A La Carte Nonsense

by on July 26, 2005 · 6 comments

I’m not too surprised to see populist interest groups on the right and left jump on an intellectually incoherent but crowd-pleasing proposal like “a la carte” cable, but Matt Yglesias should know better.

What everyone seems to miss in this debate is that a cable channel isn’t like a banana. If every grocery store somehow forced you to buy a banana with every orange, the banana-orange bundle would be more expensive than a banana or an orange alone, and a lot of bananas and oranges would end up in the garbage.

But a cable channel is a non-rivalrous good. The marginal cost of providing it to another consumer is zero. The goal of the cable company is to recover it’s rather large fixed costs in equipment, programming, etc. It will price its products so that it is able to recover those costs along with a profit margin.

To simplify things, let’s imagine that a cable company has only two channels, Spike TV and Women’s Entertainment, and only two kinds of customers, men and women. Men value STV at $10 and WE at $4. Women value WE at $10 and STV at $4. The cable company might bundle the channels together and charge $12 for the bundle. Each consumer would be getting $14 of TV for $12.

Now, people like Yglesias seem to assume that in an a la carte world make each channel would cost, say, $6. In that case, men would buy only STV, women would buy only WE, and consumers would save a bunch of money.

But that’s absurd. The cable company would lose half of its revenue in that scenario, and would be unlikely to even be covering its fixed costs. More likely, it would set the price for each channel at $10. The cable company would still be losing a lot of revenue, but that might be enough to keep it in business.

But notice that both the consumer and the cable company loses in this scenario. Before, the cable company was getting $12/subscriber, now it’s getting $10. The male consumer, meanwhile, went from getting $14 of TV for $12 to getting $10 of TV for $10. There might be a show he likes on WE, but not that he likes enough to pay twice as much for his cable bill.

Bundling increases consumer welfare by distributing low-marginal-cost goods to wider audiences. A la carte cable wouldn’t save consumers money. It would simply reduce the number of channels on their TVs. Buying twice as many cable channels isn’t like buying twice as many bananas.

It might be objected that the cable company does pay a per-viewer fee to the studio for those channels. But that’s just the same phenomenon one step removed. How do the studios price their channels when selling them to the cable company? Their marginal costs are also close to zero, so the same bundling argument above applies to them. If they gave their customers the option of buying channels a la carte, they’d have to dramatically raise their per-subscriber rates to cover their fixed costs. Consumers would be the loser–paying about the same for a much smaller variety of channels.

  • Brett Bellmore

    Your example is highly simplified, to the point that it’s incapable of exibiting the features that cause people to object to bundling, and demand ala carte.

    Let us say that the cable station carries not two, but 100 channels. And you want to watch not one, but ten channels. The station offers ten bundles of ten channels each, which you must pay separately for.

    If the list of channels you want to watch happens to corrispond to one of the pre-existing bundles, you’re in hog heaven: You pay for ten channels, and watch ten channels. Peachy.

    However… What you actually find in practice is that the bundles are cunningly composed so that each bundle only contains perhaps one or two channels you actually wish to view, while most of the channels in a bundle you either have no interest in, or find actively obnoxious. And so you have to buy, and pay for, maybe seven separate bundles of channels, in order to get the ten you really want to watch. The promise of ten channels for a low, low price turned out to be a cheat.

    It’s rather as though you went into a Chinese restaurant, intending to eat sweet and sour shrimp, with an egg roll on the side, and a pot of tea. Only to find that the food is bundled so that in order to get the tea you must order the Peking Duck dinner, the egg roll is only available with the Mongolian beef, the shrimp is a side dish that comes with an order of egg foo yung, and the sweet and sour sauce has to be drained out of a serving of sweet and sour pork.

    And so, to put together your perfectly ordinary lunch, you have to order, and pay for, a feast for four, most of which you have to throw away. While the guy at the next table, who luckilly wanted tea with Peking Duck, eats the same amount of food for a quarter of what you paid.

    Oh, and don’t tell me it would be insanely expensive to administer ala carte; They’ve already got the necessary tools in place, in order to handle pay per view.

  • Brett Bellmore

    Your example is highly simplified, to the point that it’s incapable of exibiting the features that cause people to object to bundling, and demand ala carte.

    Let us say that the cable station carries not two, but 100 channels. And you want to watch not one, but ten channels. The station offers ten bundles of ten channels each, which you must pay separately for.

