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Entertainment and Media: Markets and Economics

Professor William Greene

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Economic Foundations for Entertainment and Media

Production, Cost and Organization of Firms in E&M Industries

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Production and Cost Features of Entertainment and Media Firms

Conventional economics explains much of production

There are special features of E&M production

Economic Foundations for Production Production functions – the technology Costs of production – element of competition Economies of scale and scope – market

advantages Technological change – markets evolve

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Characteristics of the Creative Industries

What do we mean by “the creative industries?” Not synonymous with experience goods: E.g.,

amusement park vs. art Are there distinguishing features?

Implications for the organization of market activities: Contracts among producers Market organizations for distribution

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Caves on Creative Industries

Characteristics of production in creative industries that are unlike more conventional production

Uncertainty of demand – difficult to resolve using market research

Producers’ emotional connection to the output – art, music Assembly of widely diverse skills for production - movies,

sports) Differentiated products – different consumers have very

different interests in the same proeuct. The role of time in consumption Durable products and durable rent streams

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The Production Function

Output Inputs – The

factors of production

The “process”

Labor

Capital

Materials

?

The amount producted, Q, depends on “inputs” or factors of production.Conventional inputs: Capital, labor, materials used in making moviesUnconventional inputs: Music used in distribution and production in stores and offices

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About Production Functions

Factors and Factor Intensity Higher education is very labor intensive, but less so over time. Broadway theater – very labor labor intensive and there is almost no

opportunity 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.

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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.

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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.

NYT, OpEd, 7/10/10

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Multiple Output Processes Managing a multiplex – Two outputs

Concessions (the primary source of profits) Movies (the secondary profit center)

Casino: Gambling Food and entertainment

Professional sports performance The sport: Outcome on the field and the signal for

broadcasting Concessions including food and merchandise

Music Distribution Performances (public) Music videos Music for private consumption

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A Theory That Produces Pricing in the Inelastic Region

Monopoly Pricing Model for Tickets=Q(P,q,m), P=Price, q=quality, m=market conditions

Pricing is cognizant of a second good; Concessions=C(R,P,q), R=concession price

Total profit from both Tickets+Concessions Ticket Price might be low to draw people to the

concessions. Movie theaters are a prime example.

Marberger, D., “Optimal Pricing for Performance Goods,” Managerial and Decision Economics, 1997, 18, 5, 375-381.

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Multistage Production Is Common

This is not the same as joint production of more than one product

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Multiple Stages in Production

Players

Capital

Equipment

F(x)

Capital

Equipment

Labor F(x)

TV Sports

What’s better for this process, one firm or two?

Disney Pixar, or Disney/Pixar?

The game on the field Team

The TV broadcastNetwork

The viewerCable Operator

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Features of Production in Entertainment and Media

Multiple stages of production Outputs as downstream inputs

Content creation is often very labor intensive Labor intensive Little substitution Less Technologically Oriented Not always - animation is a major exception

Delivery – Exhibition, distribution Capital intensive Technological advance

Applications: Books, Movies, TV, Newspapers, Radio, Recorded Music

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Live Performance Production is Unconventional

Production function – One “stage” Simultaneous production and consumption Feedback between consumers and producers

Concerts Big Sports eBay watchers

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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

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Cost and Revenue Trends

2002-2004: Revenue growth from $115M to $130M 2002-2004: Cost growth from $111M to $130M

65% due to production and marketing 20% rising home video manufacturing costs 15% due to higher “talent participation”

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Box Office Revenue

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Production Costs

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Changing Economics for Stars 2005: $10M, $15M, $20M, … 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

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Terminator 3 Production $100m

Marketing 85m

(WB=50m, Sony=35m)

Austrian actor 29.25m

Rights: WB 50m

Sony 75m

Profit anticipated (WB) 25m

Actual:

U.S. Box Office: $150.4M

World incl. US: $ 417.3M

(#113 all time – on a list that does not correct for inflation, currency, or anything else.)

