Entertainment and Media: Markets and Economics

1. Entertainment and Media: Markets and Economics Professor William Greene

2. Economic Foundations for Entertainment and Media Production, Cost and Organization of Firms in E&M Industries

3. 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

4. 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

5. 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

6. The Production Function • Output • Inputs – The factors of production • The “process” The amount producted, Q, depends on “inputs” or factors of production. Conventional inputs: Capital, labor, materials used in making movies Unconventional inputs: Music used in distribution and production in stores and offices ? Labor Capital Materials

7. 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.

8. 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.

9. 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

10. 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

11. 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.

12. Multistage Production Is Common This is not the same as joint production of more than one product

13. Multiple Stages in Production  The TV broadcastNetwork The game on the field Team  The viewerCable Operator Capital Equipment Labor Players Capital Equipment F(x) F(x) TV Sports What’s better for this process, one firm or two? Disney  Pixar, or Disney/Pixar?

14. 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

15. Live Performance Production is Unconventional • Production function – One “stage” • Simultaneous production and consumption • Feedback between consumers and producers • Concerts • Big Sports • eBay watchers

16. 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

17. 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”

18. Box Office Revenue

19. Production Costs

20. 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

21. 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

22. Production cost $100M Exhibitors At least $300M Sandra Bullock $ 77M = $20M + 15% x Studio net (45% ) + Misc TV, DVD, etc. George Clooney ? Net so far $231M - ? Promotion and advertising ? Probably $50M - $100M Other distribution ? Such “first dollar” guaranteed box office deals for actors are becoming rare, the Hollywood Reporter said, because studios now want to recoup all the costs for expensive productions before sharing the profits with talent. 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

23. CD Costs and Profits Consumer Retailer $6.20 Record Label $10.80 .75 1.40 2.15 .86 1.08 1.29 .70 1.94 .59 1.36 1.36 2.55 .97 Marketing and Promotion Sales and Distribution Overhead and Distribution CD and Booklet Manufacturing Artist Development Royalty to Recording Artist Royalty to Composer and Lyricist Operating Profit Labor Distribution Rent (Shopping Mall) Operating Profit Cooperative advt. and Discounts Fixed CostsVariable CostsSunk CostsOperating Profit

24. Production and Cost Functions?

25. 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

26. Economies of Scale in E&M • Cablevision • Professional sports • Publishing/Movies – Backlists of titles • Casinos • Movies • Television

27. 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

28. 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

29. 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)

30. Labor Saving Technological Change in Poker

31. “Book” Production Costs

32. Who should bear the cost?(About $100,000/screen) (2013 $50,000-$75,000) Film makers? Distributors? Exhibitors? Equipment makers? New York State?

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

34. 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?

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

37. 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?

39. 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

40. 3D 2D

41. 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.

42. 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 • …