How did the 500-channel TV universe become a reality?

by on November 13, 2007 · 12 comments

I’ve written plenty here before about the potential pitfalls associated with a la carte regulation of cable and satellite television. What troubles me most about a la carte regulatory proposals is that proponents make grandiose claims about how it would offer consumers greater “choice” and lower prices without thinking about the long-term consequences of regulation. As I pointed out in a recent editorial in the Los Angeles Daily Journal, the problem with these regulatory activists is that “Their static view of things takes the 500-channel universe for granted; they assume it will always be with us and that it’s just a question of dividing up the pie in different (and cheaper) ways.” But as I go on to explain, a la carte regulation could bring all that to an end:

To understand why [it will harm consumers], we need to consider how it is that we have gained access to a 500-channel universe of diverse viewing options on cable and satellite. All of these channels didn’t just fall like manna from heaven. Companies and investors took risks developing unique networks to suit diverse interests. Thirty years ago, few could have imagined a world of 24-hour channels devoted to cooking, home renovation, travel, weather, religion, women’s issues, and golf. Yet, today we have The Food Channel, Home & Garden TV, The Travel Channel, The Weather Channel, EWTN, Oxygen, The Golf Channel, and countless other niche networks devoted to almost every conceivable human interest. How did this happen?

The answer is “bundling.” Many niche-oriented cable networks only exist because they are bundled with stronger networks. On their own, the smaller channels can’t survive; nor would anyone have risked launching them in the first place. “Bundling” is a means for firms to cover the enormous fixed costs associated with developing TV programming while also satisfying the wide diversity of audience tastes. Bundling channels together allows the niche, specialty networks to remain viable alongside popular networks such as CNN, ESPN and TBS. Bundles, therefore, are not anticonsumer but proconsumer.


I also point out why it’s likely a myth that prices for programming will fall much for consumers in the long-run:

it’s unlikely that prices will actually fall for the most popular channels that do survive. Channel bundling not only promotes programming diversity, it also keeps the cost of the most popular channels in check by spreading out costs across a bigger group of subscribers.

For example, The Disney Channel, Discovery Channel, ESPN and TBS are received in virtually every cable or satellite subscriber’s home today. Because they are on almost every basic cable system, the higher cost of those networks is spread across all subscribers. If such channels lose subscribers in an a la carte environment, the cost per network will increase until, eventually, consumers are stuck paying about the same amount they do today, yet with far fewer channels to show for their money.

Anyway, you can read the entire editorial here.

  • eric

    It appears to me that a large number of customers want more choices than cable companies are currently offering them. Let me suggest an alternative.

    In the music field, eMusic offers a bundle of up to 30 downloads per month at a set price. (I think they also have another bundle for 50 downloads for the real music junkie.) However, the customer gets to choose those songs out of a wide selection.

    Why can’t we have cable TV bundling and choice at the same time? Say, for a set price the customer gets a bundle of up to 40 channels per month, choosen out of a menu of 200 channels? One reason people want a la carte cable is to specifically exclude certain channels they don’t want coming into their homes, in addition to selecting a few channels that might only be offered in a different bundle. This scheme could accomodate that desire.

    Perhaps a “bundling with choice” option would please almost everyone. Or not. But in music, people who don’t like the eMusic bundling model can still buy songs a la carte at a higher cost per song from iTunes. Need I point out that in music, the iTunes a la carte model (more expensive, as you suggest) is more popular than the eMusic bundling model? People pay more for smaller portions! To you that might seem irrational, but the customer wants what he wants. Why should he be denied a similar option in purchasing TV entertainment?

  • eric

    It appears to me that a large number of customers want more choices than cable companies are currently offering them. Let me suggest an alternative.

    In the music field, eMusic offers a bundle of up to 30 downloads per month at a set price. (I think they also have another bundle for 50 downloads for the real music junkie.) However, the customer gets to choose those songs out of a wide selection.

    Why can’t we have cable TV bundling and choice at the same time? Say, for a set price the customer gets a bundle of up to 40 channels per month, choosen out of a menu of 200 channels? One reason people want a la carte cable is to specifically exclude certain channels they don’t want coming into their homes, in addition to selecting a few channels that might only be offered in a different bundle. This scheme could accomodate that desire.

