Convergences

Marginal Cost & the Content Industries

[The following was posted on the AEI's Enterprise Blog yesterday.]

Margin of Error: Against a Persistent and Pernicious Fallacy

By James DeLong

January 29, 2010, 5:24 pm

In a pair of recent posts (here and here), Matt Yglesias embraces one of the most pernicious and destructive fallacies of economic thought: the proposition that prices “should” equal marginal cost. As my colleague Solveig Singleton explained in “Is Cheaper Always Better? Misusing the Concept of Marginal Cost in Policy Discussions,” the idea that “efficiency” is reached by the P = MC equation is true only in an abstract world of unrealistic and static assumptions, but the persistence of the myth continues to cause great damage.

Does the concept of static efficiency or marginal cost have *any* appropriate uses? Rarely. . . .

Models of perfect competition and the concept of marginal cost have some power to explain some of the forces at work in real markets, but they are not a sound normative measure of what the real world ought to look like.

For more discussion, see “Marginalized,” and for a real coup de grace see the eminent economist William Baumol’s 2006 monograph for AEI, How Regulators Can Be Misled By Simplistic Theory, which warns:

Only this year I heard a conference presentation dealing with the economic and legal principles of copyright suggest that the innovating Schumpeterian entrepreneurs are automatically to be deemed proper subjects for antitrust attentions because in the period before imitators enter the market, they can charge prices that exceed the marginal-cost levels of perfect competition. Never mind that this is a prescription for undermining intertemporal efficiency. Never mind that marginal-cost pricing would generally preclude recoupment of the research and development (R&D) costs of the innovations at issue, costs that will have to be incurred many times again if innovation is to continue.

Baumol is too kind in limiting his indictment to “some economists” who are “not as careful as they should be,” because the fallacy and its consequences are woven into a great deal of professional analysis and policy recommendations, not to mention most of antitrust.

Six years ago, the Competitive Enterprise Institute (CEI) did an excellent workshop on Declining Marginal Cost Industries, featuring talks by giants Ronald Coase and Lester Telser. (Disclosure: I helped Fred Smith put it together.) The descriptive blurb notes:

The declining marginal cost problem remains the key challenge to a range of industries. As Ronald Coase long ago noted, a declining cost industry must find some way to finance itself: either via creative multipart pricing (facilitated by bundling or contracts) or via some form of government subsidy. The markets solution has traditionally relied on distinct marketing strategies in different geographic regions and to different segments of the markets, with market segmentation facilitated by the high costs to consumers of transport and/or the difficulty of acquiring information about the prices paid by others. The government subsidy approach inevitably entails government regulatory and /or price controls (there are no “free” subsidies). Clearly, we prefer the market solution.

The Big Blog Candy Mountain

Blogger Barry Ritholtz became the latest to suggest that maybe news really should not be free, and he endorsed a system of micropayments, introduced slowly so the blogger frogs do not object to the water getting hotter:

The problem facing journalism and newspapers is not one of technology—it is one of behavior. People are used to free, they don’t think they need to pay for content. A solution that ignores this simple fact is destined to fail, regardless of technology, software or widgets . . . This requires a behavioral change, from both the newspapers and its readers.

However, Reuters blogger Felix Salmon not only objects, he advocates kicking over the pot.

[READ THE REST AT THE ENTERPRISE BLOG]

NYT Gets Ready to Jump . . .

. . . into the paid business. The FT (paid subscription required) says the NYT is "preparing the ground" to charge $30/$60 year for access to its website.

The news biz must go this way. The big problem for many papers is their primary content comes from the wire services, and this is so widely available that no one will pay. The NYT generates enough unique product to make it work. But even for a brand like the NYT, it will not be easy to resist the pressure from the information-wants-to-be-free crowd.

I am happy to see this because perhaps it will give the paying customers more clout. After reading it for years, I gave up the NYT a decade ago for philosophical reasons -- every story I read in an area about which I knew something was slanted in an anti-free market, pro-statist direction. So I assumed that areas about which I am ignorant received the same treatment, and I decided to cease being systematically misled.

Indiscreet

In the remake of the classic movie Indiscreet,  Leslie-Anne Down accidentally appears in front of Robert Wagner with her face covered by a particularly bizarre mudpack. She says (from memory): “Can you just forget you ever saw me this way?”  To which he responds: “I seriously doubt it.”

So it is with the latest escapade of the Washington Post. The paper sent invitations to lobbyists to bring their CEOs to a private soiree at the home of Post publisher Katherine Weymouth, at which they would not only “interact with key Obama Administration and Congressional leaders” but “build crucial relationships with Washington Post news executives.” The cost: $25,000 for one; a cool quarter of a mil for a series.

One of the lobbyist recipients questioned the ethics and blew the whistle, whereupon everyone involved backed away, tossing the blame on a top marketing guy (who will soon be either unemployed or very well paid indeed). From media commentator Howard Kurtz:

Executive Editor Marcus Brauchli said he was "appalled" by the plan. "It suggests that access to Washington Post journalists was available for purchase," Brauchli said. The proposal "promises we would suspend our usual skeptical questioning because it appears to offer, in exchange for sponsorships, the good name of The Washington Post."

For WaPo phobes, this brings to mind the classic doggerel: 

You cannot hope to bribe or twist thank God! The British journalist.

But seeing what the man will do unbribed, there's no occasion to.

-- Humbert Wolfe

The bright side is that seldom has the Post afforded so much pure pleasure to conservatives.  I am among them, since it confirms my thesis that DC has turned so completely into a special interest state that it is tone deaf to its own corruption; how else could anyone in a newspaper think that this was within bounds?

