o n e
INTRODUCTION TO MEDIA ECONOMICS
T
he study of media and communications has traditionally been
dominated by non-economic disciplines. Analysis of media content,
for example, can provide a means of understanding the societies
we live in and our value systems. But economics is also a valuable subject
area for media scholars. Most of the decisions taken by those who run
media organizations are, to a greater or lesser extent, influenced by
resource and financial issues. So economics, as a discipline, is highly
relevant to understanding how media firms and industries operate.
This book provides an introduction to some of the main economic
concepts and issues affecting the media. It is designed for readers who
are not specialists in economics but who want to acquire the tools needed
to unravel some of the more interesting economic features and pressing
industrial questions surrounding media firms and markets. No prior
knowledge of economics is assumed.
The first two chapters explain a number of broad and fundamental
concepts relevant to the study of economics as it affects the media. This
opening chapter introduces you to firms and markets and it examines
the distinctive economic characteristics of media. Chapter 2 focuses on the
relationship between these special characteristics and the corporate
strategies that are commonly deployed by media firms.
These initial chapters are followed by six others, each of which
concentrates on a particular sector of media activity, e.g. television broadcasting,
print media publishing or ‘new’ media. Sector-specific chapters
are not intended to offer stand-alone accounts of the economics of each
media activity. Instead, they provide a framework within which two or
three of the main economic concepts or questions that are commonly
associated with or best exemplified by that industry sector may be examined
more closely. So, the structure of the book enables a series of
economic themes and questions relevant to the media to be gradually
and progressively opened up and explored. The final chapter examines
what role media economics can play in informing public policy questions.
After studying this opening chapter, you should be able to:
• Identify the kinds of questions that media economics seeks to address
• Explain what a firm is, and its motivations
• Describe the different types of competitive market structures that exist
• Understand what is special about the economics of the media
• Identify and explain some of the key economic characteristics of the
media
WHAT IS MEDIA ECONOMICS ABOUT?
Media economics combines the study of economics with the study of
media. It is concerned with the changing economic forces that direct and
constrain the choices of managers, practitioners and other decision-makers
across the media. The economic concepts and issues introduced in the
course of this book provide a basis for developing your understanding
of the way in which media businesses operate and are managed.
Some attempts have been made to formalize a definition of media
economics. Economics has been described as ‘the study of how people
make choices to cope with scarcity’ (Parkin et al., 1997: 8). Scarcity is a
familiar concept for most, and we are all economists to the extent that
we have to decide how to make the best of our limited incomes or
resources. According to Robert Picard, media economics ‘is concerned
with how media operators meet the informational and entertainment
wants and needs of audiences, advertisers and society with available
resources’ (1989: 7). Likewise, Albarran’s definition of media economics
focuses on ‘how media industries use scarce resources to produce content
. . . to satisfy various wants and needs’ (1996: 5). For Alexander et al.,
media economics refers to ‘the business operations and financial activities
of firms producing and selling output into the various media industries’
(1998: 2).
Media economics, then, is concerned with a range of issues including
international trade, business strategy, pricing policies, competition and
industrial concentration as they affect media firms and industries. These
themes are explored below, as each of the main sub-sectors of the media
is examined in turn. The predominant focus throughout the book is
2 Understanding media economics
‘microeconomic’ (i.e. to do with specific individual markets or firms), but
some of the questions addressed also have a macroeconomic dimension.
MACROECONOMICS AND MICROECONOMICS
The distinction between macro and microeconomics is about whether that
which is being studied involves large groups and broad economic
aggregates or small well-defined groups and individual firms and sectors.
Macroeconomics is concerned with very broad economic aggregates and
averages, such as total output, total employment, national income, the
general price level, and the rate of growth of the economy as a whole.
These sorts of aggregates are arrived at by summing up the activities
carried out in all individual markets and by summarizing the collective
behaviour of all individuals.
One of the most commonly used measures of a nation’s overall level
of economic activity is its Gross Domestic Product (GDP). A country’s
GDP represents the sum of the value of all goods and services produced
within the economy over a particular period, usually a year. Media goods
and services represent a small but growing proportion of total economic
activity in developed countries and, in the United Kingdom (UK) for
example, they account for some 3–5 per cent of GDP.
In the UK, the long-term trend in GDP since the Second World War has
generally been upwards and this, in turn, has facilitated a substantial
increase in living standards. Within this overall growth trend, a second
feature of movements in GDP has been short-term fluctuations around the
trend. Rather than growing at a steady and consistent pace, economies
tend to move in a series of up and down ‘business cycles’ which are
characterized by four phases: trough, recovery, peak and recession (Lipsey
and Chrystal, 1995: 500–5).
The overall performance of the economy has important implications
for the business performance and prospects of firms in all sectors, including
media. Indeed, the fortunes of most media firms are highly sensitive to
the ups and downs of the economy as a whole. Many media firms rely
on advertising as a primary source of income. Analysis of long-term trends
in advertising shows that there is a strong association between the
performance of the economy as a whole and levels of advertising activity.
Revenues for media firms from direct expenditure by consumers are
also clearly dependent on broader economic aggregates such as levels of
disposable income and consumer confidence.
In theory, public policies on the economy (monetary, fiscal, etc.), and
policies to promote or restrain growth or social welfare may have an effect
Introduction to media economics 3
on the economic environment in which media firms and industries operate
(Alexander et al., 1998: 9). For example, government control over the
supply of money and over interest rates provides a means of influencing
levels of investment and economic activity in general. However, it may
be argued that the power of state authorities to exert such influence is
waning. ‘Globalization’ means that it is increasingly difficult for open
economies to predicate monetary and other economic policies on domestic
considerations alone.
Whereas macroeconomics is about forces that affect the economy as
a whole, microeconomics is concerned with the analysis of individual
markets, products and firms. An economy is ‘a mechanism that determines
what is produced, how, when and where it is produced, and for whom
it is produced’ (Parkin et al., 1997: 21). These decisions are taken by
three types of economic actors – consumers, firms and governments –
and are co-ordinated in what are called ‘markets’. Economics relies on
certain assumptions about how these actors make their choices.
Each consumer, for example, is seen as having unlimited wants and
limited resources. It is assumed that all consumers seek to maximize their
total ‘utility’ or satisfaction. ‘Marginal’ utility represents the change in
satisfaction resulting from consuming a little more or a little less of a given
product. The law of diminishing marginal utility suggests that the more
of a given product that an individual consumes, the less satisfaction he
or she will derive from successive units of the product. The example used
by Lipsey and Chrystal to illustrate this principle shows that, everything
else being equal, the more films a consumer attends each month, the more
satisfaction he or she gets. However, the marginal utility of each additional
film per month is less than that of the previous one – i.e. marginal utility
declines as quantity consumed rises (1995: 128–9).
THE FIRM IN ECONOMIC THEORY
In economics, production is defined as the conversion of resources –
labour, land and capital – into goods and services. ‘Firms’ are establishments
where production is carried out and industries consist of a number
of firms producing a commodity for the same market. The concept
of a media firm spans a variety of different types of business organization,
from the online ‘fanzine’ publisher to the vast television corporation
and from single proprietorship to major transnational Stock Exchange
listed companies. What all media firms have in common is that they
are involved somehow in producing, packaging or distributing media
content.
4 Understanding media economics
All media firms are not, however, commercial organizations. Most
countries have a state-owned broadcasting entity which takes the form
of a public corporation and which is dedicated to ‘public service’ television
and radio broadcasting. Many public service broadcasters (PSBs) rely
on public funding (e.g. grants) but some depend, in part or in whole, on
revenues derived from commercial activities such as sale of airtime to
advertisers. Even when they compete for revenues from commercial
sources, PSBs are usually distinguished from commercial firms by the fact
that their primary goal is to provide a universally available public
broadcasting service rather than to make a profit.
By contrast, it is assumed that a commercial firm’s every decision is
taken in order to maximize its profits. The assumption that all firms seek
to maximize profits is central to the theory of the firm. It allows economists
to predict the behaviour of firms by studying the effect that each of the
choices available to it would have on its profits.
However, there are two commonly cited criticisms of the traditional
theory of the firm and both are relevant to media. The first suggests
that it is too crude and simplistic to assume that businesses are motivated
purely by pursuit of profits. The case for profit maximization on the part
of business owners is thought to be ‘self-evident’ but, in fact, some are
undoubtedly motivated by alternative goals. These range from straightforward
philanthropy to the desire for specific benefits associated with
owning certain types of businesses. An alternative motivation – especially
in the case of media firms – might well be the pursuit of public and political
influence.
A second criticism is that the theory assumes that all firms will behave
in the same way, irrespective of their size and organizational structure.
In reality, a firm’s institutional structure may have an important bearing
on its priorities. Rupert Murdoch’s involvement in the running of News
Corporation shows how some media firms are closely managed by their
owners. But the dominant form of industrial organization these days is
the public limited company (or plc) under which, more typically, the
day-to-day running of the firm is carried out not by the owners (or
shareholders) but by managers.
When ownership and control of an organization are separate, its
managers may decide to pursue goals other than maximizing profits and
returns to shareholders. This conflict of interest is referred to as a type
of ‘principal–agent’ problem. The managers appointed to run a media
firm (agents) may not always act in the manner desired by shareholders
(principals) but might, instead, have their own agendas to pursue. When
the agent’s goal is allowed to predominate then pursuit of profits may
be superseded by, for example, a desire to maximize sales revenue or the
firm’s growth.
Introduction to media economics 5
There are good grounds for questioning how well the broad assumptions
of conventional economic theory apply in practice to the behaviour
of media organizations. Nonetheless, to the extent that media firms and
consumers make their decisions in a ‘rational’ manner and in pursuit of
what are assumed to be their own individual goals (of, respectively, profit
and utility maximization), there will be a role for government to play in
creating a regulatory environment within which these individual goals
are not achieved at the expense of societal welfare (Alexander et al., 1998:
14). The issue of supplying violent media content provides an example
of an economic activity that realizes the goals of one set of economic actors
(i.e. it contributes to the success and profitability of film and television
programme-makers) but, arguably, may detract from overall well-being
of society (ibid.).
A firm’s profits are the difference between its revenues and costs. Costs
in economic theory refer to all ‘opportunity costs’ – i.e. ‘the cost of using
something in a particular use is the benefit forgone by (or opportunity cost
of) not using it in its best alternative use’ (Lipsey and Chrystal, 1995: 185).
So, as well as assigning costs to purchased or hired inputs, an ‘imputed’
cost must also be calculated for and assigned to any factors of production
owned by the firm, especially the firm’s own capital.
The concept of opportunity cost is important in economics. Our
resources can be used in many different ways to produce different
outcomes but, essentially, they are finite. All of the land, labour and capital
available to us will be relatively more efficient in some activities rather
than others. Opportunity cost is inevitable and requires firms to make
trade-offs. The most productive outcome will be achieved when every
worker, piece of land and item of capital equipment is allocated to the task
that suits it best (i.e. the one that results in the most productive outcome).
For example, if we want more educational CD-Roms and fewer
computer games, we might switch some of the creative, marketing and
administrative personnel, the computers and production equipment
involved in producing computer games into CD-Rom publishing instead.
However, because game inventors will be less good at creating CD-Roms
than original educational CD-Rom publishing personnel, the quantity of
CD-Roms produced will increase by a relatively small amount while the
quantity of computer games produced falls considerably. Similarly, CDRom
creators can be reassigned to the task of producing interactive
computer games but, because they are not as good at this activity as the
people who currently make computer games, there will be an opportunity
cost in terms of lost output. The opportunity cost of switching resources
from computer games to CD-Rom production (or from CD-Roms to
games) can be calculated as the number of games that must be given up
in order to produce more CD-Roms (or vice versa).