    Perhaps a “bundling with choice” option would please almost everyone. Or not. But in music, people who don’t like the eMusic bundling model can still buy songs a la carte at a higher cost per song from iTunes. Need I point out that in music, the iTunes a la carte model (more expensive, as you suggest) is more popular than the eMusic bundling model? People pay more for smaller portions! To you that might seem irrational, but the customer wants what he wants. Why should he be denied a similar option in purchasing TV entertainment?

  • http://www.ikeelliott.typepad.com Ike Elliott

    I agree with Adam’s post, and am skeptical that cable regulation will achieve the lofty goals of which FCC Chairman Martin speaks. I also question whether the FCC has a legislative mandate to pursue its regulatory agenda in the cable industry, based upon its loose interpretation of the 70/70 rule in the 1984 Cable Act. I find it ironic that the FCC is looking to include fiber-optic telco subscribers in its count of cable subscribers in order to reach the 70% threshold it needs in order to regulate cable. Using evidence of competition to regulate seems like a big stretch to me. More on my blog at http://ikeelliott.typepad.com/telecosm/2007/11/

  • http://www.ikeelliott.typepad.com Ike Elliott

    I agree with Adam’s post, and am skeptical that cable regulation will achieve the lofty goals of which FCC Chairman Martin speaks. I also question whether the FCC has a legislative mandate to pursue its regulatory agenda in the cable industry, based upon its loose interpretation of the 70/70 rule in the 1984 Cable Act. I find it ironic that the FCC is looking to include fiber-optic telco subscribers in its count of cable subscribers in order to reach the 70% threshold it needs in order to regulate cable. Using evidence of competition to regulate seems like a big stretch to me. More on my blog at http://ikeelliott.typepad.com/telecosm/2007/11/fcc-regulatory-.html

  • http://www2.blogger.com/profile/14380731108416527657 Steve R.

    Eh???? Is a little bit collectivism emerging???
    It seems that we have switched “sides” in this case.

    While I have no trouble with government running cable, providing a signal, and even operating at a loss for the common good; I don’t think that it is economically justifiable for a corporation to include a product that can not support itself in a bundle. Furthermore, a customer should not be forced to subsidize an unwanted service as a compromise just to get service for the programs the customer does want.

    Promoting bundling is advocating (based on the “common good”) the use of a subsidy program and a fixed selection for the consumer. Doesn’t seem much like the free market concept of “free to choose”.

  • http://www2.blogger.com/profile/14380731108416527657 Steve R.

    Eh???? Is a little bit collectivism emerging???
    It seems that we have switched “sides” in this case.

    While I have no trouble with government running cable, providing a signal, and even operating at a loss for the common good; I don’t think that it is economically justifiable for a corporation to include a product that can not support itself in a bundle. Furthermore, a customer should not be forced to subsidize an unwanted service as a compromise just to get service for the programs the customer does want.

    Promoting bundling is advocating (based on the “common good”) the use of a subsidy program and a fixed selection for the consumer. Doesn’t seem much like the free market concept of “free to choose”.

  • Mark Seecof

    (Please see reference to academic paper on bundling below.)

    In this and many other TLF posts on bundling, one or two false ideas keep getting repeated:

    Wrong Notion #1: bundling is always good for the consumer; whenever you see bundling that means a supplier is acting to obtain a scale economy and he will pass the benefits of it on to consumers thanks to competition.

    Wrong Notion #2: maximizing (monopolist/ oligopolist) supplier profits is the same as maximizing overall welfare. To purveyors of this notion it doesn’t matter if all surplus accrues to the supplier as profits or some remains in the hands of consumers.

    Let me refute Wrong Notion #2 first: For one thing, when price discrimination is imperfect, supplier profits may be maximized at prices which leave some consumer demand unfilled even though willingness-to-pay exceeds marginal cost of provision. By definition, overall welfare isn’t maximized in that situation. But notion #2 is wrong even assuming perfect price discrimination. If consumers retain more surplus they can buy other things from other suppliers. Not only will consumers be better off (get more for their money), but the economy as a whole will benefit because it will be broader and there will be more opportunities for innovation and growth. If certain suppliers manage to extract the maximum possible surplus from their consumers (i.e., all that perfect price discrimination can obtain) the economy will be narrower because those few producers will act as a bottleneck on demand. They will redirect all that extra surplus to fewer, often positional, goods like golf-course memberships for top executives. So even with perfect price discrimination, maximizing supplier profits is not the same as maximizing overall welfare.