And then there is something I once heard on sentencing day in federal court. The judge asked the defendant if he was sorry for his crime, and the answer was: “Oh yes, your honor; ever since I got caught I can’t sleep a wink.”

UPDATE: Editor & Publisher links to numerous reactions, including a funny video spoof.

Here is the flyier. Image from the Washington Examiner.

Newspapers

THE AMERICAN just posted my article "Preparing the Obituary: Netizens and the news business are locked in a mutually destructive death spiral. Can anything arrest the decline?"

The answer:  Not unless they figure out how to monetize their product. The news has become a giant commons. The producer cannot charge for it directly, nor can it capture enough associated advertising dollars to pay for the production. Like an overfished ocean, anyone can drop a line into the news and hook some advertising dollars.

XM Sirius and the Antitrust Goldfish Bowl

A friend is fond of quoting the factoid "a goldfish has a short-term memory of six seconds, so every trip around the bowl is a new experience."

Antitrust partisans suffer from the same condition. Earlier this week, Sirius XM avoided, or perhaps only postponed, bankruptcy. Yet up to only eight months ago, when the companies were finally allowed to merge, endless time and money was spend on hand-wringing over the potential monopoly power of such a merged entity. And conditions were imposed that seriously impact the survival capacity of the merged entity.

Even before this most recent round, when satellite radio was first set up the FCC, prodded by various paladins of "the public interest," insisted that there be two companies. Competition with entrenched existing radio, the Internet, and personal devices was not enough. It was essential that two satellite providers be pitted at each other in ruinous prices wars and talent payments that would ensure that neither achieved a sound financial footing. We call this "competition policy."

All of this has gone down the memory hole. As a big fan of satellite radio, I want an apology from all the meddling fools who have brought this great service to the brink of ruin.

More on the News Biz: Factoid of the Day

The main source of national and international news is the Associated Press. To a large degree, the newspaper business consists of taking AP product, adding some local news, wrapping it in advertising, and selling it to the local market.

So it is interesting to note that the AP's annual revenue in 2007 was $710 million. Daily newspaper circulation was about 51 million, so do the arithmetic and newspapers paid $14.20 per subscriber for a service that provides a hefty slug of their news product. (This is a maximum; AP also gets paid by radio, TV, and Internet users of its product, so not all the cost is on subscriptions.)

For this, newspapers collected $55 billion in revenue, over $1,000 per subscriber. That is a pretty good mark-up.

Overfishing the News Commons

The dismal state of newspaper finances has produced a spate of articles about the news business, plus a website called newspaperproject.org to defend the relevance and value of news organizations. "More People Will Read A Newspaper Today Than Watched Yesterday's Big Game." 

It's a good point, and people do indeed love the news -- they love it on Drudge, Google, Yahoo, and a zillion other websites that feed on the product produced by the newspapers and their wire services. The news organizations have made the news into a commons. Seduced by the free culture-ites of academia, they do not protect their intellectual property, allowing anyone to drop his fishing line into the ocean of content and hook some advertising dollars.

The one solution rarely proposed is to charge for content. An exception: Peter Osnos of the Century Foundation, who says: "With the print newspaper and magazine business model irreversibly in decline, these enterprises have to start demanding payment for use of their material, or they will disappear."  He suggests starting with Google: "[Google] spokesmen, especially CEO Eric Schmidt, have repeatedly said they would like to help newspapers, if only they could figure out how. Well, how about sitting down with representatives of the floundering news gatherers and devising a system that would pay royalties for click-throughs supported by advertising?"

Good luck with that project, but Osnos is right. If producers of content cannot monetize their work, then they will stop producing it, and we will be left with a rump business of amateur productions.

Business Talks: Rupert Murdoch Gets It Right

Rupert Murdoch is one of the towering figures of business history, and, in keeping with his chosen field of media, an unusually articulate one.

Now 77, Murdoch seems to be feeling a bit valedictory (even as he is probably scheming to add the New York Times to his domain). The Australian Broadcasting Corp. recently broadcast a series of six lectures by Murdoch called A Golden Age of Freedom that are well worth the listening, or reading, since transcripts are available.

The theme:

Rupert Murdoch beholds a period of great transformation that will bring prosperity to billions around the world. This golden age of freedom will unleash a new global middle class. Markets, media and technology will all play their part.

But to reap the rewards we must make some drastic changes. A ballooning welfare state, failing state schools and full reconciliation among all Australians head his list.

Thanks to Coop's Corner.

Dead Business Model Walking (but now it is down to a crawl)

Today's Financial Times has an excellent article by John Gapper, "Who will mourn local newspapers?" He makes the point, indisputable but often ignored, that the institution of the newspaper depended ona  congruence of technologies and economic advantages, that the Internet has superseded the technologies and slain the advantages, and that the local newspaper is a dead institution.

His conclusion:

My working assumption . . . is that consolidation – or, more accurately, eradication – of local newspapers will strengthen the editorial position of the remaining elite: The New York Times, The Wall Street Journal, Bloomberg, the Financial Times etc.

I also assume that this elite will find some way to cover its costs. Here’s hoping, anyway.

The last point is the rub. Newspapers were based on a two-sided business model of selling content to readers and at the same time selling those reader eyeballs to advertisers. At the moment, it is impossible to enforce property rights in content, so it is extremely difficult to think of a model that will cover costs. Without property rights, the creator cannot even monetize its effort via advertising.

Of course, the press has mostly supported things like P2P and attacked all efforts by content creators to defend themselves, so one can watch its destruction without a sense of fairness outraged. Live by the sword, etc.