6 Understanding media economics
In order to maximize profits, firms need to decide which overall rate
of output would be most profitable (e.g. whether to produce 100,000 or
200,000 copies of a magazine). To do so, they need to know exactly
what costs and revenues might be associated with different levels of output.
The so-called ‘production function’ describes the relationship between
input costs and different levels of output. Changes in relative factor prices
(of labour, capital equipment, etc.) will result in a replacement of factors
that have become relatively more expensive by cheaper ones. For example,
the introduction of new print and desk-top publishing technologies in
the magazine publishing industry in the 1980s and 1990s reduced capital
equipment costs and allowed a reduction in labour inputs.
‘Marginal product’ is the change in total product (or the total amount
produced by the firm) that results from adding a little bit more or a little
less of a variable input to a fixed input. The ‘law of diminishing returns’
suggests that if extra quantities of a variable factor (e.g. freelance technicians)
are applied to a given quantity of a fixed factor (e.g. plant and
equipment), the marginal and average product of the variable factor will
eventually decrease. Picard offers the example of a television news director
who is deciding how many news crews (whose labour represents the
‘input’) are needed to produce a newscast (the ‘output’). The size of
the marginal product increases at first, demonstrating increasing returns
to scale, and then it begins to decline. According to Picard’s example,
the onset of diminishing returns occurs because, as more production crews
are added and the use of production equipment has to be shared, the
efficiency and productivity of each crew begins to reduce (1989: 53–4).
But contrary to what is implied by the law of diminishing returns, many
media firms tend to enjoy increasing rather than diminishing marginal
returns as their output (or, rather, consumption of it) increases. The
explanation for increasing returns to scale in the media industry lies in
the nature of the product and how it is consumed. The value of media
content lies not in the paper that it is printed on or the ink or videotape
that conveys its text or images but in the meanings, messages or stories
that it has to offer – its intellectual property. This is an intangible and costs
virtually no more to reproduce in large than in small quantities. The cost
of producing a television programme or a film is not affected by the
number of people who watch it. So, for media firms, the relationship
between input costs and different levels of output tends to be skewed by
the availability of increasing returns to scale.
Introduction to media economics 7
COMPETITIVE MARKET STRUCTURES
As discussed above, the production function describes how costs vary at
different levels of output. Firms that wish to maximize profits are not only
concerned with costs but also need to know what revenues are associated
with different levels of output. To a large extent this depends on what sort
of ‘competitive market structure’ a firm finds itself operating in.
Economic theory offers us a model for analysing the different sorts of
structures a market can have and the degree of competition between firms
in that market. The competitive market structures within which media
operate will have an important bearing on how efficiently media firms
organize their resources and business affairs. The main theoretical market
structures are perfect and imperfect competition (i.e. monopolistic competition
and oligopoly) and monopoly. The distinction between these
structures is largely dictated by the number of rival producers or sellers
in a given market. This provides a significant indication of the ‘market
power’ that individual firms possess and their ability to control and
influence the economic operations in that market (e.g. to set prices). The
less market power individual firms have, the more competitive the market
structure they are operating in.
The structure of a market depends not only on the number of rival
sellers that exist but on a variety of other factors, including differences
in their product, the number of buyers that are present, and barriers to the
entry of new competitors. Perfect competition and monopoly are at
opposite extremes. In perfect competition, markets are highly competitive
and open and each firm has zero market power. In monopoly, a single firm
has absolute control over the market. Most firms tend to operate in some
intermediate market structure rather than at the extremes.
Perfect competition exists when there are many sellers of a good or
service that is homogeneous (i.e. exactly the same or not differentiated)
and no firm(s) dominate(s) the market. In such a situation economic forces
operate freely. Each firm is assumed to be a price-taker and the industry
is characterized by freedom of entry and exit. So, under perfect competition,
no barriers to entry exist – there are no obstacles (e.g. lack of
available spectrum, or high initial capital costs) to prevent new rivals from
entering the market if they wish. Monopoly, at the other extreme, involves
just one seller, no competition whatsoever and (usually) high entry
barriers.
It is very rare to find an example of perfect competition in the real
world. Most industries, including the media, sell ‘differentiated’ products,
i.e. products that are similar enough to constitute a single group (such
as books) but are sufficiently different for consumers to distinguish one
from another. In other words, they may be close substitutes but are not
8 Understanding media economics
exact substitutes as would be the case in perfect competition. Monopolistic
competition exists when there are a number of sellers of similar goods
or services, but the products are differentiated and each product is
available only from the firm that produces it. Firms thus have some control
over their prices.
If there are only a few sellers in a market but some competition exists
for their products, either homogeneous or differentiated, the market
structure is described as an oligopoly. How few is ‘a few’? The most
usual method of measuring the degree of oligopoly in a market is by
applying a ‘concentration ratio’. These measures show the proportion
of, say, output or employment or revenue accounted for by the top four
or five firms in the sector. In the media sector, concentration levels can
be calculated on the basis of audience shares (as defined by ratings or
readership figures). According to Lipsey and Chrystal, in an oligopoly
‘each firm has enough market power to prevent it from being a price-taker,
but each firm is subject to enough inter-firm rivalry to prevent it from
considering the market demand curve as its own’ (1995: 262). So, in an
oligopoly firms have a greater degree of control over the market than in
a monopolistic competition.
Oligopoly is the most common type of market structure that media
firms operate in. The next chapter addresses the question of why it is
that so many sectors of the media are dominated by a few large firms.
In many cases, the answer is to be found in falling costs due to the
economies of large-scale production. Economies of scale are prevalent in
the media because the industry is characterized by high initial production
costs and low marginal reproduction and distribution costs. Economies
of scope – economies achieved through multi-product production – are
also commonly characteristic of media enterprises. So there are major
advantages in large size for firms that operate in the media industry.
The theory of imperfect competition says that cost advantages associated
with size will dictate that an industry should be an oligopoly unless
some form of market intervention or Government regulation prevents
the firms from growing to their most efficient size. If no such intervention
takes place, existing firms in the industry may create barriers to entry
where natural ones do not exist so that the industry will be dominated
by a handful of large firms only because they are successful in preventing
the entry of new firms. But substantial economies of scale in any industry
will, in themselves, act as a natural barrier to entry in that any new firms
will usually be smaller than established firms and so they will be at a cost
disadvantage.
Introduction to media economics 9
MARKET STRUCTURE AND BEHAVIOUR
The expectation that the behaviour or conduct of firms may be determined
by the market structures within which they operate is formalized in what
is called the Structure–Conduct–Performance (SCP) paradigm. The SCP
paradigm suggests that market structure (the number of firms, barriers
to entry, etc.) will determine how the firms in an industry behave (e.g. their
policies on pricing and advertising) and this conduct will, in turn,
determine the performance of the industry in question – i.e. its productive
efficiency (Moschandreas, 1994: 11). This model implies that the fewer
firms in a market, the greater the likelihood of collusion, anti-competitive
strategies and other inefficiencies.
More recently, some doubt has been cast on the causal links of the
SCP paradigm by the theory of market contestability, as developed by
US economists Baumol, Panzar and Willig. A market is ‘contestable’ if
entry to it is possible. The theory of contestability suggests that the very
fact that a market is potentially open to a new entrant will serve to contain
the behaviour of monopolists – i.e. market contestability prevents the
exploitation of market power to restrict output and to raise prices (Lipsey
and Chrystal, 1995: 271). Contestable markets are therefore said to be
susceptible to ‘hit and run’ entry (George et al., 1992: 276).
How media firms behave, in practice, under different market structures
has been a concern for many media economists (Picard, 1989: 79–83;
Wirth and Bloch, 1995; Albarran, 1996) and will be a subject of interest
throughout this book.
WHAT IS SO SPECIAL ABOUT THE ECONOMICS OF THE MEDIA?
Because media and other ‘cultural’ output have special qualities not shared
by other products and services, the application of economic theory
and economic perspectives in the context of media presents a variety of
challenges. Media output seems to defy the very premise on which the laws
of economics are based – scarcity. However much a film, a song or a
news story is consumed, it does not get used up.
Economics seeks to promote ‘efficiency’ in the allocation of resources.
The notion of economic efficiency is inextricably tied up with objectives.
But the objectives of media organizations tend to vary widely. Very many
media organizations comply with the classical theory of the firm and,
like commercial entities in any other industry, are primarily geared
towards maximizing profits and satisfying shareholders. A good number,
however, appear to be driven by alternative motives. For those who
10 Understanding media economics
operate in the public service sector, quality of output and other ‘public
service’ type objectives form an end in themselves. Some broadcasting firms
find themselves in between the market and the non-market sector –
appearing to fulfil one set of objectives for an industry regulator, and
another set for shareholders. Because objectives are hazy, the application
of any all-embracing model based in conventional economic theory is
difficult.
In free market economies, most decisions concerning resource allocation
are made through the price system. But the relationship between price and
resource allocation in the media is somewhat unusual, particularly in
broadcasting where (notwithstanding the growth of subscription-based
channels) many of the services consumers receive still do not involve a
direct payment from the viewer. Without price as a direct link between
consumers and producers, there is a failure in the usual means of registering
consumer preferences with suppliers.
In terms of economics, production methods are said to be inefficient
if it would be possible to produce more of at least one commodity –
without simultaneously producing less of another – merely by reallocating
resources. However, when it comes to the production of media output,
this approach begins to look inadequate. For example, it might well be
possible for a television company to redistribute its resources so as to
produce more hours of programming output or bigger audiences for the
same cost as before. But if this were to narrow the diversity of media
output, could it be said to be a more efficient use of resources?
These questions about the efficiency of production and allocation
belong to the branch of economic theory called welfare economics. Much
of the work that has been carried out in the UK in relation to broadcasting
economics and associated public policy issues – most notably by Alan
Peacock and, more recently, by Gavyn Davies and others – belongs to
this area. Implicit in this approach is the assumption that a ‘welfare
function’ (i.e. a functional relation showing the maximum welfare that
can be generated by alternative resource decisions) can be defined for
society as a whole. Within such a conceptual framework, media economics
can play a role in showing how to minimize the welfare loss associated
with any policy choices surrounding media provision.
KEY ECONOMIC CHARACTERISTICS OF THE MEDIA
A good way of getting to grips with what is special about media economics
is to consider the characteristics of the media as a whole that distinguish
it from other areas of economic activity. One such feature is that media
Introduction to media economics 11
firms often sell their wares simultaneously in two separate and distinct
sorts of markets. Media industries are unusual in that they generally
operate in what has been referred to by Picard as a ‘dual product’ market
(1989: 17–19). The two commodities that media firms generate are, first,
content (television programmes, newspaper copy, magazine articles, etc.)
and, second, audiences. The entertainment or news content that listeners,
viewers or readers ‘consume’ constitutes one form of output which media
firms can sell. The audiences that have been attracted by this content
constitute a second valuable output, insofar as access to audiences can
be packaged, priced and sold to advertisers.
Audiences are the main currency for many media companies, as these
provide advertising revenue which, as later chapters will discuss, is a
primary source of income for commercial television and radio broadcasters
as well as for newspapers and many magazines. Even non-profit-seeking
media are concerned with audiences. Public service broadcasters, for
example, must pay close attention to their ratings and the demographic
profile of their audience because the audience utility or satisfaction they
can demonstrate is normally central to negotiations surrounding what level
of funding, whether public or otherwise, is made available to them.