    If the list of channels you want to watch happens to corrispond to one of the pre-existing bundles, you’re in hog heaven: You pay for ten channels, and watch ten channels. Peachy.

    However… What you actually find in practice is that the bundles are cunningly composed so that each bundle only contains perhaps one or two channels you actually wish to view, while most of the channels in a bundle you either have no interest in, or find actively obnoxious. And so you have to buy, and pay for, maybe seven separate bundles of channels, in order to get the ten you really want to watch. The promise of ten channels for a low, low price turned out to be a cheat.

    It’s rather as though you went into a Chinese restaurant, intending to eat sweet and sour shrimp, with an egg roll on the side, and a pot of tea. Only to find that the food is bundled so that in order to get the tea you must order the Peking Duck dinner, the egg roll is only available with the Mongolian beef, the shrimp is a side dish that comes with an order of egg foo yung, and the sweet and sour sauce has to be drained out of a serving of sweet and sour pork.

    And so, to put together your perfectly ordinary lunch, you have to order, and pay for, a feast for four, most of which you have to throw away. While the guy at the next table, who luckilly wanted tea with Peking Duck, eats the same amount of food for a quarter of what you paid.

    Oh, and don’t tell me it would be insanely expensive to administer ala carte; They’ve already got the necessary tools in place, in order to handle pay per view.

  • http://www.binarybits.org/ Tim

    Brett, the simplification is designed to illustrate the concept that bundling increases welfare for both the consumer and the cable company. I could make the same argument with more channels, but the math would be even more tedious.

    As for there being bundles featuring combinations you don’t like: well, life’s tough. If I want Britney Spear’s “Toxic” on CD, I’m “forced” to buy all the other songs on that album, even if I don’t want them. If I want a cell phone for daytime calls, I’m “forced” to buy evening and weekend calls too. If I buy Lucky Charms, I’m “forced” to buy the toy at the bottom of the box as well.

    The fact that the bundles companies decide to offer please some customers more than others doesn’t strike me a problem requiring government remedy. The point is that a la carte cable won’t save most customers money. Rather, the average customer will end up paying about the same price for far fewer channels.

  • http://www.binarybits.org/ Tim

    Brett, the simplification is designed to illustrate the concept that bundling increases welfare for both the consumer and the cable company. I could make the same argument with more channels, but the math would be even more tedious.

    As for there being bundles featuring combinations you don’t like: well, life’s tough. If I want Britney Spear’s “Toxic” on CD, I’m “forced” to buy all the other songs on that album, even if I don’t want them. If I want a cell phone for daytime calls, I’m “forced” to buy evening and weekend calls too. If I buy Lucky Charms, I’m “forced” to buy the toy at the bottom of the box as well.

    The fact that the bundles companies decide to offer please some customers more than others doesn’t strike me a problem requiring government remedy. The point is that a la carte cable won’t save most customers money. Rather, the average customer will end up paying about the same price for far fewer channels.

  • Brett Bellmore

    Customers whose preferences happen to match a pre-existing bundle pay less under a system of bundling. Customers whose preferences are a poor match for the bundles offered pay far, far more under bundling, because they must purchase many bundles in order to assemble the bundle THEY want from bits and pieces of the others.

    I agree, it’s not a matter that ought to be addressed by legislation. I merely object to the claim that the specific people asking for ala carte are being irrational. THEY would be better off under such a system, even if the average consumer might not be.

    And I’d argue it’s an empirical question whether even the average consumer is better off under bundling… The assumption you’re making is that the cable company is TRYING to design bundles to satisfy as many consumers as cheaply as possible. There are other strategies they could pursue, that aren’t so beneficial to the customer.

  • Brett Bellmore

    Customers whose preferences happen to match a pre-existing bundle pay less under a system of bundling. Customers whose preferences are a poor match for the bundles offered pay far, far more under bundling, because they must purchase many bundles in order to assemble the bundle THEY want from bits and pieces of the others.

    I agree, it’s not a matter that ought to be addressed by legislation. I merely object to the claim that the specific people asking for ala carte are being irrational. THEY would be better off under such a system, even if the average consumer might not be.

    And I’d argue it’s an empirical question whether even the average consumer is better off under bundling… The assumption you’re making is that the cable company is TRYING to design bundles to satisfy as many consumers as cheaply as possible. There are other strategies they could pursue, that aren’t so beneficial to the customer.

Previous post:

Next post: