3.2) and assuming that p1 .c 22 and p2 .c 21 it follows that the set of parameters supporting a bunching equilibrium is smaller than that in the case where firms generate revenues solely through advertising. In other words, assuming the marginal costs of subscription TV are sufficiently small then allowing firms to choose both advertising and subscription fees increases the chance of programme diversity in equilibrium, a point shown more generally by Spence and Owen (1977). 8
It is conceivable for a negative price to be set by the firms in the second stage, where the firms pay consumers to view. However, we do not consider this here.
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Next consider the case of subscription TV in which diversity was shown to characterize the outcome in any price equilibrium. Whether it is profitable to show advertising depends on the relative size of the disutility effect a. Advertising can certainly generate revenue in the second stage but this is at the cost of a lower subscription fee and hence lower subscription revenues. Where a is relatively small, it is likely that the firms would show advertising. On the other hand, where the disutility of advertising is relatively high the firms may choose not to advertise because total revenue and hence profits would decline. It is possible in equilibrium for one firm to set a subscription fee and advertise and for the other firm to set only a subscription fee; or for one firm to show advertising and for the other to set a subscription fee and advertise; or even for one firm to show advertising and for the other to levy a subscription fee. Such funding combinations are increasingly being observed in competitive broadcasting markets.
7. Welfare and regulation Suppose the parameters are such that society would maximize welfare by having programme diversity. In this case subscription TV would certainly generate programming consistent with the preferred outcome, whereas advertising supported TV may not yield this outcome. It might be suggested therefore that to safeguard public interest a regulatory rule would require broadcasters to set a subscription fee. However, if the marginal costs of subscription TV are relatively high, maximum welfare may be achieved when diverse programming is shown on advertising TV. In the absence of any regulation an equilibrium under advertising TV is more likely to support bunching. If bunching does characterize the equilibrium under advertising supported TV, this means that one or both of the inequalities in Eq. (3.3) and Eq. (3.4) hold. Suppose that both these inequalities are satisfied and that advertising funded TV is the most efficient way to broadcast programming. There are two regulatory instruments which could achieve programme diversity in this setting. First, a regulator could instruct each firm to choose a particular form of programming. This could be achieved in practice through the appropriate design of license conditions. The discussion in the introduction illustrates how this direct approach is used in the United Kingdom. An alternative regulatory instrument is taxation which is less direct as it works by changing market incentives rather than by dictating strategies. Programme diversity can be achieved by implementing a tax on second stage operating profits.9 For a profits tax to be effective it would need to be set so that both inequalities Eq. (3.4) and Eq. (3.4) are reversed. This could be achieved by setting taxes t and t 9 9 Inspection of Eq. (3.3) and Eq. (3.4) shows that it is not possible to use only lump-sum taxes, say through adjustments to a license fee, in the first stage to change incentives in a way that gurarantees programme diversity for all parameter values.
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˜ /22 F1 ,(12a)l2 F2 and t9lb ˜ /22 F2 , such that following inequalities hold: lut a2 F1 . These inequalities imply the following tax rates: 2[(1 2 a )l 2 F2 1 F1 ] t # ]]]]]]], ul˜
(7.1)
2[a 1 F2 2 F1 ] t 9 # ]]]]]. blˆ
(7.2)
Hence, if a regulator is as informed as the firms about the underlying parameters it could set taxes in a way that ensures welfare is maximized.10 For the above scheme to work the regulator needs to announce in stage 1 what the tax rates would be in stage 2. Note that the setting of individual tax rates is contingent on the programme type and mix. The setting of taxes to be levied in the second stage enables the payoff matrix to be changed in a way that guarantees the social welfare maximum can be attained. The important feature of using tax rates to change incentives is to ensure the appropriate design of the contingent tax rates.