The other type of media output – i.e. content – exhibits a number of
interesting and unusual features, as have been noted by, for example,
Blumler and Nossiter (1991) and Collins et al. (1988: 7–10). Media
content is generally classified as a ‘cultural’ good. Feature films, television
broadcasts, books and music are not merely commercial products but may
also be appreciated for the ways they enrich our cultural environment.
Many cultural goods share the quality that their value for consumers is
tied up with the information or messages they convey, rather than with
the material carrier of that information (the radio spectrum, CD, etc.).
Messages and meanings are, of course, intangible. So media content is
not ‘consumable’ in the purest sense of this term (Albarran, 1996: 28).
It is sometimes difficult to define what constitutes a unit of media
content. This could describe, for example, a story, an article, a television
programme, an entire newspaper or a radio channel. One way or another,
the essential quality that audiences get value from is meanings, which
are not, in themselves, material objects. Because the value of media content
is generally to do with attributes that are immaterial, it does not get used
up or destroyed in the act of consumption. If one person watches a
television broadcast, it doesn’t diminish someone else’s opportunity of
viewing it. Because it is not used up as it is consumed, the same content
can be supplied over and over again to additional consumers.
So television and radio broadcasts exhibit one of the key features of
being a ‘public good’. Other cultural goods such as works of art also
qualify as public goods because the act of consumption by one individual
12 Understanding media economics
does not reduce their supply to others. Public goods contrast with normal
or private goods in that private goods (such as a loaf of bread, jar of
honey or pint of Guinness) will get used up as they are consumed. As
soon as one person consumes a loaf of bread it is no longer available to
anyone else. A loaf of bread can only be sold once. But when an idea or
a story is sold, the seller still possesses it and can sell it over and over again.
The consumption of private goods uses up scarce resources and
therefore needs to be rationed (usually by the market and by prices). But
public goods do not comply with this logic. The initial cost involved in
establishing a public good may be high but then the marginal costs
associated with supplying an extra unit of it are next to zero. The marginal
cost involved in conveying a television or radio programme to an extra
viewer or listener within one’s transmission reach is typically zero, at
least for terrestrial broadcasters. Likewise, the marginal cost of providing
an online publication to one additional Internet user is negligible.
Hoskins et al. (1997: 31–2) note the widespread use of a Research
and Development (R&D) analogy to exemplify the very high initial
production costs and low replication costs which are characteristic of
broadcasting and other media. Generally speaking, once the first copy
of a media product has been created (in the expensive R&D phase), it then
costs little or nothing to reproduce and supply to extra customers.
Increasing marginal returns will be enjoyed as the audience for any given
media product expands.
Conversely, there are relatively few savings available for media firms
when audiences contract. In most other industries, producers can vary
some of their costs up and down in response to how much of their product
is being sold (they can cut back on purchases of raw materials if demand
slows down). For broadcasters, however, the cost of putting together and
transmitting a given programme service is fixed, irrespective of how many
viewers tune in or fail to tune in. Similarly, few savings can be made by
newspaper and other print media publishers when circulation fails to live
up to expectations (although, unlike in broadcasting, marginal print and
distribution costs are present).
ECONOMIES OF SCALE
Economies of scale, then, are a highly prevalent feature of the media
industry. They will be mentioned and discussed frequently throughout this
book so it is worth clarifying what is meant by the term. Economies of
scale are said to exist in any industry where marginal costs are lower
than average costs. When the cost of providing an extra unit of a good
falls as the scale of output expands, then economies of scale are present.
Introduction to media economics 13
Many industries experience economies of scale, especially those engaged
in manufacturing (e.g. of cars) where larger production runs and automated
assembly line techniques lead to ever lower average production
costs. A variety of reasons may explain why economies of scale are present.
Sometimes it is because large firms can achieve better (bulk) discounts
on required inputs than smaller firms can. Often, scale economies are to
do with the benefits of specialization and division of labour that are
possible within large firms.
Economies of scale exist in the media because of the public-good
attributes of the industry’s product. For media firms, marginal costs (MC)
refer to the cost of supplying a product or service to one extra consumer.
Average costs (AC) are the total costs involved in providing the product
or service, divided by its audience – the total number of users who watch,
read, listen to or otherwise consume it. In most sectors of the media,
marginal costs tend to be low, and in some cases they are zero. Marginal
costs are virtually always lower than average costs. Consequently, as more
viewers tune in or more readers purchase a copy of the magazine, the
average costs to the firm of supplying that product will be lowered. If
average production costs go down as the scale of consumption of the firm’s
output increases, then economies of scale and higher profits will be
enjoyed.
ECONOMIES OF SCOPE
Economies of scope are also to do with making savings and gaining
efficiencies as more of a firm’s output is consumed. In this case, however,
savings are created by offering variations in the character or scope of the
firm’s output. Economies of scope – economies achieved through multiproduct
production – are commonly characteristic of media enterprises
and, again, this is to do with the public-good nature of media output.
Economies of scope are generally defined as the economies available
to firms ‘large enough to engage efficiently in multi-product production
and associated large scale distribution, advertising and purchasing’ (Lipsey
and Chrystal, 1995: 880). They arise when there are some shared
overheads or other efficiency gains available that make it more costeffective
for two or more related products to be produced and sold jointly,
rather than separately. Savings may arise if specialist inputs gathered for
one product can be re-used in another.
Economies of scope are common in the media because the nature of
media output is such that it is possible for a product created for one market
to be reformatted and sold through another. For example, an interview
14 Understanding media economics
with a politician which is recorded for broadcast in a documentary might
also be edited for inclusion in other news programmes, either on television
or, indeed, on radio: the same television content can be repackaged into
more than one product. And the reformatting of a product intended for
one audience into another ‘new’ product suitable for a different audience
creates economies of scope.
Whenever economies of scope are present diversification will be an
economically efficient strategy because ‘the total cost of the diversified firm
is low compared with a group of single-product firms producing the
same output’ (Moschandreas, 1994: 155). Strategies of diversification
are increasingly common amongst media firms and this reflects the
widespread availability of economies of scope. Economies of scope and
economies of scale are important characteristics of the economics of media
and these concepts will be developed and exemplified in later chapters.
Introduction to media economics 15
two
CORPORATE STRATEGIES
T
his chapter examines the relationship between the special economic
characteristics of media and the corporate configurations that
media firms tend to adopt. The vertical supply chain for media is
introduced and strategies of horizontal, diagonal and vertical expansion
are explained. Taking account of how media markets have been altered
by recent technological and regulatory changes, the advantages and
benefits available to firms from strategies of monomedia (single sector)
and cross-media growth are analysed.
After studying this chapter, you should be able to:
• Understand what is meant by the vertical supply chain
• Distinguish between strategies of vertical, horizontal and diagonal
growth
• Discuss the implications for media firms of ‘convergence’ and of
‘globalization’
• Explain the principal motivations behind media and cross-media
expansion
• Analyse the economic advantages associated with these strategies
THE VERTICAL SUPPLY CHAIN FOR MEDIA
In order to analyse an industry, one approach used by economists is to
carry out a vertical deconstruction or disaggregation. The production of
any good or service usually involves several stages that are technically
separable. Vertical deconstruction means breaking the industry’s activities
up into a number of different functions or stages so that each activity
can be studied more closely. The concept behind the vertical supply chain
is that the activities of an industry are ordered in a sequence which starts
‘upstream’ at the early stages in the production process, works its way
through succeeding or ‘downstream’ stages where the product is processed
and refined, and finishes up as it is supplied or sold to the customer.
This framework provides a useful starting point for analysing the media.
For media industries, it is possible to identify a number of broad stages
in the vertical supply chain which connect producers with consumers. The
first is the business of creating media content (e.g. gathering news stories,
or making television or radio programmes). Second, media content has
to be assembled into a product (e.g. a newspaper or television service).
Third, the finished product must be distributed or sold to consumers
(Figure 2.1).
Essentially, the media industry is about supplying content to consumers.
The aim is to make intellectual property, package it and maximize revenues
by selling it as many times as is feasible to the widest possible audience
and at the highest possible price. The first stage in this process is usually
‘production’. The creation of media content is carried out by filmmakers,
writers, journalists, musicians, television and radio production companies.
Producers may sometimes supply content directly to consumers but, more
generally, their output (e.g. television programmes) takes the form of
inputs for a succeeding ‘packaging’ stage. This is when content is collected
together and assembled into a marketable media product or service and
it is carried out by, for example, newspaper publishers, television networks
and magazine publishers. Finally there is ‘distribution’, which means
delivering a media product to its final destination – the audience.
Distribution of media output takes place in several different ways and,
for some products, is quite a complex phase. Television and radio services
are generally transmitted over the airwaves or conveyed via broadband
communication infrastructures. Distribution of pay-television services,
however, involves encryption and subscriber management activities as well
as transmission of signals. Newspapers and periodicals are usually
conveyed to the consumer via another intermediary – newsagents – or they
may be delivered directly to the home or to places of employment on
18 Understanding media economics
PRODUCTION PACKAGING DISTRIBUTION
FIGURE 2.1 The vertical supply chain for media
a subscription basis. Electronic distribution over the Internet is another
possibility for most types of media content.
All of the stages in the vertical supply chain for media are interdependent.
For example, media content has no value unless it is distributed
to an audience, and distribution infrastructures and outlets have no value
without content to disseminate. No single stage is more important than
another: all are interrelated. So, the performance of every firm involved
in the supply chain will be threatened if a ‘bottleneck’ develops – i.e. if
one player manages to monopolise any single stage in the chain. If one
company gains control over all the substitute inputs at an upstream stage,
or all of the facilities required for distribution, then rivals will be put at
a considerable disadvantage and consumers are also likely to suffer.
The interdependent relation of different phases in the supply chain
has important implications for what sort of competitive and corporate
strategies media firms will choose to pursue. The desire for more control
over the market environment may act as an incentive for firms to diversify
into additional upstream or downstream phases. Vertical integration refers
to the extent to which related activities up and down the supply chain
are integrated or are carried out jointly by ‘vertically integrated’ firms
whose activities span two or more stages in the supply process. Media
firms may expand their operations vertically either by investing new
resources or by acquiring other firms that are already established in
succeeding or preceding stages in the supply chain.
CHANGING MARKET STRUCTURES AND BOUNDARIES
Economics provides a theoretical framework for analysing markets based
on the clearly defined structures of perfect competition, monopolistic
competition, oligopoly and monopoly. In practice, many media firms –
especially broadcasters – have tended to operate in markets where levels
of competition have been strongly influenced by technological factors (e.g.
spectrum scarcity) or by state regulations (e.g. broadcasting licence
requirements) or by both. These factors have held back competition. In
addition, the traditional tendency for media organizations to operate in
quite specific geographic markets, and to be closely linked to those markets
by their product content and the advertising services they provide within
those markets, has curtailed levels of domestic and international competition
in some, though not all, mass-media products and services.
However, things are changing. Many of the traditional legislative and
technical constraints have recently given way to more competitive market
structures. In print media, new technology has reduced some of the high
Corporate strategies 19
production costs which used to impede industry entry (Picard, 1998:
123–4). In broadcasting, a steady expansion in the means of delivery (via
cable, satellite and, more recently, digital technology) has removed
spectrum scarcity and opened up markets to new service providers (Brown,
1999: 17). In audiovisual production, lower capital costs of digital
equipment have reduced technology-based entry barriers. And some new
content creators have been successful in exploiting the distribution access
offered by the growth of the Internet.
But just as new technologies and liberalizing legislation have done away
with some of the conventional entry barriers affecting media markets,
one or two other new barriers have sprung up in their place. The development
of pay television has added extra stages to the vertical supply chain
for broadcasting and some of these new stages have been particularly
prone to monopolisation. In the UK, for example, ownership of the dominant
encryption and conditional access technology required to charge
viewers for satellite broadcasts has remained under the control of a single
proprietor, News Datacom (a sister company of BSkyB). The term ‘gateway
monopolist’ is used to describe firms that gain control over some vital
stage in the supply chain or ‘gateway’ between the broadcaster and viewer.
If left unrestrained by regulators, such gateway monopolists clearly
threaten to create new entry barriers in the broadcasting sector (Cowie
and Marsden, 1999).
More generally, the traditional boundaries surrounding media markets
are being eroded. National markets are being opened up by what is
sometimes referred to as ‘globalization’.
The communications revolution has . . . caused an internationalization of
competition in almost all industries. National markets are no longer
protected for local producers by high costs of transportation and communication
or by the ignorance of foreign firms . . . Global competition is fierce
competition, and firms need to be fast on the uptake . . . if they are to survive.
(Lispey and Chrystal, 1995: 258)
The emergence of a borderless economy and more international
competition has naturally affected media markets and firms across the
globe (Carveth et al., 1998: 223). The transnational integration of markets
that were previously just national markets through, for example, the
European Union and North American Free Trade Agreement (NAFTA),
has accelerated the process. Throughout the 1990s, policy-makers in
the USA and Europe sought to develop initiatives which supported the
development of a ‘global information society’. To some extent at least,
their hopes have been realized by the dramatic growth of a truly transnational
and borderless distribution infrastructure for media in recent
years – the Internet.
20 Understanding media economics
So, changes in technology are also helping to erode traditional market
boundaries. And it is not just geographic market boundaries that are being
affected but also product markets. Technological convergence has blurred
the boundaries between different sorts of media and communication
products and markets. The term ‘convergence’ is used in different ways
but, generally speaking, it refers to the coming together of the technologies
of media, telecommunications and computing. Digital technology – the
reduction of pieces of information to the form of digits in a binary code
consisting of zeros and ones – is the driving force behind convergence.
Sectors of industry that were previously seen as separate are now converging
or beginning to overlap because of the shift towards using common
digital technologies.
The implications of convergence are far-reaching. With the arrival of
common digital storage, manipulation, packaging and delivery techniques
for information (in all types of media content), media output can more
readily be repackaged for dissemination in alternative formats. For
example, images and text gathered for a magazine, once reduced to digits,
can very easily be retrieved, reassembled and delivered as another product
(say, an electronic newsletter). Digitization and convergence are weakening
some of the market boundaries that used to separate different media
products.
Convergence is also drawing together the broadcasting, computing and
information technology (IT) sectors. According to consultants KPMG,
‘[u]ltimately, there will be no differences between broadcasting and
telecommunications’ (Styles et al., 1996: 8). More and more homes are
now linked into advanced high capacity communication networks and,
through these, can receive a range of multimedia, interactive and other
‘new’ media and communication services as well as conventional television
and telephony. Because of the potential for economies of scale and scope,
the greater the number of products and services that can be delivered to
consumers via the same communications infrastructure, the better the
economics of each service.
STRATEGIC RESPONSES OF MEDIA FIRMS
The ongoing globalization of media markets and convergence in
technology between media and other industries (especially telecommunications
and computers) have caused many media firms to adapt their business
and corporate strategies. As traditional market boundaries and barriers
have begun to blur and fade away, the increase in competition amongst
the media has been characterized by a steady growth in the number
Corporate strategies 21
of perceived distributive outlets (or ‘windows’) which are available to
media firms.
The logic of exploiting economies of scale creates an incentive to expand
product sales into secondary external or overseas markets. As market
structures have been freed up and have become more competitive and
international in outlook, the opportunities to exploit economies of scale
and economies of scope have increased. Globalization and convergence
have created additional possibilities and incentives to re-package or to
‘repurpose’ media content into as many different formats as is technically
and commercially feasible (book, magazine serializations, television
programmes and formats, video, etc.) and to sell that product through
as many distribution channels or windows in as many geographic markets
and to as many paying consumers as possible.
The media industry’s response has been marked. Media firms have been
joining forces at a faster pace than ever before. They have been involved
in takeovers, mergers and other strategic deals and alliances, not only with
rival firms in the same business sector, but also with firms involved in other
areas of the media and even with firms in other industries (e.g. telecommunications)
which are now seen as complementary business areas.
Convergence and globalization have strengthened trends towards
concentrated media and cross-media ownership, with the growth of
integrated conglomerates (e.g. Time Warner/AOL, Pearson, Bertelsmann)
whose activities span several areas of the industry. This makes sense.
Highly concentrated firms who can spread production costs across wider
product and geographic markets will, of course, benefit from natural
economies of scale and scope in the media (Hoskins et al., 1997: 22;
Corn-Revere and Carveth, 1998: 64–5). Enlarged, diversified and vertically
integrated groups seem well suited to exploit the technological and other
market changes sweeping across the media and communications industries.
At least three major strategies of corporate growth can be identified
and distinguished: horizontal, vertical and diagonal expansion. A horizontal
merger occurs when two firms at the same stage in the supply
chain or who are engaged in the same activity combine forces. Horizontal
expansion is a common strategy in many sectors: it allows firms to expand
their market share and, usually, to rationalize resources and gain economies
of scale. Companies that do business in the same area can benefit
from joining forces in a number of ways, for example by applying common
managerial techniques or finding greater opportunities for specialization
of labour as the firm gets larger. In the media industry the prevalence
of economies of scale makes horizontal expansion a very attractive
strategy.
Vertical growth involves expanding either forward into succeeding
stages or backward into preceding stages in the supply chain. Vertically
22 Understanding media economics
integrated media firms may have activities that stretch from creation of
media output (which brings ownership of copyright) through to distribution
or retail of that output in various guises. Vertical expansion generally
results in reduced transaction costs for the enlarged firm. Another benefit,
which may be of great significance for media players, is that vertical
integration gives firms some control over their operating environment and
it can help them to avoid losing market access in important upstream or
downstream phases.
Diagonal or ‘lateral’ expansion occurs when firms diversify into new
business areas. For example, a merger between a telecommunications
operator and a television company might generate efficiency gains as both
sorts of services – audiovisual and telephony – are distributed jointly across
the same communications infrastructure. Newspaper publishers may
expand diagonally into television broadcasting or radio companies may
diversify into magazine publishing. A myriad of possibilities exists for
diagonal expansion across media and related industries. One useful benefit
of this strategy is that it helps to spread risk. Large diversified media
firms are, to some extent at least, cushioned against any damaging movements
that affect any single one of the sectors they are involved in. More
importantly perhaps, the widespread availability of economies of scale and
scope means that many media firms stand to benefit from strategies of
diagonal expansion.
In addition, many media firms have become what are called transnationals
– corporations with a presence in many countries and (in some
cases) a decentralized management structure. Globalization has encouraged
media operators to look beyond the local or home market as a way
of expanding their consumer base horizontally and of extending their
economies of scale. For example, UK media conglomerate EMAP plc
acquired several magazine publishing operations in France in the mid-
1990s and has since expanded heavily into the US market. Swedish group
Bonnier, which specializes in business news and information, expanded
into the UK in autumn 2000 with the launch of a new daily newspaper,
Business AM, in Scotland.
The basic rationale behind all such strategies of enlargement is usually
to try and use common resources more fully. Diversified and large scale
media organizations are clearly in the best position to exploit common
resources across different product and geographic markets. Enlarged
enterprises are better able to reap the economies of scale and scope which
are naturally present in the industry and which, thanks to globalization
and convergence, have become even more pronounced.
This leads towards what Demers calls the ‘paradox of capitalism’ – that
increased global competition results in less competition in the long run
(Demers, 1999: 48). Even with a loosening up of national markets and
Corporate strategies 23
fewer technological barriers to protect media incumbents from new
competitors, the trend that exists in the media – of increased concentration
of ownership and power in the hands of a few very large transnational
corporations – clearly reflects the overwhelming advantages that accrue
to large scale firms.
MANAGERIAL THEORIES
The economic characteristics of media output and the market changes
discussed above provide a compelling explanation for why profitmaximizing
media firms should pursue strategies of expansion. But there
are alternative schools of thought on what it is that drives firms – media
or otherwise – to expand. Other approaches suggest that expansion is
usually more to do with satisfying the personal interests of managers rather
than with maximizing profits.
Most firms these days take the form of a public limited company (or
plc) and are run by managers rather than by owners (or shareholders).
Ownership and control of the firm are therefore separate and, because
managers have different objectives from shareholders, a divergence from
profit maximization becomes possible.
Principal–agent analysis shows that, when ownership and control are
separated, the self-interest of agents . . . [in this case, media managers] . . .
will tend to make profits lower than in a ‘perfect’, frictionless world in which
principals . . . [in this case, media shareholders] . . . act as their own agents.
(Lipsey and Chrystal, 1995: 318)
Managers are, of course, concerned with keeping up profits, but they
also have their own personal concerns. Marris – an influential management
theorist – suggested that a principal aim of managers is try to expand
the firms they are running, at all costs, and irrespective of whether it would
make the firm more efficient or more profitable (Moschandreas, 1994:
284–5). The suggestion by Marris, Williamson and other managerial
theorists is that growth of the firm is the main objective because this
raises managerial utility ‘by bringing higher salaries, power, status, and
job security’ (Griffiths and Wall, 1999: 91).
So the reasons why managers try to expand the firm may be because,
first, salary levels for senior management are quite closely linked to the
scale of a firm’s activities. For example, the Chief Executive of British
Telecommunications (BT) earns more than the Chief Executive of Scottish
Media Group (SMG) or of the Stirling Observer. Fast-growing rather than
24 Understanding media economics
static firms also give higher remuneration to managers. In addition, as a
firm grows, its senior managers become powerful captains of industry
and are often invited to join prestigious industry bodies, such as the
Confederation of British Industry (CBI). The senior manager of a large
media firm clearly has a powerful and politically influential role.
Another reason why managers try to ‘build empires’ may be because
it makes it more difficult for their firm to be taken over by a predator.
Senior managers usually want to avoid takeover and the risk of replacement
by a new management team. By expanding – e.g. through acquisition
of several smaller companies – a firm makes itself a more expensive and
difficult target for takeover. The less prone a firm is to takeover, the greater
the job security of its senior managers.
Most scholars of industrial economics accept that managers have
some element of discretion to pursue goals other than profit maximization,
and that managerial agendas can sometimes help explain corporate
behaviour. On the other hand, deterministic approaches to expansion
on the part of the firm tend to emphasize profit maximization as the
fundamental motive. The remaining sections of this chapter draw on recent
empirical research carried out in the UK for examples of what sorts of
benefits and advantages accrue, in practice, as media firms expand.1
ADVANTAGES OF HORIZONTAL EXPANSION
In general, horizontal expansion – i.e. expansion in a firm’s market share,
either through internal growth or by acquisition of another firm with a
similar product – may be motivated by the profit-maximizing firm’s desire
for greater market power (e.g. the ability to exercise some control over
price) or by efficiency gains. The net impact of expansion on market
performance and, ultimately, on societal welfare generally depends on
the trade-off between these two possible outcomes. Whereas the achievement
of efficiency gains (an improved use of resources) may be seen as
serving the public interest, the accumulation of market power and market
dominance may lead to behaviour and practices which run contrary to the
public interest.
The relationship between the size and efficiency of firms depends largely
on the availability of economies of scale: on whether marginal costs are
less than average costs as output expands (Martin, 1993: 21). Economies
of scale, which are frequently cited as the most important motive for
Corporate strategies 25
1. The findings of this research are reported in fuller detail in Doyle (2000).
horizontal mergers or acquisitions (Griffiths and Wall, 1999: 90–1), are
a particularly prevalent incentive for expansion by media firms.
The experience of a sample of UK television broadcasting companies
in 1996 provides evidence that large broadcasters are more profitable than
small ones (Figure 2.2). The correlation between market share and
profitability suggested by this data is largely to do with economies of scale.2
The factors other than size which are most likely to have a bearing on
the financial performance of individual media companies are variations
in managerial efficiency and niche product positions. The relationship
between size and performance may, of course, be subject to some additional
complexities.3
Nonetheless, the evidence provided by this sample
group confirms that television broadcasters enjoy greater economies of
scale (and, in turn, higher profits) as their market share expands.
This correlation is not entirely surprising. As previous writers have
noted, extensive product-specific economies of scale exist in the broadcasting
industry because, once a delivery infrastructure is in place, the
marginal costs of providing the service to an additional viewer (within one’s
26 Understanding media economics
2. According to findings gathered from interviews carried out in 1997 with senior
managers across this group of UK media firms.
3. Different delivery systems for television in the UK have different cost and
revenue structures, partly reflecting technology but also because of (uneven)
regulation.
50
45
40
35
30
25
20
15
10
5
0
0 2 4 6 8
Grampian Scottish TV
BSkyB (NI)
UN&M
Granada
Share of total UK TV audience (%)
Operating
profit
margin (%)
FIGURE 2.2 Market share and operating profit margins in television broadcasting
in 1996
Note: Figures compiled drawing on Broadcasters Audience Research Board (BARB)
ratings, company annual accounts and estimates for divisional analysis. News
International (NI) is the largest shareholder in satellite broadcasting BSkyB. United News
& Media (UN&M), like Granada, Scottish Television and Grampian Television operated
one or more regional terrestrial services in 1996.
transmission area or ‘footprint’) are zero or extremely low (Cave, 1989:
11–12). The overhead costs associated with providing a given service tend
to be equal, regardless of audience size and so, ceteris paribus, economies
of scale arise as larger audiences are translated into more revenue.
Economies of scale are present in virtually all sectors of the media, from
magazine publishing to radio broadcasting to music publishing. Consequently,
horizontal expansion is an advantageous strategy for most media
firms. In newspaper publishing, for example, the marginal costs involved
in selling one additional copy of the same edition of a newspaper are
relatively low, so product-specific economies of scale will arise as circulations
expand. Marginal costs are positive since (unlike broadcasting) the
product is delivered in a tangible form, involving some printing and
distribution costs. But editorial overheads tend to be the largest single
component of expenditure for print media publishers and these do not
necessarily change as consumption of the product expands or contracts.
The editorial overheads associated with publishing any given newspaper
title tend to be ‘fixed’, regardless of actual circulation volume, and so
economies of scale can be gained as larger levels of readership are translated
into more revenue.
The widespread availability of economies of scale in the media industry
is generally associated with low replication costs for media output. Initial
production costs (the cost of creating the first or master copy) may be high
but then very few marginal costs are incurred as the product is replicated
and distributed or sold over and over again to ever greater numbers of
consumers. However, even within the expensive initial content production
phase, economies of scale may be present. Firms engaged in content
production may find that marginal costs (say, the cost of creating one
additional hour of a television drama) are lower than average costs (total
production costs divided by the number of hours of drama already
produced) as output expands.
As the output of a television production company increases, the firm
may derive economies of scale on fixed overheads by, for example, making
better use of capital equipment (cameras, post-production facilities, etc.)
or salaried personnel. So horizontal expansion may be motivated by the
desire to increase the use of under-utilized resources. Media companies
that expand horizontally and increase their output may also enjoy
productivity gains because of the opportunity for specialization of tasks
as the firm grows larger. The realization of scale economies may, arguably,
facilitate higher levels of gross investment and speedier adoption of new
technologies on the part of large media firms. And faster growing media
firms may be able to attract better-quality personnel.
When a firm expands horizontally, an important potential efficiency
gain is the opportunity to spread the use of specialized resources or
Corporate strategies 27
expertise across more than one product. Any savings made in this way
represent economies of scope. Efficiency gains will arise if specialist content
gathered for one media product can be re-used in another.
So economies of scope as well as economies of scale may co-exist for
television broadcasters who operate more than one programme service,
and the more homogeneity possible between both services, the greater
the economies of scope. To the extent that the owner of two regional
broadcasting services or two local cable franchises is able to share the same
programming, or common elements of programming, a cost advantage
can be achieved. Broadcasting ‘networks’, which are discussed in Chapter
4, are based on the logic of exploiting such advantages. As a broadcaster
expands horizontally and increases the number of services it is delivering,
opportunities arise to combine back-office activities (e.g. finance and
administration) as well as specialist support functions such as airtime sales
or secondary programme sales.
The prevalence of economies of scope in the media explains the
widespread tendency towards expansion and the high number of multiproduct
firms. For example, EMAP plc currently owns some 19 separate
local radio stations throughout the UK. News Corporation owns four
major national newspaper titles.
For newspaper proprietors that publish more than one title, various
economies of scope may arise. Large publishers may achieve better
collective terms on input prices or support services (e.g. printing or
distribution). Publishers of several titles may be able to combine and
rationalize back-office functions or other shared activities such as advertising
sales. However, there is disagreement about the extent to which
economies of scope can be gained within the editorial process. Perspectives
offered by experienced managers in the UK newspaper industry indicate
a divergence in opinions about how far the process of sharing costs
between different newspaper titles can go.
At one extreme, some newspaper executives believe that the most costeffective
way to produce a given range of titles is to draw, as appropriate
to each newspaper’s individual character, on what is regarded as a
completely flexible internal pool of shared journalistic expertise:
[Title X] . . . has a whole machinery for covering television soap operas
and the Royal Family, so why would it be duplicated by . . . [Title Y]?
Why doesn’t . . . [Title Y] simply leverage the resource brought in by its
partner newspaper, and customise it, so that it’s all in the editing process
rather than the gathering process?4
28 Understanding media economics
4. Citation from interview carried out in April 1997 with the CEO of a major
UK newspaper publishing firm.
However, many publishers are sceptical about the benefits available from
trying to integrate as many cost functions as possible for competing titles.
Combining the journalistic functions of different titles may yield cost
savings but a majority of UK publishers seem to feel that this would
jeopardize the individual tone of each product:
We’ve looked at all this and it is not any easy one . . . Sharing journalists
across different titles would be extreme. It is very hard to do . . . You risk
losing the independence of your title . . .5
The presence of economies of scale and scope in the media implies a natural
gravitation towards oligopoly market structures and large scale multiproduct
firms. Provided that product quality does not suffer as a result
of sharing or spreading costs amongst more consumers or over a greater
number of media products, then strategies of horizontal expansion will
yield efficiency gains which, in theory, ought to add to societal welfare.
However, if cost-savings are achieved at the expense of viewers’ or readers’
utility then we cannot say that expansion leads to improved efficiency.
Aside from efficiency, another important advantage of having a large
market presence in any sector of the media (or of cross-owning media
products in several sectors) is that it gives the firm greater ‘critical mass’.
Large firms have greater negotiating leverage in deals with suppliers and
with buyers. For example, large newspaper and magazine publishers will
tend to get a better deal on paper and newsprint prices. A dominant firm
has greater ability to exercise some control over the prices it charges its
customers. Large media firms who control access to mass audiences may
well be able to command premium prices for advertising (i.e. a higher
cost per thousand – CPT – rate than smaller firms).
The greater market power which large media firms command will
enhance their profitability, but it may also harm consumer interests (e.g.
if prices charged are too high) and it may pose a threat to the operation
of markets. To the extent that the exercise of market power by large media
groups serves to impede competition, then the strategic advantage it
confers upon the individual firm is simultaneously an obstacle to market
efficiency and a disadvantage for consumers. In summary then, strategies
of horizontal expansion can deliver a range of efficiency gains that
contribute positively to societal welfare but they will pose a threat when
individual firms are allowed to acquire excessive market power.
Corporate strategies 29
5. Citation from interview carried out in April 1997 with the Finance Director
of a major UK newspaper publisher and television broadcaster.
ADVANTAGES OF DIAGONAL EXPANSION
Diagonal expansion refers to developing the business sideways or ‘diagonally’
into what may be perceived as complementary activities (e.g.
newspapers plus magazines, or television plus radio). Many strategies of
diagonal cross-media expansion result in positive synergies and efficiency
gains. A very important potential advantage is the opportunity to spread
the use of specialized resources or expertise across more than one sort
of media product. This will, of course, give rise to economies of scale
and of scope.
The combinations of cross-media ownership that yield the most significant
economic efficiencies tend to be those which enable the firm to share
either common specialized forms of content or a common distribution
infrastructure. When a media firm’s output is characterized by a particular
theme or subject matter, then expanding operations into several different
sectors will usually create important synergies. For example, Pearson’s
specialization in providing one particular form of media content – management
information – enables it to exploit economies of scale and scope
across several different products (e.g. the Financial Times newspaper, FT
business magazines, FT newsletters, FT newscasts, etc.) and modes of
delivery (e.g. print, broadcast) for that content.
A focus on one particular type of content may enable the firm to build
very strong brands that are more likely to be successful in crossing over
from one platform to another. So specialization and the development of
recognizable brands (e.g. the Financial Times) make it easier for firms to
exploit new vehicles for delivery of media content, such as the Internet.
In addition, diversified media companies such as Pearson or Time Warner
are able to reduce costs by exploiting overlaps in the production process
for some of their products. Cross-ownership between, for example,
newspaper publishing, magazine publishing and book publishing creates
potential economies in any processes and inputs which are common to
all of these activities, such as printing and purchasing paper.
Most significantly, however, the availability of economies of scale and
scope depends on the extent to which specialist inputs – i.e. elements of
media content – or other important resources can be re-used or exploited
more fully as the firm expands diagonally. This, in turn, may depend on
how homogeneous the content of each media product is and how readily
such content can be repackaged into different formats (i.e. the relationship
between the marginal costs of reformatting content and the marginal
revenues likely to be raised by selling it again in extra product markets).
Digitization makes it possible to reduce all sorts of images, sounds
and text to a common format and to transport these via a common distribution
infrastructure. Media content, when reduced to digital ‘metadata’,
30 Understanding media economics
can be stored, retrieved, manipulated, reformatted and repackaged with
much greater ease than before. So the spread of digital technologies across
different sectors of the media and communications industries has significant
implications for the savings and efficiency gains that are potentially
available via strategies of diagonal cross-media expansion.
The benefits and advantages of diagonal expansion involving media
and telecommunications companies have been analysed by Albarran and
Dimmick, who use the term ‘economies of multiformity’ to describe the
benefits of diagonal concentrations of ownership (1996: 43). Economies
of multiformity refer to any and all advantages that firms derive from
cross-owning activities in more than one sector of the media or communications
industry. Such economies will be gained by a telephone company
moving into the cable television industry and using its existing distribution
infrastructure to sell two services instead of just one – i.e. economies of
scale in distribution. Or economies of multiformity arise when the same
media content is repackaged or repurposed into different media products
– i.e. economies of scope. Thus, the term ‘economies of multiformity’
embraces all benefits that come about through diagonal cross-ownership
in the media and communications industries.
Different combinations of diagonal cross-ownership will, of course,
yield different sorts of efficiency gains. Expansion from print to electronic
publishing offers plentiful opportunity to share or repurpose specialist
content between these two different text-based activities. Likewise,
diagonal mergers between magazine and newspaper publishers can offer
operational synergies. Efficiency gains are also possible, to some extent,
through sharing of production and transmission resources between radio
and television (as exemplified by the ‘bi-media’ approach introduced at
the BBC in the 1990s).
However, combinations of text-based plus audio products, or textbased
plus audiovisual products will not necessarily give rise to economies
of scale or scope or to any other economic advantages. Where a newspaper
and a television service share a strong common focus or theme (e.g. a focus
on business news or on a specific locality) then clearly opportunities will
arise to share or repurpose intellectual property. But when no such overlap
in content exists then relatively few other potential efficiency gains seem
to be available. Some opportunities may arise to combine back-office
activities or, perhaps, to introduce improvements in managerial efficiency
but no more than in any merger involving other (loosely related) sectors
of activity. As one senior UK media executive points out:
[t]here are actually a lot of successful groups who have operated both
[television broadcasting and newspaper publishing], always operating each
distinctly – with the exception of, occasionally, slavishly cross-promoting
[e.g. using an established newspaper title to promote a new TV service] . . .
Corporate strategies 31
I do not think that television and newspapers are a ‘natural’ diversification
from each other.
Notwithstanding the spread of digital technologies, the skills, techniques
and equipment involved in newspaper production and distribution are,
in fact, generally still quite different from those required in the television
industry, and vice versa. So, combining these activities under common
ownership will not necessarily create any special efficiency gains or
opportunities to rationalize resources. Unless each service has a strong
shared focus there is little economic incentive for seeking to combine these
activities. Consequently, diversified media conglomerates such as News
Corporation will often allow broadcasting and newspaper subsidiaries
to operate in almost complete isolation from each other.
If ‘natural’ economies of scope between broadcasting and newspaper
publishing activities are non-existent, it follows that few economic benefits
can be directly or solely attributed to diagonal expansion from television
to newspapers or vice versa. Why then, are strategies of diagonal crossmedia
ownership so common?
One very important special feature of cross-owning television and
newspapers is the opportunity it creates to cross-promote the firm’s
products. Whether this feature is economically beneficial or damaging
depends on how it is used. When cross-promotion is used to facilitate
de novo expansion (the introduction of new products which increase
choice) then welfare and competition should be enhanced (Moschandreas,
1994: 349). For example, if a media conglomerate uses the pages of its
newspapers to attract attention to and promote the launch of a new
television service that adds to competition and viewer choice then,
arguably, cross-promotion is economically beneficial. On the other hand,
if the conglomerate uses cross-promotion to build cross-sectoral dominance
for its existing media products then this will have a negative impact
on competition and on pluralism.
Risk-reduction is another potential benefit associated with diagonal
expansion. Firms diversify in order to spread their risks and so that they
are not too dependent on any one product market. A media firm whose
income is derived wholly from advertising (e.g. a commercial radio
broadcaster) may expand operations into another media sector where
revenues come directly from consumers in order to protect or cushion itself
against cyclical downturns in advertising expenditure. A firm operating
in a declining industry may wish to diversify into a perceived growth
area. The UK national newspaper industry provides a clear example of
a sector which is in slow decline while subscription television and electronic
media are perceived as growth areas. So newspaper publishers might
well seek to diversify in order to secure growth in future earnings.
32 Understanding media economics
Another motivation underlying strategies of cross-media expansion is
the desire to exploit anticipated synergies and ‘economies of multiformity’
between newspaper publishing and television broadcasting which may
develop over the long term. The expectation that growth in electronic
communications will stimulate demand for new products based on both
audiovisual images and text has been cited as one factor encouraging
diagonal mergers between UK television broadcasters and newspaper
publishing companies.
Motives other than profit maximization – i.e. managerial motives – may
also play a role in cross-media mergers. A television company may decide
to join forces with a newspaper publishing firm as ‘a defensive move’
against hostile takeover, i.e. in order to make the enlarged company less
attractive to potential predators. Alternatively, the managers of a media
firm may pursue a strategy of diagonal expansion because, irrespective
of efficiency implications, their own prestige (and, perhaps, political
influence) will increase as their ‘empire’ grows.
So in analysing the gains that arise from any strategy of diagonal
expansion, it is worth distinguishing between different sorts of advantage
– efficiency gains versus risk-spreading, etc. – and between different
potential beneficiaries – the firm’s shareholders, or its managers or society
at large. The achievement of efficiency gains (e.g. economies of scale and
scope) will not only serve the interests of the firm but should also
contribute to the wider good of the economy by engendering an improved
use of resources. However, strategies of cross-media expansion that yield
no efficiency gains and are predicated solely on the strategic interests of
the firm’s shareholders or managers will not give rise to any general
economic gains.
On the contrary, the accumulation of greater size, more market power
and dominant market positions can lead to behaviour and practices which
run contrary to the public interest (Moshandreas, 1994: 483–4). Once a
firm achieves a dominant position, the removal of competitive pressures
may give rise to various inefficiencies, including excessive expenditure of
resources aimed simply at maintaining dominance. Hence, competition
policy – which applies to media as well other firms – strives to promote
sufficient competition to induce firms to operate efficiently. Public policy
issues surrounding concentrated media ownership are dealt with in fuller
detail in Chapter 9.
Corporate strategies 33
ADVANTAGES OF VERTICAL EXPANSION
The vertical supply chain outlined in Figure 2.1 indicates how it is possible
to break down into stages each of the activities involved in making
and then supplying a media product to the consumer. For instance, the
newspaper industry can be disaggregated into news-gathering, editing,
printing, distribution and retailing. The television industry can be broadly
broken down into programme production, assembling the schedule and
transmission to viewers. Many media firms are vertically integrated – i.e.
they are involved in activities at more than one stage in the supply process.
Vertical expansion is a strategy which is increasingly common, for
example, amongst the main US television broadcasting networks and their
suppliers and rivals (Owen and Wildman, 1992: 202–4).
Why is vertical integration an attractive strategy? Broadly speaking,
it makes sense to control both content production and distribution because
the greater the distribution of your output the lower your per-unit
production costs will be. In television, per-viewer production costs can
be reduced by ‘selling’ the same output to as many different audiences
or segments of the audience as possible. As a distributor, vertical expansion
upstream into production means that you have an assured supply of
appropriate content to disseminate through your distribution infrastructure.
As a content producer, vertical integration with a distributor
means assured access to audiences.
Vertical expansion is not only about maximizing revenues and gaining
more security or control over the market. Another advantage is that it
can reduce ‘transaction costs’. Broadcasters who internalize the programme
production process rather than purchasing programme rights in
the open market may face fewer complications, delays and so on in
securing exactly the sort of content they require.
So, as with other forms of expansion, the two main incentives associated
with vertical growth are improved efficiency and the accumulation of
market power. In any example of vertical expansion, both motives may
be present and, indeed, ‘the two are not unrelated’ (George et al., 1992:
65). Vertical integration may be motivated by the desire to minimize
costs or by the desire for greater security (e.g. access to essential raw
materials such as, for a broadcaster, attractive television programming)
but then the latter – the desire to gain some control over the market
environment – may itself result in market dominance.
Looking more closely at how vertical integration can help minimize
costs, an important consideration is the difference between the expenses
involved in buying from or selling to other firms – obtaining information,
negotiating contracts, etc. – and the expenses involved in carrying out the
functions performed by these other firms within one’s own organization.
34 Understanding media economics
Ronald Coase (1937) first introduced the idea that ‘the market’ and ‘the
firm’ represent alternative modes for allocating resources. For Coase, firms
exist because the co-ordination of economic activity through the firm (by
hierarchies of managers) is less costly than through the market (by the
pricing system). Integration of activities within the structure of a firm will
occur because it creates ‘transaction cost’ savings and these act as an
incentive to integrate vertically.
The potential for cost reduction within a firm may stem from improved
information – about price or product specifications or, more generally,
about the market. In the television industry, for example, the costs (created
by uncertainty, weaker informational flows, etc.) involved in inter-firm
trade between programme producers and broadcasters may well be higher
than when both activities are carried out in house. It may save time and
hassle to be able to source the programmes that are needed directly from
an in-house production division rather than having to shop around,
negotiate and make deals with external programme-makers.
But, for media firms, a more important factor encouraging vertical
expansion stems from the interdependent relation of different phases in
the supply chain. Media content is no good without access to audiences,
and vice versa. So, the main driving force for firms to diversify into
additional upstream or downstream phases is the desire to gain more
security and control over the market environment. Integrated media firms
can avoid the market power of dominant suppliers or buyers. Vertical
expansion gives secure access to essential inputs or essential distribution
outlets for output. This is a key advantage in the media, since firms depend
on getting access both to content and to avenues for distribution of
content.
A broadcaster that has to rely on external producers to supply all the
‘hit’ programmes in its schedule will find itself vulnerable to the possibility
of post-contractual opportunistic behaviour on the part of these suppliers.
If the supplier of a key programme series in a broadcaster’s schedule
threatens to withdraw that series or sell it at a higher price to a rival
broadcaster, then high costs may have to be incurred to retain that
programme. Vertical integration is a way of avoiding the higher costs
associated with such behaviour (Martin, 1993: 274).
If monopoly power is present in the programme production stage (say,
because a supplier has control over a specific programme for which no
perceived substitutes are available) then, even without vertical integration,
the firm with upstream monopoly power may be able to appropriate some
of any monopoly profits available at the broadcasting stage (Moschandreas,
1994: 417). It is rarely the situation that no substitutes are available for
a particular product but, in television programming specificity of inputs
(particular actors, writers or presenters) is a factor in their popularity and
Corporate strategies 35
success. So, to avoid being held to ransom by important suppliers, broadcasters
and other media distributors may have no choice other than to
expand vertically into production.
From a content-producer’s point of view there are also numerous
attractions in vertical integration. Ownership of, say, a broadcaster or a
video distributor ensures that the firm’s output will find its way to
audiences. Vertical integration may lead to a more predictable and reliable
stream of orders. According to the Finance Director of a major television
company which is part of the ITV network in the UK, a production
company that is vertically integrated with a broadcaster will gain
informational advantages over its independent rivals which help it to
secure more ‘commissions’ or orders for programmes:
Everyone likes to pretend that there’s a level playing field in terms of access
[for independent and vertically integrated producers] to the ITV network
– I don’t think anyone actually does believe that because it’s perfectly
obvious that if you’ve got the same people working in production as
broadcasting then you’re not going to have ‘Chinese Walls’. There’s going
to be occasions when someone from broadcasting says to someone from
production – ‘I’ll tell you what we really want: a cracking entertainment
programme for Wednesday nights’. There is absolutely no doubt that being
part of ITV [broadcasting] gets the intelligence to you faster. It would be
daft to pretend otherwise, because it’s self-evident, really . . .
