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1 Business of Entertainment All products contain some degree of information. Entertainment products contain a higher degree of information and smaller component of physical inputs than most other products. The Internet Economy is particularly suited to the transmission of information goods. We begin with a review of Useful Economic Concepts that you may or may not have had in the past (in MECO 6303, say).

2 Economic Assumption: Scarcity 1.Our wants are greater than our abilities to fulfill them (scarcity). Factually correct throughout history. 2.If we do not have scarcity, then everyone has as much of all products as they want. There would be no trading, no markets, and no prices. 3.The problem of scarcity could in principle be ‘solved’ either by increasing output or decreasing wants. Some religious or philosophical movements work on decreasing wants; Capitalism tends to go the increasing output route.

3 Assumption: Economic Actors Are Rational 1.Voluntary actions are only undertaken when they are expected to make people better off. 2.Consumers try to get the best deal on products they buy and they only buy products when they believe the product provides greater value to them than what they pay (the next best values for the money). 3.Producers try to maximize profits.

4 Some Useful Economic Concepts Supply and Demand Elasticity Price Discrimination Public (Information) Goods Consumer and producer surplus Fixed and Variable Costs

5 Demand Defined for a single market – particular product and particular consumers. Each unit of the good is identical to all other units. represents highest price consumers are willing to pay. Holds everything but price and quantity constant (income, price of other goods, gravity, Y2k problems….) time dimensions law of demand – demand slopes down – based on empirical observation. movement along versus movement on

6 D P Q Demand

7 P1P1 P RNE QEQE Q2Q2 D Demand for Rethinking Network Economy Q1Q1 P2P2

8 D D1 P Q Perhaps a positive review in the Economist leads to an increase in demand curve Shift in Demand for RNE

9 Area under demand = total value of that output Total Value of Q 1 Units= 1+2+4 Total Value of Q e Units= 1+2+3+4+5 QeQe Q1Q1 P1P1 PePe 1 2 3 4 5 D

10 Supply: Represents minimum price sellers require to voluntarily provide the product. assume it slopes up for now. In reality it depends on the cost conditions of the firm. Same assumptions as with demand: everything else is held constant.

11 P2P2 P1P1 Q2Q2 Q1Q1 S minimum price firm is willing to accept. Should be equal to the cost of producing the additional output Meaning of Supply

12 P1P1 PePe QeQe Q1Q1 S D Surplus Shortage P2P2 Q2Q2 Illustration of Supply Demand Equilibrium


14 Examples of changes in Equilibrium Supply and Demand analysis assumes that market moves from one equilibrium position to another. Shifts in D or S alter equilibrium. For example, how would you expect the price and quantity of Video Rentals to change when: –1. Price of television sets falls. –2. Ability to download movies increases –3.Income (GDP) falls. –4. Summer changes to winter. –5. Cable television rates reduced. –6. “On Demand” added. Answers on next slide.

15 Price and quantity of Video Rentals –1. Prices of televisions fall. TV is a complement, meaning that it is used with VCRs and rental tapes to watch movies. This lowers the overall cost of viewing and therefore increases the demand for video rentals, raising the price and quantity if supply is upward sloping –2. Ability to download unauthorized movies increases This lowers demand for legitimate video rentals. Opposite impact from (1). –3.Income (GDP) falls. Most goods have demand fall when income falls. This would decrease demand for video rentals. It is conceivable that poorer consumers switch from seeing movies in theaters to rentals (which are cheaper) and that the demand increases. –4. Summer changes to Winter. In most locations individuals spend more time out of doors in the summer and video rentals are likely to be lower then. Might not be true in Dallas. Of course, students are also out of school which might cut the other way. –5. Cable television rates reduced. “On demand” added. These are substitutes for video rentals. When a substitute becomes more attractive, it lowers the demand for the product we are analyzing (video rentals). Will lower the quantity purchased and possibly the price.

16 P2P2 Q2Q2 Q1Q1 S1 D1 Changing Equilibrium D2 P1P1 1 2

17 Price Elasticity Of Demand def: percentage change in quantity divided by percentage change in price (ΔQ/Q)/(ΔP/P) or (ΔQ/ΔP) (P/Q) measure of responsiveness a. If Elasticity is >1 known as elastic (responsive customers) b. If Elasticity is =1 ; unit elastic c. If Elasticity is <1; inelastic (less responsive customers) d. Infinite and zero elasticity

18 D with infinite elasticity D with zero elasticity P Q Illustrations of elasticity

19 Elasticity and TR When elasticity is greater than 1 (elastic) increases in price lead to decreases in revenue and vice-versa When elasticity is equal to 1, changes in price lead to no change in revenues When elasticity is less than 1 (inelastic) increases in price lead to increases in revenue.

20 Implications of Elasticity If Elasticity is <1, firm can always increase Profit by increasing price (revenues increase and costs decrease because output decreases) If Elasticity =1, firm can always increase profit by increasing price If Elasticity>1 firm can not necessarily increase its profits by a change in price. Thus firms that maximize profits must have elasticities >1. Example of early history of prerecorded movies Demonstrates Importance of knowing elasticity.