http://www.edwardjayepstein.com/x-rar1.htm

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Production cost $100MExhibitors At least $300MSandra Bullock $ 77M = $20M + 15% x Studio net (45% ) + Misc TV, DVD, etc.George Clooney ?Net so far $231M - ?Promotion and advertising ? Probably $50M - $100MOther 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.BULLOCK’S 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-ENTERTAINMENT/FILMS/NEWS/GRAVITY-STAR-SANDRA-BULLOCK-SET-TO-EARN-70M-WINDFALL-FOR-OSCARNOMINATED-FILM-9157448.HTML

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Record Label $10.80

Retailer $6.20

.75 1.40 2.15 .86 1.08 1.29 .70 1.94 .59 1.36 1.36 2.55 .97

Consumer

Fixed CostsVariable CostsSunk CostsOperating Profit

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Production and Cost Functions?

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Economies of Scale

Working definition: Declining average cost Market based definition: Competitive advantage

of large size Sources

Supply based: Technical, Demand based: Networks Indivisibilities: Lumpiness

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Economies of Scale in E&M

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

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Economies of Scope

Cost effect C(Q1,Q2) < C(Q1,0) + C(0,Q2) Not the effect behind vertical integration

News media owning the sports team?Sky News motivation for owning Manchester United

Applications Cable TV, Internet Mobile phone network Basketball, Hockey

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Technological Advance

Cost Reduction

Digital setup in newspapers

Synthesized instruments in Broadway Musical Orchestras

Digital distribution of movies

No Cost Reduction in Performance Industries: Baumol’s Disease

Live theater, Orchestra, Education

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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 (B&N) E-zines (Slate.com) Web based news services (NYTimes.com)

Movies: Creation – digital equipment, Pixar animation Distribution – transmission without film Exhibition – digital projection (expensive)

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Labor Saving Technological Change in Poker

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“Book” Production Costs

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Who should bear the cost?(About $100,000/screen)

(2013 $50,000-$75,000)

Film makers?

Distributors?

Exhibitors?

Equipment makers?

New York State?

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http://www.rollingstone.com/movies/news/how-digital-conversion-is-killing-independent-movie-theaters-20130904

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2D Format: Existing projecting systems; 20 new movies in 2008-2010.

3D Format: About 1000 existing projection systems plus 250 IMAX. Requires digital projection.

“It’s not always as good as they say it is…”“I’m not so sure our customers even know we have it…” Theater owner, New Mexico.

Can it be priced?

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PRICING MOVIE TECHNOLOGY

General Seniors ChildrenCabin in the Woods (Georgetown) 12 11 9Cabin in the Woods (7th & H)(Not digital) 12 9.25 9Loews on 84th St. New York 13 9.50 9.50Titanic Imax 18 17 15Titanic Real 3D 16 15 13Wrath of the Titans in Real 3D 16 15 13

Theater owners cannot price digital.

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3D - The Next New Thing

2D Format: Existing projecting systems; 20 new movies in 2008-2010.

3D Format: About 1000 existing projection systems plus 250 IMAX. Requires digital projection.

“It’s not always as good as they say it is…”“I’m not so sure our customers even know we have it…” Theater owner, New Mexico.

Can it be priced?

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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)

http://www.nytimes.com/2009/01/12/business/media/12film.html?_r=1&scp=2&sq=3D%20+%20%22Coming%20at%20You%22&st=cse

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3D

2D

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Entertainment and media production and costs are formed on the same theoretical foundation as other businesses. But, there are unique features of the production of experience goods.

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Markets for Experience Goods Demand is different Supply and costs are often similar but often very different (books vs.

concerts) Economies of scale and scope, technological change, etc. Complex interdependencies in markets

Market structures do not mirror the rest of the economy (large pockets of “rent”) Demand interdependencies Complex contractual arrangements Vertical integration

…