1. Competition between content distributors in two-sided markets Harald Nygård Bergh, Hans Jarle Kind, Bjørn-Atle Reme, Lars Sørgard, Norwegian School of Economics 1 Work in progress

2. Standard market structure in the literature Typical results: A “low” advertising volume => this increases the viewers’ wtp A “low” viewer price to attract a large audience => this increases the advertisers’ wtp Advertisers Consumers TV-channels

3. Actual market structure – doesn’t fit Advertisers Consumers TV-channels Distributors  TV channels set ad prices  Distributors set prices to consumers Þ Different agents set prices on the two sides of the market

4. The focus of this paper How is the two-sidedness of the market taken care of? What characterizes the strategic game between  competing distributors  distributors and content providers Seems like distributors pay a linear wholesale price or a two-part tariff in most cases (imperfect contracts). 4

5. Assumptions in this paper Each distributor sets two prices: Connection fee Program price The TV-channel sets: Advertising priceying (locked in) Common advertising level Advertisers TV-channel Distributors Consumers Distributors

6. The model (pay-per-view) One content provider (not critical) Two competing distributors, i = 1, 2. Each consumer single-homes, and pays  F i as a fixed fee (connection fee)  p i per program he watches 6

7. The consumer side c i denotes a representative consumer’s consumption level Consumer surplus from watching TV: s i = u i (c i ) – (p i +gA)c i  A is the ad level in the programs  g is the disutiliy of ads 7

8. Consumers differ in preferences for distributor  uniformely distributed over a unitary Hotelling line Distr. 1Distr. 2 Connection fee: F i Net utility if connecting to distributor 1: U 1 = v -tx +s 1 – F 1 If connected to 2: U 2 = v –t(1-x) +s 2 – F 2 Market share distributor i: x

9. The firms: Profits Let f be the price per program per viewer that the distributors pay to the content provider: Content provider: P = f(N 1 c 1 + N 2 c 2 ) + rA Advertiser k = 1,...,n p k =A k (N 1 c 1 +N 2 c 2 ) - rA k => 9

10. The game 1) The content provider sets the wholesale price f 2) The distributors compete for viewers by setting connection fees F 1 and F 2, and the consumers make their connection choices 3) The distributors set program prices (p 1 and p 2 ) and the content provider sets ad price (r) 10

11. Stage 3 Content provider’s reaction function (dP/dr = 0): Advertising price decreasing in p i  a higher program price reduces the size of the audience (and thus advertising demand) Ad price increasing in the wholesale price f  optimal to enhance the viewing time through having less ads 11

12. Stage 3, ctd Distributor i’s FOC: 12 Proposition: Program prices are higher with an endogenous ad level than if it is fixed at zero. Lemma: The distributors do not compete at this stage; for a fixed A, dp i /dp j = 0

13. Stage 3, ctd Distributor i’s reaction function: 13 Remark: Program prices are strategic complements through the effects they have in the advertising market.

14. Market outcome, stage 3 Lemma: A distributor's incentive to increase the price in order to repress the advertising level is increasing in his market share. 14

15. Stage 3: size and profitability Proposition: A distributor’s profits per viewer is decreasing in his market share, and more so the greater is the viewers' disutility of ads. => a small distributor “free-rides” on a larger 15

16. Stage 2 The distributors maximize profits with respect to the connection fee (dp i /dF i = 0) 16 Proposition: The distributors make profits even if they are undifferentiated.

17. Stage 1 Determination of the wholesale price f Recall: Content provider receives ad revenue Ads ”damage” the good sold by the distributor Assume that the content provider sets f f = argmax{rA + f(N 1 c 1 +N 2 c 2 )} Equilibrium: chooses f such that A = 0 if g > 0.34 17

18. Numerical example; t = 0 Profits, content provider Profits, distributors

19. Advertising regulation Let the regulated volume be  = A * (eq. ad volume) Distributors take  as given and set lower program prices. Tougher competition between distributors: Lower distributor profit (equals t/2). TV-channel’s profit higher: Higher advertising prices due to higher consumption in equilibrium.  but also TV channel harmed if tougher regulation

20. Summing up Analyzes strategic interactions between content providers and distributors  “The middleman” creates inefficiencies  viewer prices too high, ad volume too low The distributors might make positive profits even if they are undifferentiated Regulating the ad volume harms the distributors but may increase profits for the content provider At least the results from stage 2 and 3 survive also if fixed price per channel 20

21. The distributors might make positive profits even if they are undifferentiated Regulating the ad volume harms the distributors but may increase profits for the content provider At least the results from stage 2 and 3 survive also if fixed price per channel 21

22.  p k = (A k c 1 – A k r)N 1 + (A k c 2 – A k r)N 2 Aggregate profits for the distributors and the content provider are maximized by setting  p i = 0 for g < 1/3 (purely ad-financed)  p i > 0 and A > 0 for 1/3 < g < 1  A = 0 for g > 1 (only viewer payments) 22