21 Monopoly Vs. Competition Monopoly has: –Smaller Quantity –Higher Price –Price discrimination. –The tradeoff associated with patents and copyright - deadweight loss in consumption versus possible new products.

22 Types of Price Discrimination Perfect (only in theory) Two or More Markets Bundling and Block Booking Versioning

23 Perfect Price Discrimination Theoretical ideal. Cannot be fully achieved. Find maximum price that every consumer is willing to pay and charge them that price. Requires more information than any firm has, and the prevention of arbitrage. Demand Curve becomes MR curve. No Deadweight Loss. Approximate examples: automobile dealers, doctors in the old days.

24 Perfect Price Discrimination. S P6 P3 P1 D Qo

25 Examples of Price Discrimination Movie theaters (adults, children, seniors) Movie producers: theatrical release, pay per view, dvd, cable, television. Books: Hardcover and paperback. Software: full versus ‘lite’ versions. Charging different prices in different countries. Optimal but difficult to prevent arbitrage.

26 Versioning Sometimes (frequently) creating different grades of products might just better meet consumer demands. Versioning is artificially creating different products (where the high end product would meet all needs) to achieve price discrimination. Problem: avoiding cannibalization of higher end product line.

27 Marginal Revenue We assume the product sells at only one price. Because demand is downward sloping the price needs to be lowered to sell additional units. The revenue the seller gets from selling an additional unit is not the price at which it sells. It is the price minus the impact of the lower price on the other units which would be sold at a higher price.

28 Price Discrimination - 2 or more Markets If markets for a single product have different MRs, profits can be increased by shifting output from low MR markets to high MR markets. Raise price in low MR market and lower price in high MR market. High MR market is high elasticity market. Need to Prevent Arbitrage.

29 Bundling (Block Booking) Two or more products that are sold as a package. –CDs versus singles –Cable television bundles versus a la carte. –Subscription services versus pay per use – cable versus long distance telephone; Rhapsody versus iTunes.

30 Advantage of a Bundle The Matrix Green Tomatoes X Y 2000 1900 1300 1200 Bundle 3200 2 x 13002 x 1200 5000 6400

31 When Bundling Works Best

32 Successful Bundling Makes Demand More Homogeneous Qx PxPy Qy Px+y Qx+y

33 Question: Should Cable be forced to Unbundle? Proponents argue consumers shouldn’t have to pay for what they do not want. They suggest consumers will save money. Opponents argue that current system provide consumers with maximum variety. Opponents argue that consumers will not save money by a switch to a la carte. What do you think?

34 Problems with bundles (& Ties) They always reduce consumer sovereignty. Consumers don’t like them when they feel constricted by the choice. Audience reaction to Five Easy PiecesFive Easy Pieces This is the motivation behind criticism of CDs (without singles) and cable bundles (without individual stations). May be at the heart of all restrictions on ties.


36 Network Effects Increased market size makes product more valuable to consumers. This is just like an economy of scale in that it benefits large firms relative to small ones. Might lead to natural monopoly. Since demand increases for large networks, large networks should have higher prices. In Microsoft case, judge decided that they were a barrier to entry, that incumbents were locked- in, or put another way, challengers were locked- out.

37 Network Effects Definition: a product becomes more valuable to a consumer the more other consumers there are of the product. –Direct network effects occur when consumers directly interact, as with fax machines or telephones –Indirect network effects occur when some ancillary product becomes more plentiful as the network gets larger. An example would be software titles becoming more plentiful as an operating system network becomes larger. Virtually identical theoretically to economies of scale Markets will tend toward monopoly, winner-take-all result (in simple world). Example: Fax machines, some software, languages, online networks, computer standards, operating systems.

38 Network Effects Does music have network effects? How about video games? Do Network effects impact total usage of a product or do they have only distributional effects? Do buyers of CDs or videogames care how many others also listen/play those games? If so, does it make them spend more time playing the song or game?

39 Did Network Effects Kill Atari and Amiga? WordPerfect and Lotus 1-2-3? The Macintosh? Atari and Amiga were two computers that were relegated to videogame status since each had a dearth of productivity software. Each tried to increase productivity software – Atari paid Microsoft to port Write, but it was to little effect. WordPerfect came out with a version for both computers.

40 Winner-take-all Network effects give bigger networks advantages over smaller networks. This is an ‘economy of scale’ on the demand side. Many information products have old fashioned economies of scale since there is a large fixed cost and low variable cost. These factors tend toward the largest firm/network having two advantages over smaller competitors –Lower Costs. –Greater Willingness to Pay by consumers.

41 Claim: Markets do not adopt best products even when it is efficient to do so. –QWERTY, VHS-Beta are most common purported examples. Story is one of coordination failure. –We all prefer Beta. But VHS dominates, and most movies are on VHS. Since we think that everyone else will get VHS, we get VHS too. Key examples of lock-in are false. Lock-in

42 Lock-in Table Technology B Wins although Technology V is better.

43 Assumption about different slopes? What does it really entail, and is it reasonable? Assumption that consumers only look at their original payoff and not their final payoff is also unreasonable.

