James’s post in defense of a la carte makes me think that a big part of what’s going on in this debate is ambiguity and confusion regarding what exactly counts as “a la carte.” As my recent article suggests, most a la carte activists seem to imagine that, if the standard cable tier gives you 50 channels for $50/month, then you should be able to buy 10 channels for $10/month, or one channel for $1/month.

That is, of course, absurd. It would be great for consumers if it were possible, but the problem is that the cable companies would go bankrupt. It costs a lot more than $1 to deliver that one channel to the customer’s home. That’s why, if forced to adopt a “pure” a la carte model, channels would have to set the per-channel cost much higher than $1–probably more like $5-10 per channel. It should be obvious that consumers wouldn’t benefit from that.

But if we relax our definition of “a la carte,” it’s possible to imagine a model that could work. Consider a world in which every subscriber pays a $40 access fee, and then chooses channels “a la carte” for 25 cents apiece. This is, technically speaking, an a la carte system, and it would probably work just fine: at 25 cents apiece, most consumers would probably take 30 or 40 channels, roughly approximating the status quo. This could plausibly be called an “a la carte system,” and it might work just fine.

Now consider a third system, with one minor change: the cable company decides to throw C-SPAN into the basic package for free, and tacks on 6 cents to cover the subscriber fee. (If I remember correctly, this is what C-SPAN charges per subscriber) My question is: has this ceased to be an a la carte system? After all, consumers are now being “forced” to buy C-SPAN in order to get other cable channels. But it’s hard to imagine cable customer being outraged at a 6-cent hike in their bills.

What’s going on is that your monthly cable bill is actually paying for two things: the programming and the infrastrcture necessary to deliver the programming. What people don’t seem to understand is that the infrastructure is by far the largest fraction of the bill. According to this article, the average cable bill is $45 for 64 channels. Of that, $45, only $14 goes to cable networks for the cost of content. The remainder, $31, goes to cover the cable company’s own costs.

To bring this back to James’s article, I suspect the systems the Baby Bells are rolling out will be “a la carte” only in the third sense described above. There will doubtless be a basic access fee that will apply to everyone who gets the service. There’s also likely to be some content, such as C-SPAN and PBS, included for free with the basic IPTV service.

But the fact is, the current cable industry is already a la carte in this sense. There’s some content available with the basic package, and then there is other content–“premium” channels, pay-per-view content, on demand movies–that is offered “a la carte.” The only difference is a matter of degree: the Baby Bells might be putting less content in the “basic” bundle, while the cable companies are putting more.

If that’s how we’re defining the terms, it’s not clear what’s being argued about. Of course a la carte, defined in this loose sense, “works.” No sane person would claim otherwise. The debate is whether “pure” a la carte, in which there is no “basic” bundle, can “work.” I think the answer to that is clearly no, and I’ll be shocked if the Baby Bells ever offer such a pricing structure.

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The idea of a la carte pricing for cable television has taken a beating since Kevin Martin suggested it in a congressional forum a few weeks ago. (For some good pieces by my TLF colleagues, look here, here, and here. It’s clear that a la carte pricing is no free lunch for consumers (no pun), and that there have long been good business reasons for maintaining a system of packaging channels. But nothing ever stays the same in fast-changing tech markets, and that may apply to cable pricing as well. In a just-released Heritage Foundation paper, I argue that while regulation to force a la carte would be unwise, there’s a good possibility that the markeplace–without regulation–may soon provide it. Specifically, new competition by former phone companies Verizon and AT&T could upset the cable pricing applecart, and perhaps lead to a la carte pricing–or something close to it. As explained in the paper:

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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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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.

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In an interview with The Wall Street Journal today (p. A4), FCC Chairman Kevin Martin said he might consider “a la carte” mandates on cable and satellite operators as a possible way to clean up content on pay TV. He told the Journal, “I saw a quote recently where one person said ‘I can call up and order HBO, I don’t understand why I can’t call up and cancel any of my cable… programming.’ I think that there could be additional control over that.”

Well, before the Chairman rushes to impose a sweeping new regulatory regime on cable based on what he heard one guy say in the papers, I would hope he would consider what more rigorous research has revealed regarding the potential pitfalls of a la carte mandates. He might start by re-reading the report his own agency issued on the subject just 8 months ago. He should also take a second look at an important report issued by the General Accountability Office in October 2004.

These government reports, like the vast majority of serious academic reports penned on this topic, came to the conclusion that a la carte regulation would be devastating for the industry and consumers alike. (I should point out that I filed comments in the FCC proceeding as did my colleagues Randy May and Tom Lenard.)

Here’s why a la carte mandates, while sounding so good on the surface, would really be a disaster for consumers in the end:

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