    Anyway, back to Wrong Notion #1…

    Under imperfect competition (which certainly describes the American pay-TV industry, where most cable companies have local geographic monopolies, there are only two satellite-TV providers, and various circumstances make satellite service impossible or extra costly for many households), as “informal” economists have known for years and Oxford University economist John Thanassoulis explains in this recent (2006) paper, bundling is used to extract extra surplus from consumers. (Under other conditions, bundling can benefit consumers– then they generally don’t complain about it!)

    From the summary in that paper (Section 5):

    *Polar case 1: Firm Specific Preferences

    ** Utility economies of scope imply one-stop shopping [Section 3]

    ** Hybrid purchases and no economies of scope
    [Section 4]

    ** Mixed bundling causes:

    *** Profits UP

    *** Consumer Surplus DOWN

    *** Prices to small buyers UP

    *** Prices to large buyers DOWN

    Which is, of course, exactly what we see in American pay-TV pricing. Large buyers (mainly hotels and so-forth who have bargaining power, but also small consumers who just demand a lot of TV) buy the biggest bundles at low per-component prices. Smaller buyers are forced to buy bigger bundles than they would prefer and pay more for them than they would in a competitive marketplace.

    Even though consumers keep buying bundles (e.g., first-tier cable packages) smaller than the maximum (e.g., the Super Gold tier with four channels each of HBO and Starz! included) they may still be getting shafted. Their behaviour just proves that consumer demand for the low-end bundle isn’t quite elastic enough that most consumers will give up pay-TV entirely. You can assume cable suppliers are profit-maximizers, but as I explained just above, maximum supplier profit does not imply maximum overall welfare.

    Consumers realize (in the statistical sense) all of this, though most can’t explain it very well. That’s why the people who buy the “all included” bundles don’t complain, and the people who just want to watch their six or seven favorite channels do complain, because their local-monopolist cable suppliers (or semi-competitive satellite-TV providers) force them to buy the first-tier 40-channel bundle to get the few channels they want– which means they consume a less desirable entertainment package overall as they pay more for TV and less for other diversions than they would in a competitive marketplace. If there were more competition between suppliers, then there would be less bundling, and consumers would be better off. (So would, e.g., comedy clubs where people might go once in a while if they didn’t have to pay for the nature channels they never watch in order to get the sports channels they do or vice-versa.)

    Small-bundle buyers outnumber large-bundle buyers so politically the struggle is between small-bundle buyers and the suppliers who shaft them. That contest plays out in rent-seeking by both sides because there’s insufficient competition between pay-TV suppliers for consumers to influence them by altering their purchasing patterns (“switching”). So consumers ask for pro-competitive or price-controlling regulation and providers ask for anti-competitive regulation (like denying “franchises” to new market entrants like telcos). Sometimes providers cite low churn as proof of consumer satisfaction, but it really only indicates that under oligopoly conditions all providers are equally crooked, so consumers have to be especially angry or optimistic to switch providers. Politicians love rent-seeking contests, because they demand their rents from both sides– which is why the regulatory regime is always inefficient and unstable.

    (Mind you, I’m not saying that government price controls, likely influenced more by providers than consumers, represent a “solution” to the bundling problem. They would make things worse. But I’d respect TLF more if you guys at least acknowledged that the problem does exist! Then we could talk about real “solutions” like franchise deregulation and restricting horizontal mergers.)

    Minor side issues: both cable and satellite providers bundle to limit competition. Say he first- through- thirtieth cable channels cost $50/month. Suppose you would like to watch another channel that isn’t in that bundle. You can pay $20/month more to move up a tier, or $50/month more to get a basic subscription to satellite (we’ll ignore the $200 worth of equipment you need, and the question of whether your home has a clear view in the right direction). Whatcha gonna do?[1]

    Bundling restricts consumer shopping (sometimes called search) and reduces price competition. This is good for suppliers and bad for consumers. This is why suppliers (a) put more money into lobbying (regulatory rent-seeking) than advertising, and (b) avoid selling a-la-carte even as a competitive tactic. Providers share an interest in preserving the constrained (oligopolistic) market structure even as they engage in a little desultory competition.

    Another minor issue: I am quite familiar with the ways bundling can benefit consumers. No one needs to reiterate any little models of Jack and Annie and Frankie who have different elasticities of demand for products P and Q with associated fixed and marginal costs of production such that if you sell P and Q separately Jack gets P and Annie gets Q and Frank gets nothing, but if you bundle P and Q, Jack and Annie and Frankie all end up with both. I know all that. The problem is, that sort of scenario assumes P and Q are supplied competitively. When there is open competition, suppliers only create bundles to attract consumers– which only works if the bundling benefits them. When supplier competition is constrained, suppliers create bundles to extract more consumer surplus, through price discrimination, or if you prefer, by forcing consumers to the extremes of their demand curves.

    .

    [1] Suppose that extra channel you want (along with the other nineteen channels in its tier, one or two of which may interest you mildly) is only worth $2/month to you. You will forego it rather than subscribe to the higher tier. But if marginal cost of providing that channel is, say, $0.50/month, then the cable provider’s bundling scheme will cost him $1.50/month and presumably decrease your welfare as well (it depends on how good a substitute you can find for $2/month). If you were to take the bundle (assuming each channel in it costs the same) the provider would make $10/month. The provider bundles because he thinks that for every five skinflints like you there is at least one vidiot who’ll buy the bundle, so the vendor will give up $9 worth of a-la-carte sales every month but gain $10 worth of bundled sales. (In real life profit-maximizing bundle pricing is a bit more complex and may only freeze out a few customers to gain a supracompetitive profit from the rest.) Real competition drives out this approach, but it is always found where consumer choice of providers is tightly constrained.

  • Mark Seecof

    (Please see reference to academic paper on bundling below.)

    In this and many other TLF posts on bundling, one or two false ideas keep getting repeated:

    Wrong Notion #1: bundling is always good for the consumer; whenever you see bundling that means a supplier is acting to obtain a scale economy and he will pass the benefits of it on to consumers thanks to competition.

    Wrong Notion #2: maximizing (monopolist/ oligopolist) supplier profits is the same as maximizing overall welfare. To purveyors of this notion it doesn’t matter if all surplus accrues to the supplier as profits or some remains in the hands of consumers.

    Let me refute Wrong Notion #2 first: For one thing, when price discrimination is imperfect, supplier profits may be maximized at prices which leave some consumer demand unfilled even though willingness-to-pay exceeds marginal cost of provision. By definition, overall welfare isn’t maximized in that situation. But notion #2 is wrong even assuming perfect price discrimination. If consumers retain more surplus they can buy other things from other suppliers. Not only will consumers be better off (get more for their money), but the economy as a whole will benefit because it will be broader and there will be more opportunities for innovation and growth. If certain suppliers manage to extract the maximum possible surplus from their consumers (i.e., all that perfect price discrimination can obtain) the economy will be narrower because those few producers will act as a bottleneck on demand. They will redirect all that extra surplus to fewer, often positional, goods like golf-course memberships for top executives. So even with perfect price discrimination, maximizing supplier profits is not the same as maximizing overall welfare.

    Anyway, back to Wrong Notion #1…

    Under imperfect competition (which certainly describes the American pay-TV industry, where most cable companies have local geographic monopolies, there are only two satellite-TV providers, and various circumstances make satellite service impossible or extra costly for many households), as “informal” economists have known for years and Oxford University economist John Thanassoulis explains in this recent (2006) paper, bundling is used to extract extra surplus from consumers. (Under other conditions, bundling can benefit consumers– then they generally don’t complain about it!)

    From the summary in that paper (Section 5):

    *Polar case 1: Firm Specific Preferences

    ** Utility economies of scope imply one-stop shopping [Section 3]

    ** Hybrid purchases and no economies of scope
    [Section 4]

    ** Mixed bundling causes:

    *** Profits UP

    *** Consumer Surplus DOWN

    *** Prices to small buyers UP

    *** Prices to large buyers DOWN

    Which is, of course, exactly what we see in American pay-TV pricing. Large buyers (mainly hotels and so-forth who have bargaining power, but also small consumers who just demand a lot of TV) buy the biggest bundles at low per-component prices. Smaller buyers are forced to buy bigger bundles than they would prefer and pay more for them than they would in a competitive marketplace.