44 First Mover Wins? Because of the advantages that seem to accrue to the large firms/networks, some thought that the key to success was to get to market first, since that would lead to the largest share, giving the firm a large advantage over competitors. Marketing Professors thought they had evidence that first movers usually went on to dominate many industries in the past, and this should have been even stronger for high tech firms. The theory of ‘lock-in’ provided new theoretical support for the idea that the first mover would win.

45 Support for Lock-in: Qwerty Story Most famous case; –simple to identify ‘quality’ (speed of typing) –Consistent with chaos theories of unpredictable small events leading to big outcomes. Usual Story: –Qwerty Keyboard was designed to slow down typing to keep keys from getting stuck. – In a famous typing contest in Cincinnati, pitting touch typist against ‘hunt-and-peck’ the touch typist used a Qwerty and won. This is the small accident leading to big outcomes, since people then associated Qwerty with speed. –Prof Dvorak designed a keyboard to speed things up in 1930s. –During WWII Navy tested new keyboard and found that speed increased 40% and cost of retraining was recouped within 10 days of completed switch. –Keyboard never adopted. End of war reduced Navy’s need for fast typists.

46 Qwerty Story Actual Story –No evidence that Qwerty Keyboard was designed to slow down typing speed, and it wasn’t necessary to keep keys from getting stuck. –There were many other typing contest pitting touch typist against other touch typists on different keyboards and Qwerty won many of these. The point is that the Cincinnati contest was not crucial. –A highly publicized 1954 test of the Dvorak keyboard by the General Services Administration found no advantage in switching to Dvorak. –The WWII Navy study was biased in the way it calculated it results. All the biases were in favor of Dvorak. It also appears that the author of the study was probably Dr. Dvorak, the designer and patent holder of the keyboard. –Ergonomics studies on keyboard design confirm that Qwerty is a good design and not much different than Dvorak in terms of speed

47 Beta-VHS Story Story –Beta was better than VHS. –VHS got an early lead and network effects allowed it to become dominant even though it was inferior. –Network effect was the fact that prerecorded tapes were available in VHS and people wishing to rent tapes would get a VHS machine to get a good selection of tapes. Actual History –Beta started first, but could only tape for 1 hour. –Sony (Beta) and VHS (Matsushita) had a patent sharing agreement. –Only real difference was size of tape and how it was threaded. –VHS always had longer playing time which turned out to be decisive. –Beta had better editing and so it is used in professional equipment –VHS as good or better than Beta according to independent tests.

48 Other Stories Quadraphonic sound Railroad gauges Macintosh versus dos Internal combustion engine Metric versus English measurement Stereo AM AC versus DC

49 Network Effects and Software Standard Claims: Increased share of OS increases library of programs written for it; increased number of programs increases share of OS –Winner-takes-all. –Lock-In: Superior challengers cannot replace leader because it is so difficult to overcome the network effects. Empirical evidence does not support the second claim, although it does support the first.

50 Network Effects and Video Games Just like the OS/program paradigm. More games written for most popular system; system with most games gets larger share. Is there an important difference between videogame market and OS market? –Lack of compatibility with prior generations of hardware (although this is getting better).

51 Open or Closed Models? If network effects are important, large networks have advantages. Did IBM (Microsoft) defeat Apple because of open standards hardware? AOL kept its Instant Messaging software incompatible with Microsoft and Yahoo. Big proprietary networks usually try to close their networks to newcomers.

52 Open or Closed Models? Apple currently keeps iTunes/iPod as a somewhat closed system (it is open to the larger MP3 network). –RealNetworks engineered a way for iPod owners to download music from its site, but Apple changed iPods so this wouldn’t work. Microsoft strategy was to have numerous hardware manufacturers using its system. So far it has failed.

53 Videogames How do they differ from older media? Which markets are they likely to most resemble? Strong network effects for game systems. Is this like any other media markets? –Only if there are competing non-compatible standards – discs vs. cylinders; beta vs. VHS.

54 Videogame Models Atari was an open system: it produced game player and anyone could produce the games. Nintendo changed that model. Only games approved by Nintendo (and paying the license fee) could be produced. It is a closed system. This allows the players to be sold at a loss. Is this a better model?

55 Brief History of Video Games Late 1960s. Ralph Baer invents the concept of a video game. Magnavox licenses the technology and introduces the “Odyssey” in 1972. No micro electronics. Overlays were pasted on the TV screen for the ‘background’. Atari creates Pong in early 1970s, based on the Odyssey ping-pong game. Magnavox sues and wins (and later sues Mattel and Nintendo). But Pong is a giant hit. Atari produces in 1975 home Pong units for hookup to television. Atari (which had become a division of Warner Communications) home console debuts in 1977. Coleco and Mattel also have consoles. Steve Jobs works for Atari (he gets Wozniak to produce a ‘breakout’ game for Atari) and proposes building a computer, but is turned down.

