A La Carte Fairy Tale

by on December 6, 2005 · 28 comments

I’m baffled by the increasing popularity of the a la carte cable idea. The people supporting it seem not to have given any serious thought to the economics of the situation.

Cable companies are for-profit operations. Each year, they get a certain amount of revenue, (call it R) incur a certain amount of cost, (call it C) and the difference between the two is their profit or loss (call it P). If they lose money consistently, they’ll eventually go out of business.

Now, let’s assume for the sake of argument that P is relatively fixed in the long run. In a competitive market, companies tend to price their products so that they can cover their cost and get a “normal” return on their capital invested. If P rises too high, that will cause more competitors to enter the market (for example, a new satellite network, or build-out of fiber) driving prices back down to the normal level.

Now, what does a la carte cable do? To hear the rhetoric of its supporters, it will allow consumers to save money by only “paying for” the cable channels they use. The hip 20-something will get MTV but not Nickelodean, while the suburban couple with children will make the opposite choice. Since each is saving money by not being “forced” to purchase channels they don’t want, each will see their cable bills drop. In other words, a la carte cable, by the logic of its supporters, will cause R to drop. Cable companies will take in less revenue.

On the other hand, C won’t drop at all. In fact, it’s more likely to go up. The same infrastructure will need to be maintained, and some companies will need to install new hardware to support the a la carte functionality. Customer service costs, too, will probably rise as the ordering process will take longer. In short, the cable companies’ job isn’t made easier in any way by a la carte, so there’s no reason to expect their costs will go down.

But what about subscription fees? Won’t cable companies save money because they aren’t “buying” as many TV channels? Here, too, the savings are illusory. Cable channels are in an even more competitive market than cable TV services, so they don’t have a lot of extra profits from which to cover lost revenues. So if the number of subscribers goes down, they will be forced to raise their subscription rates to compensate. Even worse, because people are less likely to watch as much TV with a la carte, advertising revenues are likely to fall, which means even more will need to be made up through subscriptions.

So we’re left with the conclusion that R will go down significantly while C will stay the same or go up slightly. That’s a fairy tale. Cable companies do not have a giant pot of money at corporate headquarters with which to make up the losses imposed on them by a la carte cable. If forced to adopt a la carte, what they’ll do is simple: they’ll set the per-channel rates to generate the about same revenue as their previous pricing model. Instead of paying $60/month for 60 channels, you’ll pay, say, $10/month for each of your favorite 6 channels. The average consumer’s bill won’t change very much. The only difference is that he’ll be getting a lot fewer channels for his money.

The fundamental issue is that cable channels, like all intellectual property, is non-rivalrous. Once the cable company has set up the necessary infrastructure to deliver 100 channels, delivering 1 channel to the consumer is exactly as expensive as delivering 100. For that reason, it makes sense that every consumer would get every TV channel. Don’t watch MTV if you don’t want to, but it’s not costing you or society anything extra to have it available on your TV.

  • Walter E. Wallis

    Utilities handle this by having a facility charge and a usage charge. What would the folks asking for ala carte say to a time of viewing charge?

  • Walter E. Wallis

    Utilities handle this by having a facility charge and a usage charge. What would the folks asking for ala carte say to a time of viewing charge?

  • http://www.binarybits.org/ Tim

    Well, the idea is that the facility charge covers the cost of infrastructure, while the usage charge covers the marginal cost of providing each kilowatt or gallon, or whatever, right? If that’s the idea, then I would think the “usage charge” rate should be zero, since the cable company doesn’t incur any extra charges when you turn your TV on.

  • http://www.binarybits.org/ Tim

    Well, the idea is that the facility charge covers the cost of infrastructure, while the usage charge covers the marginal cost of providing each kilowatt or gallon, or whatever, right? If that’s the idea, then I would think the “usage charge” rate should be zero, since the cable company doesn’t incur any extra charges when you turn your TV on.

  • Walter E. Wallis

    The programming is the marginal cost.

