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.

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