56 Brief History Nintendo, a maker of playing cards, creates videogame system in 1977 (after licensing Magnovox’s game system). 1981: Nintendo creates Donkey Kong for arcades. 1983, Nintendo tries to get Atari to license its new videogame system. An agreement is reached but not finalized and when Atari has personnel problems at the top, Nintendo decides to go it alone. 1984, the year the video game market crashed. Afterwards, the players were Nintendo and Sega. Flops were Atari Jaguar and 3-DO

57 Brief History Sony Playstation introduced in 1994. Earlier version played Nintendo games and played CDs. Sony came to dominate consoles and Nintendo the handheld market. Sega’s hardware machine floundered. In 2000 Microsoft introduced the X-box In 2005 Sony takes on Nintendo in the handheld market.

58 Business Model After the crash of 1984, the business model was changed. –System manufacturers produce the hardware; sell it at a loss –License game producers and take a share of their revenues. This is a model like that used by inkjet printer manufacturers. Why? –To avoid repeat of the crash? –To price discriminate? –To reduce risk? Should advertising be sold within the games? [Product placement]


60 Non-Rivalrous (Public) Goods 1. Definition: Goods that do not get used up when consumed. In other words, one person’s consumption of a good doesn’t reduce anyone else’s potential consumption of the same good. 2. Examples: Ideas, television broadcasts, national defense. Are usually ideas and artistic expressions. 3. Most of these creations can usually be put in a ‘tangible’ form, such as a CD or book. The CD is not a public good, nor is the book. But the music and stories are public goods. 4. Since a public good cannot be used up, once it is produced there is no scarcity of it and its optimal price is zero.

61 Titles and Copies 1. Book titles can be thought of as public goods, but the physical copies of a single book title are private goods that embody a public good. 2. Several questions arise: how many titles are optimal to publish? How many copies of each title would be optimal? How do competitive markets work? Monopolies? Finally, is it possible to produce public goods efficiently?

62 1.Reproductions of a single Title are Private Goods 2.Seller of the Reproductions cannot appropriate the entire potential value of the reproductions since he is not a perfect price discriminator. 3.With a single price for the reproductions, too few reproductions are produced (Q*-Qm). This leads to a social (deadweight) loss (area 7 in figure). 4.Consumers of the reproductions get surplus, which is another loss of appropriation for the reproduction seller. (1+2 in figure) The Market for reproductions of a single Title

63 number of copies of a title MC of printing 1 2 3 4 5 6 7 8 Pm Qm MR D Q* Pc Consumption of a Title—Too low How big is this? D

64 Market for Titles 1. Because appropriability for reproductions of any title is imperfect, the sellers of titles can not achieve the vertical sum of demands (perfect discrimination demand in next figure). 2. Instead, the best the sellers can do is some distance below the vertical sum of individual demands (attainable demand curve in the next figure). 3. This leads to too few titles being produced relative to the ‘ideal’.

65 number of titles written MC of writing another title Pm Qm Perf Discrimination Demand for titles Q* Market Demand for Titles Attainable Demand for titles Q**

66 Copyright Tradeoffs This leads to a tradeoff: –Under-consumption of individual titles. –Underproduction of titles. Copyright exists to give creators of ‘artistic’ works the ability to generate revenues. The theory is that without copyright, competition in selling reproductions of a title would drive the price down to the marginal cost of producing a reproduction. Competition would also drive the (economic) profits down to zero, leaving no money with which publishers can pay the author.

67 Copyright Tradeoffs It isn’t clear, however, that competition leaves no payment for the author. Arnold Plant argued that being first gave enough of a head start that sufficient profits could be earned to allow authors to receive optimal remuneration. (Ex. English authors in the US market). The lead from being first is, with current technology, unlikely to allow much profit.

68 Optimal Copyright The figure on the next page illustrates optimal duration of copyright. It contrasts the gains from lengthier copyright (the value of additional works created) against the harms (unnecessary loss of consumer surplus)


70 Actual Copyright Life of the author plus 70 years ‘Work for hire’ records, movies, games? 95 years. Is this too long? –Creative commons members say ‘yes.’ –17 economists say ‘yes.’ –Mark Twain says ‘no’. In fact, no one knows if it is too long.

71 An Example

72 Fair Use There is in the law an attempt to balance the interests of copyright holders and those of users. Fair use is a defense to a claim of copyright infringement. It allows copying in instances when the copying appears not to be hurting the copyright owners revenues.

73 Fair Use 4 factors –Amount of the copyright product that is copied. –Nature of the Copyright product (commercial versus academic or scholarly. –Nature of the use of the copied product –Impact on the revenues of the copyright holder. Last factor is the most important. Betamax Case said home videotaping was fair use, and thus home videotaping was allowed.

74 Fair Use Economic Rationale: –If a use is too small to make the transaction worthwhile, we might as well allow it to happen since it doesn’t harm the copyright owner and benefits the users. As technology changes, this rationale might disappear. DRM can allow payments for individual uses, so fair use might not be needed.