8. Entry and welfare As broadcasting technology advances conditions are changing in the industry enabling more firms to enter the market. This is occurring throughout the world and especially in more advanced economies. In this section we illustrate how entry might have an adverse effect on welfare by undermining minority programming. Suppose that programme diversity is consistent with attaining a social welfare maximum and that there are two channels offering different programme types as above. Assume that this outcome can be supported under subscription TV or advertising TV. We now modify the analysis in the following way. Suppose that the majority group of consumers can be sub-divided into two equal groups holding preferences over two different but similar popular programme types, PT1 and PT19. Assume that the cost of producing a popular TV programme falls to a level below that used above, say F 19 ,F1 . This is intended to reflect technological progress which typically leads to lower programme making costs. (It may also be the case that the cost of producing a minority programme is also lower.) Assume that social welfare now attains a maximum with two slightly different popular programme channels and one minority channel. If the industry is supported entirely through advertising the effect of entry would be to diminish the profits obtained by popular programming. Nevertheless, social 10
In imperfect information environments the revelation mechanism could be deployed to establish separating equilibria. This is not examined here.
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welfare would be higher as the majority would face a choice over two similar programmes and the profit obtained by the channel offering the minority programme would be unaffected. However, where the industry relies on subscription charges the outcome is different. Here entry does effect the profitability of the minority channel. This can be seen by inspecting the prices in Eq. (4.7) and Eq. (5.1). The entry of an additional popular programme channel would lower subscription charges for customers purchasing popular programmes, and the effect of this would be to lower the subscription fee for the minority channel. If the minority channel obtains a positive profit following entry, then entry and increased competition is unambiguously desirable. On the other hand, if greater competition in the popular sector leads to the exit of the channel broadcasting the minority programme, then social welfare is adversely affected. If entry were to result in exit and lower welfare, this suggests that there might be scope for regulation. One solution to the possible problem of entry and programming diversity in the context of subscription TV is the imposition of price controls. If a regulator were to impose a price floor on the subscription fees levied by popular channels, this would shelter the minority channel from the effects of competition. The imposition of a price floor, however, is itself unlikely to be popular. Another mechanism that could achieve the same end is a tax levied on the second stage profits of the popular channels. (Alternatively a subsidy could be levied on the minority channel.) The effect of the tax would be to raise subscription fees for popular programming above what would otherwise be the case, and therefore enable the minority channel to set a higher subscription fee. Furthermore, tax revenues could be transferred to the minority channel in the form of a subsidy. A mechanism which in principle is similar to this, although in practice is rather more complicated, has been used in the United Kingdom to support the minority programming offered by the terrestrial station Channel 4.
9. Regulatory risks In the above discussion regulation has been introduced in ways to demonstrate how it can enhance welfare. The traditional public economics approach contrasts with the political economy approach to regulation which suggests that regulation need not always be benefical. Suppose that in stage 1 it is not possible for a regulator to commit credibly to tax rates or to the number of licenses that may be awarded in stage 2 and beyond. Although a regulator might set tax rates to promote programme diversity in stage 1, once a firm has sunk resources the regulator might change the rules in stage 2. This is more likely to occur in instances where a regulatory body is insufficiently independent of government. If a firm that is considering the placing of investments into minority programming believes that regulatory risks are considerably high, it may choose to withdraw its investment altogether or it might require a much greater subsidy to reflect a higher
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cost of capital. In an extension to the above analysis the adverse effect of regulatory risk could be considered. The informal discussion here is intended to show that regulation is not necessarily a panacea for all ills, like a competitive market it is subject to deficiencies.
10. Conclusions The regulation of firms in a competitive broadcasting market is undertaken primarily to promote diversity of programming content or to prevent monopoly abuse. We have concentrated on the issue of programme content and shown that two instruments can be used to achieve goals which might not be attained in an unregulated setting. One solution proposed that a regulator could instruct TV firms about the nature of material to be broadcast by individual firms. In practice this is undertaken through terms inserted into a firm’s operating license. However, there is a danger with this approach: it can lead to undesirable censorship. An alternative mechanism is the use of taxation. By setting appropriate profit taxes we showed that firms can retain discretion over programme choice. Importantly we showed that a profit tax can be designed to be conditional on programme type and that this can effectively deliver diversity. In practice regulators use both instruments to achieve the desired target of programme diversity. Furthermore, the declining cost of supplying subscription TV is raising concerns about exclusion, particularly in the area of live sports broadcasting, and future regulation is also likely to include measures which oversee subscription fees. The regulation of subscription fees was also touched upon in this paper.
Acknowledgements I should like to thank Steve Wildman for providing very helpful comments and the European Commission Phare-ACE programme for funding this research through the project ‘‘The Economics of the Media’’ (grant number P95-2166-R).
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