A steady and predictable production slate is an important advantage for
programme-makers. This, in turn, allows the vertically integrated production
company to plan more effectively and to use its production resources,
equipment, technicians and personnel more efficiently. The assured
distribution enjoyed by a vertically integrated production firm also helps
to build that producer’s reputation, or brand name, as a supplier of
programmes.
An example of another sort of vertical/diagonal merger in the media
industry was provided recently by Time Warner and America Online
(AOL). Time Warner, a major producer of news and entertainment, owns
a huge library of media content and also runs the second-largest US cable
network. America Online is the largest Internet Service Provider (ISP) in
the US with some 26 million subscribers. The potential gains for Time
Warner/AOL from bringing together strengths both in content creation
and in online distribution are clearly very promising. The dangers posed
to rivals by allowing such a powerful vertically integrated entity to take
shape were summed up in a Financial Times editorial as follows: ‘The
combined group could harm other content providers by restricting access
to AOL subscribers and damage other ISPs by denying them access to Time
Warner content’ (2001: 22).
36 Understanding media economics
It is sometimes difficult to disentangle the pursuit of greater efficiency
and greater security from the pursuit of monopoly power (George et al.,
1992: 72). A media firm might well expand vertically in order to gain
greater security, but the more control it acquires over all stages in the
vertical supply chain, the more danger there is that it will start to dominate
the market, with detrimental consequences for rivals and consumers.
Vertical integration may protect the market power of incumbent firms
by raising barriers to entry. For example, if all the best programmeproducers
are cross-owned by broadcasters then, in order to secure its own
supply of attractive programming, a new market entrant in the broadcasting
arena would also be forced to adopt a vertically integrated structure
(thus pushing up the costs of market entry). So, vertical expansion can
be seen, in one way (i.e. that of Coase), as a response to market failures
and imperfections and, in another sense, as a source of such market
imperfections.
Corporate strategies 37
three
ECONOMICS OF ADVERTISING
O
ne of the main sources of revenue for many media organizations
is advertising. Consequently, patterns of advertising activity exert
a very significant influence on the fortunes of the media industry
as a whole. This chapter is concerned with the key arguments surrounding
the economic role played by advertising, and with its impact on market
structures and on consumer decision-making. It introduces you to the
economic forces and factors which determine the extent of advertising
activity in an economy, examining why levels of advertising vary from one
country to another, and over time. It also considers the impact of new
media technologies on patterns of advertising.
After studying this chapter, you should be able to:
• Understand why advertising takes place
• Identify and explain the factors which influence the amount of
advertising activity taking place in an economy, and understand why
it is cyclical
• Assess whether advertising is a beneficial or a harmful economic force
• Explain the problems firms face in deciding how much of their resources
to devote to advertising
THE ADVERTISING INDUSTRY
Advertising is ubiquitous. Its roots can be traced back to the cave but,
in the twenty-first century, its reach and influence have become virtually
inescapable. Over the last 50 years an increased willingness on the part
of firms to invest in building awareness of themselves and of their wares
has given rise to the rapid development of the advertising, marketing and
public relations sectors. Advertising agencies have generated catchphrases,
jingles and images to make brands familiar to audiences both across the
globe and across generations.
Advertising is big business, and the industry it has spawned has grown
quickly and diversified to keep pace with ongoing market changes and
with the development of newer forms of media. Alongside the basic
function of creating advertising messages, many agencies offer an array
of specialist communication services, including provision of sophisticated
market research information or consultancy related to sponsorship deals.
The major advertising agencies in the world – of which WPP, Omnicom
and Interpublic are currently the largest – are diversified multinational
corporations with networks of operating subsidiaries and strategic
alliances that provide clients with global audience reach as well as creative
advertising ideas.
As advertising expenditure has grown in response to rising economic
prosperity in the developed world, the advertising industry has flourished.
According to estimates from Zenith Media (cited in Tomkins, 2000),
global expenditure on advertising reached some $330 billion in the year
2000 – a sizeable slice of our collective resources. But even this understates
the extent of advertising, because industry projections tend to focus on
conventional media only – i.e. television, radio, press, cinema and ‘outdoor’
or billboard sites. This excludes some significant investment in other
forms of advertising and marketing including, of growing importance since
the late 1990s, expenditure on Internet advertising. It is suggested that
around $7.5 billion was spent globally on Net advertising in 1999 (Zenith
Media, 2001: 115) and expenditure on it is continuing to expand rapidly,
particularly in the USA.
The growth of the advertising sector has brought about the establishment
of various industry bodies including, in the UK, the Advertising
Association (AA). Founded in 1924, the AA represents all branches of
the industry and its functions include promoting the benefits of advertising,
lobbying on behalf of its members and gathering information about all
aspects of advertising (Meech, 1999: 29). Annual statistics compiled by
the Association provide a clear picture of the extent of advertising activity
both within individual sectors, such as television or radio, and across the
media as a whole. The breakdown provided in Table 3.1 reveals a healthy
pattern of growth in UK expenditure on advertising in all the major media
in recent years.
40 Understanding media economics
WHY DOES ADVERTISING TAKE PLACE?
Why does all this advertising take place? Firms spend money on advertising
in the hope of persuading consumers to buy their products. The general
aim behind advertising expenditure is to try to increase sales and to
reinforce consumers’ loyalty to particular brands.1
So, advertising is a form
of competitive behaviour: it is one of the main tools that firms can use
to compete to entice consumers to switch to their own product rather than
that of a rival. Other tactics a firm might use to try to gain advantage
over its competitors include making changes to the quality of the product
so as to increase its attractiveness, or simply making adjustments to its
price so as to undercut rivals.
According to the economic theory of firms, whether or not an organization
is likely to engage in competitive behaviour depends on which
kind of market structure it is operating within. As discussed earlier, the
term ‘competitive market structure’ describes the kind of market situation
a firm can find itself in, and is primarily to do with how many rivals it
has, whether the market is open to new entrants, how similar the goods
on offer are, and how much power each firm has in relation to market
demand and over prices. Advertising generally takes place in market
situations where firms have an incentive to engage in some form of
competitive behaviour (Chiplin and Sturgess, 1981; Lipsey and Chrystal,
1995: 259).
Broadly speaking, the more competition that is present in a market,
the greater the need to advertise. Thanks to globalization, most sectors
of industry are now operating in a much more competitive environment
than at any time in the past. In addition, deregulation and the wider
Economics of advertising 41
TABLE 3.1 Breakdown of total advertising expenditure in the UK (£bn)
1995 1996 1997 1998 1999
Press 5.98 6.41 6.97 7.53 7.83
Television 3.14 3.39 3.70 4.03 4.32
Outdoor & Transport 0.41 0.47 0.55 0.61 0.65
Radio 0.30 0.34 0.39 0.46 0.52
Cinema 0.07 0.07 0.09 0.10 0.12
Total 9.89 10.68 11.70 12.73 13.44
Source: Advertising Association (2000: 33)
1. When advertising is successful, it may cause the demand curve to shift outwards
(reflecting an increased market share) and also to become steeper (as price
elasticity is reduced). The concept of elasticity is discussed in further detail in
Chapter 7.
availability of inexpensive technological know-how have served to intensify
competitive pressures in many areas of industry. Consequently, there
is an ever-increasing trend for firms to regard advertising as the best means
of differentiating and drawing attention to their own brands, and this is
reflected by growth in overall levels of advertising in recent years. As
demonstrated in Table 3.1 , total expenditure on advertising across the
major media in the UK grew from £9.9 billion in 1995 to £13.4 billion
in 1999.
Nonetheless, the decision by specific firms about whether or not to
engage in advertising or other sorts of competitive behaviour is determined,
to a large extent, by which kind of market structure the company
is operating within. Perhaps surprisingly, firms that operate in ‘perfectly’
competitive markets do not need to compete actively to stoke up demand
for their own product because, in theory, none has any influence over
the market. It is assumed that in the rather utopian circumstances of perfect
competition, there is no point in any individual firm spending money to
advertise its wares because each firm’s goods are exactly the same as
everyone else’s and consumers are perfectly well aware of this.
At the other end of the scale, in very uncompetitive market circumstances
such as a monopoly or a monopolistic market structure – where
there are no close substitutes for an organization’s products – the firm
has no rivals to worry about. So, monopolists also have relatively little
to gain from expending resources on advertising.
On the other hand, firms operating in an oligopoly market structure
are strongly motivated to advertise. Oligopolists do, indeed, have a degree
of market power but they are aware that their rivals also have some power
to influence the market. So competitive behaviour – e.g. advertising or
price competition – is a particular feature of oligopolistic market structures.
In the real world, a very great and increasing number of industries
operate in imperfectly competitive or oligopoly situations. So, at the most
basic level, it is the competitive behaviour of firms operating in oligopoly
market structures that fuels advertising activity. And as global competition
continues to intensify, patterns of advertising expenditure will reflect
this trend.
ARE FIRMS IN CONTROL OF THEIR OWN MARKETS?
US economist J.K. Galbraith has put forward an interesting theory about
the role of advertising. He suggests that firms use advertising to control
their own markets (Lipsey and Chrystal, 1995: 321). Galbraith points out
that firms have to make sizeable investments in developing and launching
42 Understanding media economics
new products but, despite market research, they cannot be entirely certain
how well these new products will be appreciated by consumers and how
profitable they will turn out to be. Firms are exposed to and threatened
by the unpredictability of future events, especially changes in patterns of
demand or fashions or technology. So, to make the future less unpredictable,
firms invest vast sums of money in advertising.
According to Galbraith, expenditure on advertising is intended to
manipulate market demand and to guard against sudden unexpected shifts
in public tastes. Advertising expenditure enables companies to sell what
they themselves want to produce rather than what consumers would want
to buy. At the same time, firms decide not to produce some new products
that consumers might actually like to buy. This allows them to cut the
risks and expenses involved in launching untried products which, even
if they are successful, might well simply undermine the market for existing
products.
So, from Galbraith’s point of view, consumers appear to be the hapless
victims of corporations. We are forced, by the manipulative power of
advertising, to buy things we do not necessarily want and we are deprived
of those products we might like to have. Can this really be true?
Even though the purpose underlying firms’ expenditure on advertising
is to try to increase demand for particular products, wholly unexpected
shifts in consumer demand sometimes occur. At times, the demand for
new categories of products or services cannot just be explained by
manipulative advertising; it has to do with more basic changes, or with
some technological innovation. For example, the general success of the
motor car or of the washing machine can hardly be put down to brainwashing
by advertisers, even if advertising may persuade us to opt for
one brand of these products rather than another. Likewise, the explanation
for escalating interest in Internet services in recent years seems to owe more
to technology, consumer convenience and fashion than to the efforts of
advertisers. So, although advertising plays an important part in shaping
demand, the view that firms can effectively control their own markets is
not entirely a convincing one.
Where advertising seems to be most effective is in shifting and determining
the pattern of demand among existing products which are similar
to each other. In other words, advertising is likely to have more of a
bearing on which brands rather than which products consumers will want
to buy. It undoubtedly helps to create and sustain loyalty to particular
brands but it is unable to dictate overall trends in consumer demand, nor
can it hope to overcome the influence of technology, fashion or the media
on the sorts of products people express a wish for.