  • Walter E. Wallis

    The programming is the marginal cost.

  • http://www.binarybits.org/ Tim

    If we’re talking about the a la carte issue, in some cases programming is a marginal cost to the cable company, but only because the studio that produces the program charges on a per capita basis. Programming isn’t a marginal cost from the perspective of the studio–it costs as much to distribute its programming to a thousand customers or a million.

    From the perspective of economic efficiency, what matters is the marginal cost to the economy as a whole, and that’s clearly 0.

    What I was talking about in the previous comment was the idea of metered TV access. In that case, the marginal cost is zero–it costs as much to watch 1 hour of MTV as 100.

  • http://www.binarybits.org/ Tim

    If we’re talking about the a la carte issue, in some cases programming is a marginal cost to the cable company, but only because the studio that produces the program charges on a per capita basis. Programming isn’t a marginal cost from the perspective of the studio–it costs as much to distribute its programming to a thousand customers or a million.

    From the perspective of economic efficiency, what matters is the marginal cost to the economy as a whole, and that’s clearly 0.

    What I was talking about in the previous comment was the idea of metered TV access. In that case, the marginal cost is zero–it costs as much to watch 1 hour of MTV as 100.

  • Lewis

    While I’m generally of the opinion that a al carte pricing is a pipe dream, I can’t ignore the fact that cable companies are already doing it, albeit at a coarser grain. It’s called tiered pricing and it seems to drill holes in your argument. Why can I not simply buy the premium package without having to buy the lousy “basic cable” first? The answer is, of course, “because they can get away with it” but at the same time it suggests that a la carte is not entirely a bad idea from an economic standpoint.

    There appears to be a middle ground (somewhere between pure a la carte and the bundled system we have now) that no one is exploring.

  • Lewis

    While I’m generally of the opinion that a al carte pricing is a pipe dream, I can’t ignore the fact that cable companies are already doing it, albeit at a coarser grain. It’s called tiered pricing and it seems to drill holes in your argument. Why can I not simply buy the premium package without having to buy the lousy “basic cable” first? The answer is, of course, “because they can get away with it” but at the same time it suggests that a la carte is not entirely a bad idea from an economic standpoint.

    There appears to be a middle ground (somewhere between pure a la carte and the bundled system we have now) that no one is exploring.

  • enigma_foundry

    “So we’re left with the conclusion that R will go down significantly while C will stay the same or go up slightly. That’s a fairy tale. Cable companies do not have a giant pot of money at corporate headquarters with which to make up the losses imposed on them by a la carte cable. If forced to adopt a la carte, what they’ll do is simple: they’ll set the per-channel rates to generate the about same revenue as their previous pricing model. Instead of paying $60/month for 60 channels, you’ll pay, say, $10/month for each of your favorite 6 channels. The average consumer’s bill won’t change very much. The only difference is that he’ll be getting a lot fewer channels for his money.”

    Except there is one issue that is being forgotten–Cable is exists in a non-competitive environment–I can’t go to company B or C, I have to take what Cable Co A offers, or take no Cable.

    But the issue will resolve itself–people can now get programming over the internet that is much more finegrained than channels–individual programs for sale.

    If there is a market demand for a more fine grained price structure, with less bundling (and there certainly is the demand) consumers will get what they want. Cable Companies of course will resist, because now they are extracting monopoly profits, but the competitive pressures form other media will force them to be competitive.

    The basic fallacy of Tim Lee’s argument is that it only looks at the side of the producers (an error common among planners in command driven economies, but I am surprised to see it here) and not those of the consumer. The consumer wants to pay as little as possible, and if an individual program is for sale on the internet for $2.00 and that is what the consumer wants to buy, it the producer (the cable company) that has to adapt to the market place.

  • enigma_foundry

    “So we’re left with the conclusion that R will go down significantly while C will stay the same or go up slightly. That’s a fairy tale. Cable companies do not have a giant pot of money at corporate headquarters with which to make up the losses imposed on them by a la carte cable. If forced to adopt a la carte, what they’ll do is simple: they’ll set the per-channel rates to generate the about same revenue as their previous pricing model. Instead of paying $60/month for 60 channels, you’ll pay, say, $10/month for each of your favorite 6 channels. The average consumer’s bill won’t change very much. The only difference is that he’ll be getting a lot fewer channels for his money.”

    Except there is one issue that is being forgotten–Cable is exists in a non-competitive environment–I can’t go to company B or C, I have to take what Cable Co A offers, or take no Cable.

    But the issue will resolve itself–people can now get programming over the internet that is much more finegrained than channels–individual programs for sale.

    If there is a market demand for a more fine grained price structure, with less bundling (and there certainly is the demand) consumers will get what they want. Cable Companies of course will resist, because now they are extracting monopoly profits, but the competitive pressures form other media will force them to be competitive.

    The basic fallacy of Tim Lee’s argument is that it only looks at the side of the producers (an error common among planners in command driven economies, but I am surprised to see it here) and not those of the consumer. The consumer wants to pay as little as possible, and if an individual program is for sale on the internet for $2.00 and that is what the consumer wants to buy, it the producer (the cable company) that has to adapt to the market place.

  • http://www.binarybits.org/ Tim

    The rationale for tiering is somewhat different from the rationale for a la carte. The goal of tiering is to segment the market in order to increase revenues. There’s typically a “basic” package that’s cheap and one or more levels of “premium” content that includes the lower levels within them.

    This generates more revenue for the cable company because it can charge wealthier customers a higher price without scaring off poorer customers.

    In contrast, a la carte cable isn’t a market segmentation scheme. Under a la carte, the family that buys Fox News and ABC Family pays the same rate as the single guy that that buys MTV and VH1 (or whatever). So it doesn’t generate any extra revenue for the cable company.

    The argument for a la carte is always, at least implicitly, that it will lower consumers cable bills. My point is that it won’t, and I think that, if anything, the example of cable tiers reinforces that.

    enigma_factory: there might be only one cable company, but virtually every customer has satellite TV as an alternative. And the Baby Bells are frantically laying fiber to get into the video marketplace. And I think it would be great if competition from Internet video forced the cable industry to lower its rates. I just don’t want the government to do it.

  • http://www.binarybits.org/ Tim

    The rationale for tiering is somewhat different from the rationale for a la carte. The goal of tiering is to segment the market in order to increase revenues. There’s typically a “basic” package that’s cheap and one or more levels of “premium” content that includes the lower levels within them.

    This generates more revenue for the cable company because it can charge wealthier customers a higher price without scaring off poorer customers.

    In contrast, a la carte cable isn’t a market segmentation scheme. Under a la carte, the family that buys Fox News and ABC Family pays the same rate as the single guy that that buys MTV and VH1 (or whatever). So it doesn’t generate any extra revenue for the cable company.

    The argument for a la carte is always, at least implicitly, that it will lower consumers cable bills. My point is that it won’t, and I think that, if anything, the example of cable tiers reinforces that.

    enigma_factory: there might be only one cable company, but virtually every customer has satellite TV as an alternative. And the Baby Bells are frantically laying fiber to get into the video marketplace. And I think it would be great if competition from Internet video forced the cable industry to lower its rates. I just don’t want the government to do it.

  • Walter E. Wallis

    Once fiber optics replaces co-ax, the franchise no longer needs to be exclusive. Customers then could pay a basic physical plant maintenance fee, then choose between suppliers for TV, internet and elevator music plus remote reading of utility meters, monitoring of smoke detectors, and uses unimaginable today.

  • Walter E. Wallis

    Once fiber optics replaces co-ax, the franchise no longer needs to be exclusive. Customers then could pay a basic physical plant maintenance fee, then choose between suppliers for TV, internet and elevator music plus remote reading of utility meters, monitoring of smoke detectors, and uses unimaginable today.

