Friday, October 16, 2009

Are cable companies stealing from over-the-air channels? Are antenna companies?

You may have seen the ad campaign by over-the-air TV channels arguing that local TV’s future is in jeopardy. The CRTC has responded to the over-the-air channels’ cries of hard times with a 50% increase in the fee (the “Local Program Improvement Fund (LPIF)”) that cable companies pay to the CRTC, to be transferred to local channels.

But the LPIF increase is really only the opening salvo into the broader debate over carriage fees, with CRTC hearings now set for December. Of course, local stations want carriage fees. Together with the LPIF they amount to a small scale “TV station bailout.” Over-the-air stations argue that the fact that cable companies rebroadcast their signals without a charge is fundamentally unfair; their argument is that cable companies are getting content for nothing in return. In truth, over-the-air stations benefit from the rebroadcast of their signals. They make money based on ad revenues, which in turn is based on viewership. Rebroadcasting by cable companies increases viewership, and therefore increases the value of the product (ad time) that they sell. A company that sells antennas also makes money delivering over-the-air stations’ content, without paying the stations anything. Do the stations think they deserve carriage fees from antenna companies, too?

Rogers’ response has been to change their pricing scheme to explicitly pass along the entire LPIF fee (both the increase and the fee from before) to consumers, and start their own ad campaign. But if they make more profit charging the extra fee now, why didn’t they pass on the LPIF before the increase? In fact, those costs were probably included in the old price, to the extent that doing so was optimal for Rogers. Effectively they are increasing prices by three times the cost increase, by adding both the new and old LPIF fees to the final bill. Many have argued that a likely explanation for this substantial price increase is to agitate consumers in advance of the fight over carriage fees. After all, is a price increase of three times the cost increase plausible, just on profit maximization grounds, and not thinking about politics?

One way to get a handle on the issue is by using basic microeconomics. To know how much a firm will increase prices in response to a cost change, we need to know how sensitive its customers are to price increases. Mayo and Otsuka, in their 1991 RAND Journal article, report a price elasticity (measuring the price sensitivity of customers) of 1.5 for basic cable in urban areas. Transferring that number to Rogers, that means that a one percent increase in price costs Rogers 1.5 percent of its customers. Textbook microeconomics tells us that the optimal mark-up in response to an increase in cost, if the elasticity is 1.5, is exactly a factor of three times the cost increase. From that perspective, maybe Rogers’ response is simple profit maximization, and not some long term political goals.

However, a lot has changed since 1991, and now cable companies face many new forms of competition from alternative TV providers, especially satellite providers. Better alternatives mean customers are probably more sensitive to Rogers’ prices, so a one percent increase in price is likely to cause a greater reduction in Rogers’ customer base than the 1.5 percent in the Mayo and Otsuka study. If demand is more sensitive to changes in price, the optimal pricing response to an increase in marginal cost is reduced. It therefore seems unlikely that the Rogers price increase is driven purely by textbook microeconomic motives, and more likely that something else is involved.

Thinking about the stations’ side, the simple economics of these local stations is that they purchase programming on the speculation of future ad revenue. Downturns in the ad market naturally lead to shortfalls for local broadcasters. (It also lowers the value of airtime, making on-air pleas for support less expensive.) If this downturn is making them ask for more from the regulators, the natural question to ask is, are they planning a rebate to the cable companies in good times? After all, if broadcast over-the-air is a viable business model, then in good times their ad revenues will once again exceed the cost of their programming. If fairness is the key issue, as CTV has said, do cable companies deserve a cut of the ad revenue in exchange for the visibility that the cable companies offer?

In the end this isn’t about fairness. Over-the-air stations want carriage fees because they think it will improve their bottom line. Cable companies don’t want to pay them because they know, like any microeconomics course will tell you, that even a firm with market power can’t pass all cost increases on to consumers indefinitely, as they appear to suddenly be doing with the LPIF. But both sides had better be careful of the possible negative impact. If over-the-air carriage fees become burdensome, cable companies might push to offer their customers packages without those stations. New HDTV antennas are both inexpensive and very effective, and channels like CTV broadcast a high definition signal to everyone for free over-the-air (unless the stations take up my idea of charging carriage fees there, too!).

The big picture is that technological change is empowering consumers. With the growth in streaming video over the internet, over-the-air channels and cable companies need to be careful not to price themselves right out of the future of TV.

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