75 Does Copyright Last Too Long? 17 famous economists say it does. Brief in the Eldred Case, which challenged the constitutionality of the 1998 Sonny Bono Copyright Act. They point out that increasing the life from 50 to 70 years after author dies should have a trivial impact on incentives to produce work. The use the concept of ‘present value’ to demonstrate how little a dollar paid far in the future is worth now. $1 in 70 years, with a 5% interest rate is worth 1/(1.05)^70, or 3.2 cents. The Interest Rate impacts optimal copyright length. Of course the deadweight loss from the extra life is also far in the future, so it needs to be discounted to present value terms as well.

76 On the Other Hand Even a small increase in payments can lead to an increase in new creations – depends on the elasticity of supply. New creations start to provide value immediately, not 70 years from now. An increase of even 3% in titles could provide significant immediate benefits. The 17 economists oversimplified this issue.

77 Further There is another possible reason for copyright even if it doesn’t bring forth any new works. It might be important to have ownership over current works to make sure that they are properly husbanded. Ownership keeps characters from being misused or overused.

78 Copyright and CD Sales






84 Risk Sharing Artistic creations are highly variable in the their economic success. Small number of successes, large number of failures. Publishers appear to be in a better position to bear the risk. An Example follows

85 Risk Sharing If one out of 10 published books generates $20K in profits (revenues minus publication costs) and the rest make zero, the average book would generate $2K above publication costs, which could be used to pay authors. A publisher of 500 books, could expect to generate profits of approximately $1 million. Because of the large number of books, the publisher can predict this value with high precision. [By analogy, this is like to knowing that if you toss a coin 500 times you will get very close to 250 heads, or how an insurance company knows that X number of people are likely to die in any given year]. Authors could be relieved of the risk and all given $2K. Or they could bear the risk, in which case 90% would get zero and 10% would get $20K. Which is the more efficient system? Normally we would think the publisher should bear the risk. But there is lots of evidence that creators prefer bearing the risk.

86 Risk Sharing Although we usually assume the individuals are risk averse, meaning that they do not like risk, authors appear to want to shoulder some risk. Examples: Royalties based on sales – standard contract in the industry book and recording industry. Star actors and directors often negotiate a piece of the revenues or profits for films [Points]. Actors and writers get residuals. Droit de Suite: Artists get paid every time their work gets resold. This does not currently exist in law, but artists claim they want it. Financial and Syndication Rule

87 What does a contract look like? It is usually exclusive under the life of the contract. Is there an advance against royalties? What is the royalty rate? Are royalties based on wholesale or retail prices? Are they based on gross or net sales? –What about returns? Discounted items? Right of First Refusal:

88 What does a contract look like? This is a contract for a book of mine, with the amounts removed. It is fairly typical.

89 Terms to Notice Wholesale or retail prices Net Receipts or Gross? Returns Reprint editions Directly sold by Publisher Premium Sales Countries other than the US

90 Royalty contracts

91 More Royalty contracts

92 What Does a Royalty Statement Look Like?

93 Residuals Writers guild of America receives money whenever programs or movies generate revenues in syndication, domestic or foreign. Screen actors guild receives money whenever movies, programs or commercials are syndicated (as well as for original production). Same is true of directors and others. A statement about royalties from the Directors Guild: “Residual payments are made to DGA directors following a film's theatrical run for its subsequent exploitation on videocassette, laserdisc and DVD, pay television, basic cable and free television. Residuals represent additional income for the DGA filmmakers. It's one of the greatest financial advantages of being a DGA member.”

94 Fin/Syn rules Law that prevented TV Networks from owning more than a very small share of the television programs that they broadcast in prime time. This essentially forced producers to rent the program to the television networks for 2 years, after which it reverted to the producer. Producers always had the option of renting their programs (in theory), so why did they need a law forcing them to do so? Why would producers wish to restrict their ability to sell programs to television networks? Particularly when television networks should be better able to bear the risk of success or failure, and should be better at gauging a programs likelihood of success (and syndication revenues).

95 Performing Rights Composers of music are paid when their works are broadcast on television. This is in addition to the payment that occurs when a composer is commissioned and the payment that occurs when the music is ‘synchronized’ with the picture. Producers wish for the right to combine the upfront payment with the performing right. Composers do not wish to allow themselves to enter into such negotiations. Why not? Several possible answers. –Maybe composers are at a bargaining disadvantage relative to networks and don’t wish to have the entire payment controlled by such circumstances. –Alternatively, it is possible that performing rights payments are too high and composers do not wish to return to a competitive up-front payment. But if this were the case composers should have been willing to pay to get their music on television in order to be able to receive the performing rights payments.

96 Droit de Suite This does not currently exist in US Copyright law, but artists claim they want it. On average, it should leave the payments constant, unless artists are at a bargaining disadvantage. Once again, it ties the artist to the success of the creation. It increases risk. It can’t be a voluntary contract since artists will not be able to monitor all sales of their creations.


98 The Sound Recording Industry History: –Edison invents a foil recording device in 1877 –Berliner invented a ‘record’ style device that was easy to duplicate. Played on the Victrola. ~1890. –The business gets going in the period 1910- 1920. Radio seems to have damaged it in early 1920s. –Tremendous crash during the depression. –80s and 90s are terrific decades.


100 Music Industry

101 Performers Deals are struck many different ways. –Record labels usually signs ‘talent’ or deals with independents who have signed talent. A&R (artist and repertoire) in-house producer is one way to go. –Talent deals: As high as 15% of retail for big names, 10% or so for beginners. –Upfront is thought to be ~50% of expected royalty. –Talent may have to share royalty with producer. Studio costs and promotion costs may be taken from royalties (not advanced) earned by the Talent.

102 Artists Take on Successful Album


104 Two articles today in WSJ –One on France’s legislation regarding DRM –One on measuring advertising for Internet radio.

105 Composers Composer gets a publisher interested. They split the revenues. Publisher then tries to sell the song. Money comes from several sources: –Performing Rights Societies (ASCAP, BMI) –Mechanical rights –Synchronization rights

106 Performing Rights Concerts, music halls, radio, television Radio, television, cable networks all use a ‘blanket license’. Blanket rates are negotiated with the final determination controlled by a court in NY. Copyright Royalty Arbitration Board (recently replaced) sets some other rates. Radio pays about 3% of revenues, TV and cable, 1.3%

107 Mechanical Rights An amount for each record sold. Depends on the length of the track Government sets the maximum rate that can be charged under the ‘compulsory license’ for sound recordings. Compulsory rate is about 10 cents for a 5 minute track. Actual amount is usually lower since the compulsory rate becomes the maximum. Usually collected by the Harry Fox agency. Question: Why should there be a compulsory license?


109 Copying Technologies to aid in copying are not new: –Unauthorized printing presses, record stamping, and the like have been in existence as the authorized versions. Slightly Older Technologies (which can be used at home) include: –Photocopying –Audio Cassettes –VCRs –Floppy discs, CDs, DVDs

110 4 Possible Impacts of Copying on the Producer Substitution Effect: Copies replace the purchase of a work. –This is most basic intuition. –Clearly decreases sales. Not a problem for videotaping. –Hard to imagine that it isn’t important for many forms of copying. Particularly counterfeiting.

111 Indirect Appropriability Producers capture value of copies ( Liebowitz, J. Political Economy, 1985) –Requires: no variability in copies made per original Or, if there is variability, the ability to identify which originals are turned into copies –This is the reason photocopying did not appear to harm publishers.

112 Try out before purchase –Defense in the Napster Case –If cost of sampling low, it is efficiency enhancing. But not necessarily revenue enhancing! Drunken Sailors Example –Empirical evidence that sampling doesn’t increase sales. Superior choices of Cable TV generally doesn’t increase viewing hours Radio doesn’t appear to increase record sales. Sampling (Exposure Effect)

113 Users have higher value because there are more other users. –It is not clear which products this might apply to, perhaps business software. Users of Copies Increase Value to Purchasers –Could in theory increase sales. Seems unlikely to be important in most instances of copying. Network Effects

114 Copying Technologies to aid in copying are not new: –Unauthorized printing presses, record stamping, and the like have been in existence as the authorized versions. Slightly Older Technologies (which can be used at home) include: –Photocopying –Audio Cassettes –VCRs –Floppy discs, CDs, DVDs

115 Historical Impacts of Home Piracy Photocopying. Took place mainly in libraries Impacted journals more than books Publishers were able to engage in indirect appropriability. Revenues and publications increased relative to audience of potential readers.

116 Impact of Photocopying This idea of indirect appropriability has been examined in a least one market. It appears that unauthorized copying has benefited copyright owners in the case of photocopying.

117 Evidence on Price Discrimination and Indirect Appropriability Libraries that:19591983 Price Discriminate359 Don’t Price Discriminate3521 Ratio of Book to Journal Expenditures, US Academic Libraries 19413.0219613.1919751.70 19443.4119653.3619771.54 19463.1319683.6719791.26 19503.0119712.9619811.13 19592.4619731.96

118 Continued Dependent variable ConstantCitesNon-Profit Dummy Age of Journal R-square P lib /P Ind 1.29.0065 [1.99].65 [4.14].17 n=80 P lib /P Ind 1.38.0071 [2.14].578 [3.36] -.16 [1.01].17

119 AudioTaping There was a drop during the early stages of cassette recorders. After 1982 there was a rapid increase in record sales—probably due to mobile recorded audio, which expanded the market. Net effect was unclear. Economic studies were ambiguous. Based on survey data.

120 Audiotaping: No Clear Result

121 The pickup after 83 is inconsistent with negative impact of copying

122 Videotaping Original concern was for broadcast television revenues, which made little sense. It opened up a new market which benefited the movie industry—prerecorded video, although the ability to record was not required for that.

123 Slightly updated numbers: Box office gross was $9.49 billion in 2003 according to the Motion Picture Association of America. According to Vogel, the movie studios net slightly less than 50% of the box office. According the Adams Media Research, revenues to the studios from the sale and rental of DVDs was $11.38 billion, and from VHS tapes $2.56 billion. Thus revenues earned by the movie studios from prerecorded movies are approximately three times as great as that from theatrical releases.