  • http://www.binarybits.org/ Tim

    Walter: That’s true, and I bet the “facility plant” fee will rise to be almost as high as a basic cable package costs today.

  • http://www.binarybits.org/ Tim

    Walter: That’s true, and I bet the “facility plant” fee will rise to be almost as high as a basic cable package costs today.

  • enigma_foundry

    My point was that generally there really is no or very little real competition in cable TV right now. As competition starts, the pressure on the bundling of many channels together will increase, and a la carte will be forced on the cable companies whether they like it or not.

    Either by regulation of a monopoly or by competive pressures in the marketplace, a la carte will become a reality

  • enigma_foundry

    My point was that generally there really is no or very little real competition in cable TV right now. As competition starts, the pressure on the bundling of many channels together will increase, and a la carte will be forced on the cable companies whether they like it or not.

    Either by regulation of a monopoly or by competive pressures in the marketplace, a la carte will become a reality

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  • Concerned Consumer

    You need to examine the argument from a macro level. Certain networks that continue to provide worthless programming and little to no value are added to the “basic” packages of a cable subscription. Why should ESPN subsidize the Oxygen network. Why does the one network deserve wide distribution over others? The thought of 10 channels costing as much as the package of 80 or 100 channels is an illogical argument, if only the Cable distributors were regulated. Do you honestly believe that Direct TV pays ESPN any more if that was offered via ala carte vs. package? Of course not. It’s the same cost. Like the power companies of the first part of this century, those that both generated and distributed electricity they had to be regulated because of a conflict of interest. Similarly, cable providers need similar guidance such that entertainment monopolies do not continue to force the distributors to create a structure in which Networks A,B and C subsidize Network X and Y. These networks should be forced to exist on their own merit of programming, and not the collusion of others. If ESPN in a free market could fetch a $2.00 per household fee because of demand, so be it. But to allow a distributor to extort its subscriber base of a higher margin just because it’s sold ala carte requires government intervention. The cable distributor needs to look down the road, for once the consumer can gain access to a product directly, and the provider can still yield the same profit or even more, the distributor becomes a non factor in the equation and thus disappears. It’s happening today in different product markets today.

  • Concerned Consumer

    You need to examine the argument from a macro level. Certain networks that continue to provide worthless programming and little to no value are added to the “basic” packages of a cable subscription. Why should ESPN subsidize the Oxygen network. Why does the one network deserve wide distribution over others? The thought of 10 channels costing as much as the package of 80 or 100 channels is an illogical argument, if only the Cable distributors were regulated. Do you honestly believe that Direct TV pays ESPN any more if that was offered via ala carte vs. package? Of course not. It’s the same cost. Like the power companies of the first part of this century, those that both generated and distributed electricity they had to be regulated because of a conflict of interest. Similarly, cable providers need similar guidance such that entertainment monopolies do not continue to force the distributors to create a structure in which Networks A,B and C subsidize Network X and Y. These networks should be forced to exist on their own merit of programming, and not the collusion of others. If ESPN in a free market could fetch a $2.00 per household fee because of demand, so be it. But to allow a distributor to extort its subscriber base of a higher margin just because it’s sold ala carte requires government intervention. The cable distributor needs to look down the road, for once the consumer can gain access to a product directly, and the provider can still yield the same profit or even more, the distributor becomes a non factor in the equation and thus disappears. It’s happening today in different product markets today.

  • Ed

    Somewhat lacking in this discussion is a recognition that, independent of the cost economics of an a la carte option, subscribers have a right to exercise a boycott of networks they find outright offensive by not having even the tiniest slice of their monthly payment go to such networks. Many of us have no desire to support the materialist, instrumental, and Marxist ideology of CNN.

  • Ed

    Somewhat lacking in this discussion is a recognition that, independent of the cost economics of an a la carte option, subscribers have a right to exercise a boycott of networks they find outright offensive by not having even the tiniest slice of their monthly payment go to such networks. Many of us have no desire to support the materialist, instrumental, and Marxist ideology of CNN.

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