    Even though consumers keep buying bundles (e.g., first-tier cable packages) smaller than the maximum (e.g., the Super Gold tier with four channels each of HBO and Starz! included) they may still be getting shafted. Their behaviour just proves that consumer demand for the low-end bundle isn’t quite elastic enough that most consumers will give up pay-TV entirely. You can assume cable suppliers are profit-maximizers, but as I explained just above, maximum supplier profit does not imply maximum overall welfare.

    Consumers realize (in the statistical sense) all of this, though most can’t explain it very well. That’s why the people who buy the “all included” bundles don’t complain, and the people who just want to watch their six or seven favorite channels do complain, because their local-monopolist cable suppliers (or semi-competitive satellite-TV providers) force them to buy the first-tier 40-channel bundle to get the few channels they want– which means they consume a less desirable entertainment package overall as they pay more for TV and less for other diversions than they would in a competitive marketplace. If there were more competition between suppliers, then there would be less bundling, and consumers would be better off. (So would, e.g., comedy clubs where people might go once in a while if they didn’t have to pay for the nature channels they never watch in order to get the sports channels they do or vice-versa.)

    Small-bundle buyers outnumber large-bundle buyers so politically the struggle is between small-bundle buyers and the suppliers who shaft them. That contest plays out in rent-seeking by both sides because there’s insufficient competition between pay-TV suppliers for consumers to influence them by altering their purchasing patterns (“switching”). So consumers ask for pro-competitive or price-controlling regulation and providers ask for anti-competitive regulation (like denying “franchises” to new market entrants like telcos). Sometimes providers cite low churn as proof of consumer satisfaction, but it really only indicates that under oligopoly conditions all providers are equally crooked, so consumers have to be especially angry or optimistic to switch providers. Politicians love rent-seeking contests, because they demand their rents from both sides– which is why the regulatory regime is always inefficient and unstable.

    (Mind you, I’m not saying that government price controls, likely influenced more by providers than consumers, represent a “solution” to the bundling problem. They would make things worse. But I’d respect TLF more if you guys at least acknowledged that the problem does exist! Then we could talk about real “solutions” like franchise deregulation and restricting horizontal mergers.)

    Minor side issues: both cable and satellite providers bundle to limit competition. Say he first- through- thirtieth cable channels cost $50/month. Suppose you would like to watch another channel that isn’t in that bundle. You can pay $20/month more to move up a tier, or $50/month more to get a basic subscription to satellite (we’ll ignore the $200 worth of equipment you need, and the question of whether your home has a clear view in the right direction). Whatcha gonna do?[1]

    Bundling restricts consumer shopping (sometimes called search) and reduces price competition. This is good for suppliers and bad for consumers. This is why suppliers (a) put more money into lobbying (regulatory rent-seeking) than advertising, and (b) avoid selling a-la-carte even as a competitive tactic. Providers share an interest in preserving the constrained (oligopolistic) market structure even as they engage in a little desultory competition.

    Another minor issue: I am quite familiar with the ways bundling can benefit consumers. No one needs to reiterate any little models of Jack and Annie and Frankie who have different elasticities of demand for products P and Q with associated fixed and marginal costs of production such that if you sell P and Q separately Jack gets P and Annie gets Q and Frank gets nothing, but if you bundle P and Q, Jack and Annie and Frankie all end up with both. I know all that. The problem is, that sort of scenario assumes P and Q are supplied competitively. When there is open competition, suppliers only create bundles to attract consumers– which only works if the bundling benefits them. When supplier competition is constrained, suppliers create bundles to extract more consumer surplus, through price discrimination, or if you prefer, by forcing consumers to the extremes of their demand curves.

    .

    [1] Suppose that extra channel you want (along with the other nineteen channels in its tier, one or two of which may interest you mildly) is only worth $2/month to you. You will forego it rather than subscribe to the higher tier. But if marginal cost of providing that channel is, say, $0.50/month, then the cable provider’s bundling scheme will cost him $1.50/month and presumably decrease your welfare as well (it depends on how good a substitute you can find for $2/month). If you were to take the bundle (assuming each channel in it costs the same) the provider would make $10/month. The provider bundles because he thinks that for every five skinflints like you there is at least one vidiot who’ll buy the bundle, so the vendor will give up $9 worth of a-la-carte sales every month but gain $10 worth of bundled sales. (In real life profit-maximizing bundle pricing is a bit more complex and may only freeze out a few customers to gain a supracompetitive profit from the rest.) Real competition drives out this approach, but it is always found where consumer choice of providers is tightly constrained.

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