124 Application to File-Sharing Can indirect appropriability work in Napster-like environment? Problem: large variability in the number of copies made from each original, and identifying at time of sale which originals are going to be duplicated. Large scale Napster copying would seem almost certainly to significantly harm copyright owners. Would work better if Napster had required upload credits to be earned before downloads were possible. Still, Napster is easier to control than Gnutella based systems.

125 History of File-Sharing Napster begins in fall of 1999.

126 File-Sharing Trends

127 Who Engages in File-Sharing?

128 Absolute Amounts Inspires confidence, doesn’t it?

129 History of Record Sales

130 How does the timing of the decline in record sales match up with the growth of file-sharing? Napster doesn’t show large numbers of users until second half of 2000. Record sales begin their steep decline. File-sharing continues to grow until lawsuits announced on June 25 th and started on September 8, 2003. The decline in file-sharing matches a stopping of the decline of record sales. Sales continue to decline in 2005. The only sour note is the increase in the second half of 2004.

131 What about the alternative Explanations? Look at alternative factors – GDP, price of CDs, quality of music, alternative forms of entertainment (DVDs) and so forth. (Liebowitz 2004) None of these factors seem capable of explaining the change. Price of CDs constant. Concerts up and radio listening up for contemporary music. GDP would predict an increase. DVD growth is frequently brought up. It is usually the leading alternative candidate. DVD sales provide results quite different from DVD revenue. Turns out that DVD growth is not a reasonable candidate.

132 Alternative Entertainment



135 Econometric Studies Each technique has problems. Cross Section of Areas –Many factors cause differences in behavior across areas. Can we control for enough of them? Do we have cross-section measures of file-sharing? Cross section of people –Data on individuals comes from surveys that might not be reliable. Cross section of Albums –How do you distinguish impact of file-sharing? Is there a fallacy of composition?

136 Industry Reaction to Copying Shutting down Napster. Shutting down Grokster. Prosecuting users who make copyrighted materials available to others. ‘Spoofing’ and other technologies to make the trading in copyrighted goods more difficult. DRM, protection device.

137 What about article in Science?


139 Advertising based Industries Broadcast television Broadcast radio Newspapers Magazines Much of the Web

140 Advertising Models Pure advertising models (television and radio) almost never are used: magazines, cable networks, newspapers, all use both advertising and subscriptions. The TV/Radio model is a flawed model. It was due to unusual historical factors, not economic forces. Better models are usually a mixture of advertising and subscriptions. Net firms thought they could be solely advertising based. Cable TV and subscription radio have advantages, but also (particularly radio) disadvantages (many individuals do not have access.

141 Broadcasting Consumers of television and radio are the advertisers. Audiences are the product that broadcasters sell. Broadcasters want audiences to see advertising. The program itself is only important as an instrument to that end. Size of the audience is more important than the intensity of the enjoyment. Number of advertising minutes used to be controlled. It no longer is. Broadcasters need to gauge viewer reaction to more ads. Also a function of the entertainment value of the ads.

142 A short history of Broadcasting Radio begins in the early 1920s. Free entry. Government claims it needs to control the spectrum. See Hazlett for a critique. FCC established, which proceeded to give spectrum away to ‘favorite’ entities. Should have sold spectrum. Same for TV later. Radio peaks in the 1930s and 40. National networks formed (NBC, CBS), and national programs. The precursor of television. Television gets going in the 1950s. Soon surpasses radio. For the last 40 years the average household has watched 50 hours of television per week.

143 History (cont) 3 major networks (ABC, CBS, NBC) dominate prime time until the 1990s. Cable networks do not play a major role until the mid 1990s. In 2003 cable networks drew larger total audience than broadcast television for the first time. The trend against broadcast continues.

144 Television killed Movies

145 Did TV finally save Movies? Table 1 lists the various sources of revenue that TV allowed movie producers to collect, which are far in excess of theatrical release. But the impact of TV on movies is still probably negative. It is true these other sources increase movie revenue by a factor of 5. But movies have on 1/8 the share of personal consumption they used to, and entertainment’s share of personal consumption has grown, leaving movies behind.

146 Measuring the Audience This is a problem because consumers do not pay for the program. PPV knows exactly how big its audience is, as do movie theaters and magazine publishers. Nielsen for television; Arbitron measures radio. Diaries were the main method for many years. They are being replaced by ‘people meters.’ Measurements are imprecise. Particularly for small cable stations. Sample used isn’t large enough to have statistical confidence. Diaries can be misleading. So too can the meters.

147 Measurement Vocabulary Reach (or cume): the favorite term of broadcasters. This is a fairly useless term, often defined per month, per week, or per day. It measures the number of individuals or households who tuned in to that station for at least 15 minutes during that interval. For major stations, reach can often be close to 100%. Is the basis for gross rating points (reach x frequency of adv). Share, is the market share of a program for all TVs that are on at that moment. Rating: the share of all (TV) households watching a show. This is the most accurate and meaningful measurement.

148 The People Meter Furor Introduced in the late 1980s. Replaced, in part, diaries. In 1990 Nielsen caused a furor when it claimed that the television audience was smaller. People meters generally give lower ratings. Industry went into shock. Advertisers asked for money back. Broadcasters attacked the ratings. What does this say about how much advertisers know about the impact of their advertising?

149 Broadcasting Regulation Federal Communication Commission (FCC) oversees broadcasting. License stuff – renewals, public service, obscenity (J Jackson; H Stern) – ownership, so forth. Limits on networks owning stations, now limits on the number of viewers they can reach. Fin/Syn rules already discussed. Broadcast Flag. HD requirements.

150 Television Financial Arrangements Networks ‘give’ programs to affiliates, but affiliates ‘give’ advertising time in the programs to the networks. Independent stations live off the syndication market (re-runs) and occasional shared first run programs

151 Television Financials


153 Advertising on the Net Original model was subscription based – AOL ISP model with specialized content. ESPN, Wall Street Journal, Slate, and a host of others tried this. Then advertising was added in, as in TV. Only WSJ and a few others stayed with subscriptions. Many found that when they charged user, number of users dropped dramatically, hurting ad revenue and dashing their hopes for large market share (they believed that network effects made first movers the winners. Eventually, subscriptions are likely to come back.


155 The Movies The history is similar to that of records. Edison, in the early 1890s creates first working camera. Competing patent claims caused difficulties and in 1908 the “Motion Picture Patents Company” was formed, which pooled the patents. Business moved to California, in part to illegally escape the patents. The advent of sound in the late 20s, along with the depression caused further consolidation, and the major studios were formed at that time. Numerous antitrust actions were taken, with the major impact being to separate the production from the distribution.


157 Movies

158 The movie industry is tied-in with other media companies, such as cable and television. The following chart shows just some of the relationships. Although not shown on the chart several are also tied in with record companies, (Universal, Sony, Warner Brothers). There has been a great number of mergers and acquisitions in the last few years.

159 Movies

160 Contracts Producers make the movies. Sometimes in house for a studio. They contract with distributors to get the movie shown. The ‘studios’ are normally the distributors. Distributors share revenues with the theaters (exhibitors). Distributor normally get a majority of exhibition revenues for the first few weeks. Distributors and producers share profits, sometimes along with stars.


162 Revenue Streams Working backwards: –Ticket sales generated by the exhibitor. These revenues are split with the distributor, with the distributor getting a majority percentage after deducting costs of operation (the nut). This is known as the distributor’s gross rental. – Distributor takes a minority percentage (30% domestic, 40% foreign). Distributor also deducts direct costs.

163 Movies: Economic Questions Text claims on page 52 : “Ticket sales are typically insensitive to changes in box office prices.” does this seem possible? Does the fact that theaters also make revenues from food enter into this analysis? Does the fact that customers often have to pay for babysitters enter into this analysis?

164 Movies

165 Revenues used to come primarily from theatrical distribution. Foreign audiences accounted for a large portion of sales for many decades. Now more revenue comes from videotapes, with smaller amounts coming from cable television.

166 Movies Movies used to be released in the US first, and then gradually to the rest of the world. Piracy has caused producers to narrow the window of these releases. Ideally, films would have different prices in different parts of the world.




170 Proposals for Alternative Copyright Systems File-sharing has led to major dislocations. Battles in the courts (Grokster), lawsuits, and so forth. Some (Larry Lessig) claim that the problem of copyright is that it intrudes on the ability of users to ‘recreate’ using digital technology. Mashups (think Grey album and Phantom Edit) are chilled by copyright. [Is this last point actually true?] Thus, the need for an alternative.

171 Compulsory License An alternative, based on a compulsory license, has been proposed. The compulsory license would require copyright owners to allow anyone to make digital copies of their works. In return, a pot of money would be established to pay copyright owners for this right. The pot most likely would come from a tax on ancillary products, such as blank discs, stereo equipment, Internet Service Providers, and so forth. A copyright Board or Panel would determine the amount of these taxes, and who would pay.

172 Evaluating these Proposals Two basic questions that need to be faced in any such system. –How much revenue should be generated? –Who is to pay? –Who gets the revenue? Markets normally determine prices, and consumers vote with their dollars. How would a Board attempt to determine the correct number of titles to support, which titles to support, which products to tax, how much to tax them? How can we prevent ‘authors’ from gaming a system to increase their payouts?

173 Other Issues Digital Rights Management (DRM) –Copyright owner can imbed code into software that will monitor use and charge accordingly. It can also prevent copying. –Copyright owner can virtually costlessly collect revenues from users. –It might be the most efficient mechanism since it approaches perfect price discrimination. –[or does it?]

174 DRM This has led to a contentious debate among academics. –Question: Is this protection ‘too strong’? Too much power to copyright owner? –Does it remove or kill Fair use ? –Does it eliminate free speech? –Does it reduce the creation of copyrighted materials?

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