Economics of advertising 43
INFORMATIVE VERSUS PERSUASIVE ADVERTISING
Advertising has two related aspects: it sets out to inform consumers of
the characteristics of the various products available, and it tries to influence
consumers by altering their tastes or preferences and, hence, their purchasing
decisions. Informative advertising – giving consumers more
information about what is available to them – can be seen as playing a
useful role in making the market system work more effectively. It fulfils
a valuable function in facilitating the interaction of consumers and
producers. The second function – persuasion – is more questionable in
terms of its impact on consumer welfare.
The distinction between information and persuasion has been a major
preoccupation in historic texts devoted to the economics of advertising.
To summarize briefly, those who see advertising as being informative in
nature tend to view it as a necessary expenditure that keeps markets
competitive in a world where imperfect knowledge is a fact of life. They
argue that, if we didn’t have advertising, then the transaction costs (i.e.
all of the costs involved in negotiating and completing a deal) of any sale
or purchase – especially those to do with the search for goods and for
knowledge about their attributes – would be higher and, as a result, buyers
would be worse off. Not only would they have to pay more for their goods
and services, but the probability of their making a wrong choice would
be increased. The greater the variety of goods and services offered for sale,
the more difficult it is for the consumer to judge the capacity of the good
to satisfy a particular want before he or she buys it and the more the
consumer will value objective information to help him or her to make
the right choice.
Not surprisingly, many who work in the advertising industry take the
view that advertising helps people to make choices in an over-supplied
world. But if the information provided by advertising is not objective, then
the choices it engenders may not be good ones and the effect of advertising
will be to diminish rather than to enhance the overall welfare or utility
of consumers. Those who view advertising as being primarily persuasive
regard it as leading to excessive differentiation of products, resulting in
prices and profits higher than those arising in an ideal competitive world
(Chiplin and Sturgess, 1981: 74–7). Think, for example, of the amount
Coca-Cola and Pepsi spend on advertising when, arguably, there is
relatively little difference between their products. Those who argue that
too many resources are being allocated to advertising are, to some extent,
saying that consumers are being bombarded with rather too much
information and that it pays firms to advertise beyond the point at which
the advertising messages provide any benefit to consumers. They are also
suggesting that the persuasive spin put upon product information by
44 Understanding media economics
advertisers results in incomplete, misleading or distorted messages rather
than a useful resource for consumers.
Is advertising generally harmful or beneficial to the operation of
markets? On the one hand, consumers have to pay a higher price for
products to cover the cost of advertising but, on the other, they benefit
from widespread information about the range and availability of
competing goods and services, and this facilitates their decision-making.
In its role as a source of information for consumers, advertising can be
a pro-competitive force leading to an improved allocation of resources.
Counteracting such a force, however, is a possible anti-competitive effect
caused by the use of advertising as a means of preventing potential rivals
from gaining entry to markets.
ADVERTISING AS A BARRIER TO MARKET ENTRY
An important criticism of advertising relates to its effect on competitive
market structures. It is suggested that firms use advertising to put up
barriers to market entry which prevent other firms from competing with
them (Chiplin and Sturgess, 1981: 112). The basic argument here is that
the millions of pounds invested every year in building up recognition
for their brands by, for example, Procter & Gamble, Kellogg’s or Elida
Fabergé make it difficult or impossible for potential new entrants to
encroach on their product markets unless they also have the scale of
resources and the will to match this expenditure. In other words, heavy
advertising is a means of imposing high set-up costs on new entrants and
this, in turn, serves to deter would-be rivals.
Advertising is a feature of oligopoly market structures. Oligopolists not
only have to worry about competing with their existing rivals to build and
defend market share, they also have to worry about potential competition
from firms that might be tempted to enter their industry. If there are no
natural barriers to entry, oligopolist firms will earn pure profits just in
the short run and until such time as other firms enter their industry.
Oligopolists can protect their profitability in the long run only if they
can find ways of creating barriers that prevent entry.
One method of keeping out potential new entrants is called ‘brand
proliferation’ (Lipsey and Chrystal, 1995: 269). Differentiated products
– i.e. products that are similar but with some discernible differences in
their attributes – usually have several characteristics that can be varied
over a wide range. Thus, there is room in the market for a large number
of similar products each with a somewhat different range of features or
characteristics. Consider, for example, the current range of breakfast
Economics of advertising 45
cereals or cars. Although the multiplicity of brands that manufacturers
make available is, undoubtedly, at least partly a response to consumers’
tastes, it may also be partly the result of a deliberate attempt by existing
players to discourage the entry of new firms. When existing suppliers sell
a wide array of differentiated products this makes it difficult for a new
firm to gain entry on a small scale. Brand proliferation means that, in
effect, all the potential niches are already occupied. The larger the number
of differentiated products already being sold by existing oligopolists, the
smaller the market available to a new firm entering with a single new
product.
Alternatively, existing firms can create barriers to entry by imposing on
new entrants significant fixed costs associated with setting up operations
in that market. This is an important tactic if there are no economies of
large-scale production to provide ‘natural’ barriers to entry. Advertising
is one means by which existing firms can impose heavy set-up costs on
new entrants (Griffiths and Wall, 1999: 127). Advertising, of course, has
effects other than creating barriers to entry. As discussed above, it may
perform the useful function of informing buyers of their alternatives.
Indeed, a new firm may find it necessary to advertise even if existing firms
don’t bother, simply to call attention to its entry into an industry.
Nonetheless, advertising can operate as a potent entry barrier. Effective
brand-image advertising means that a new firm will have to advertise in
order to catch the public’s attention. If the firm’s sales are small then
advertising costs per unit sold will be large (Lipsey and Chrystal, 1995:
270). Unit costs will only be reduced sufficiently to make a new entrant
profitable when sales volumes are large, so that the fixed advertising costs
needed to break into the market are spread over a large number of units.
The combined use of brand proliferation and of heavy advertising
sometimes acts as a formidable entry barrier. This explains why some of
the biggest advertisers often sell multiple brands of the same product.
For example, amongst the top 20 advertisers in the UK in 1999 were
washing powder manufacturers Procter & Gamble and Lever Brothers;
shampoo manufacturers L’Oréal Golden, Van den Bergh and Elida
Fabergé; car manufacturers Renault, Vauxhall, Ford, Volkswagen and
Peugeot; and breakfast cereal manufacturers Kellogg’s and Nestlé
Rowntree (Advertising Association, 2000: 227).
To some extent, the debate about advertising and market structures
is not really about the effects of advertising per se since both sides agree
that it can work as a powerful barrier to entry. Instead, it is about whether
or not barriers to market entry are a good thing or not and whether one
market structure is better than another. Competition is normally considered
a prerequisite for efficiency and, therefore, open and more competitive
markets seem preferable to monopolised ones. If however, by keeping
46 Understanding media economics
rivals out of the market, advertising enables firms to increase their output
and to achieve economies of large-scale production, then arguably this
might serve to benefit consumers. The economies of scale created by
concentration of ownership in the washing powder industry, for example,
means that (provided there is sufficient competition to prevent monopoly
pricing) consumers should enjoy lower product prices than would be
possible under a more fragmented and competitive market structure. So,
provided that firms do not become so large that they can extract monopoly
profits, consumers might occasionally benefit from the anti-competitive
effects of advertising (Parkin et al., 1997: 424–5).
ADVERTISING AND THE PERFORMANCE OF THE ECONOMY
In recent years a great deal of detailed analysis of advertising and economic
data has been undertaken by commercial agencies for the purpose of
forecasting future advertising trends. In the UK, extensive historic data
is compiled and analysed by the Advertising Association each year and
it provides compelling evidence of a link between levels of economic wealth
and of advertising activity.
Examined over a long period of time, expenditure on advertising has
tended to grow as a proportion of the national economy. Advertising
expenditure can be defined in various ways, for example including or
excluding production costs, new media and alternative promotional
expenditures. Likewise, the performance of the economy can be defined
and calculated in different ways, including by Gross Domestic Product.
GDP measures the total value of all productive output in the whole
economy, usually over a one year period and is probably the most widely
used benchmark of general economic performance. When expenditure
on advertising is calculated as a percentage of GDP, the pattern that
emerges indicates that as the national economy has grown over time in
real terms, advertising has not just grown in parallel, but it has grown even
faster. So the amount of advertising activity in an economy is related to
the size and growth rates of the economy itself, and advertising has tended
to account for a progressively more significant proportion of GDP as
time goes on.
The relationship between wealth and levels of advertising does not
simply apply to the UK. It is also clearly observable in other developed
economies and can be demonstrated by a bivariate analysis of GDP per
capita (i.e. the productive output of the country divided by the number
of inhabitants) and advertising expenditure per capita. As demonstrated
in Figure 3.1, the pattern which emerges from international comparisons
Economics of advertising 47
shows a strong and positive association between economic wealth in any
country and the level of advertising expenditure it enjoys. This correlation
is disturbed only occasionally when, for example, government restrictions
on advertising hold back levels of expenditure on commercial airtime.
Generally speaking, richer countries such as Switzerland enjoy a much
higher level of advertising expenditure than poorer countries such as
Greece and Portugal (Advertising Association, 2000: 22).
Why is this? There have been two arguments about the relationship
between advertising and living standards. One is that advertising stimulates
the levels of consumption that are found in countries with high per
capita incomes. This perspective implies a causal connection between high
levels of advertising, high consumption and, in turn, higher levels of
economic activity and growth. The other viewpoint is that advertising is
a ‘waste of resources’ that can only be afforded by rich countries (Chiplin
and Sturgess, 1981: 7).
Historic UK data shows that the growth in advertising as a proportion
of GDP is not exactly steady and continuous. Advertising growth is cyclical
and it reflects, in an exaggerated way, the ups and downs of the economy
at large. In periods of economic expansion the proportion of GDP spent
on advertising increases; the converse is true in recession. Figure 3.2 shows
advertising as a proportion of GDP over 44 years. It demonstrates how
advertising, when expressed as a percentage of GDP, peaks at the top of
economic boom periods such as in 1973 and 1989. By the same token,
expenditure on advertising bottoms out at the lowest point in the economic
48 Understanding media economics
40
35
30
25
20
15
10
5
0
0 50 100 150 200 250
Portugal
Greece
Spain
Italy
Belgium
France
Japan
Austria
Netherlands
UK Ireland
Norway
Sweden
Finland
USA
Denmark
Switzerland
Germany
Press display + classified ad pend per capita (US$)
GDPpercapita(’000US$)
FIGURE 3.1 National advertising expenditure vs GDP, 1998
(NTC Research, Advertising Association, 2000: 22)
cycle, such as in 1975 at the height of oil crisis or in the more recent
recession in 1993. Advertising tends to gallop ahead more quickly than
the economy in boom periods, but then slumps more quickly in recession.
To understand why advertising is cyclical, it is helpful to carry out more
detailed analysis of advertising expenditure data. Advertising is sometimes
broken down into ‘display’ and ‘classified’. Display advertising (the bulk
of advertising expenditure) is total advertising minus financial notices,
classified and advertising in trade or technical journals. Classified is
recruitment, housing, personal advertisements, etc. Different sets of factors
will affect the performance of each of these two categories.
The two primary forces which appear to determine the growth or
decline of display advertising expenditure are consumers’ expenditure and
company profits (Advertising Association, 2000: 20). The close correlation
between company profits and display advertising expenditure suggests
that, perhaps not surprisingly, companies can afford to and do spend more
on advertising when times are good. Likewise, the correlation between
consumers’ expenditure and display advertising expenditure suggests that
companies are willing to spend more when consumer spending and
confidence are buoyant, i.e. when advertising expenditure is more likely
to translate into increased sales. In short, advertising expenditure expands
along with consumer expenditure, but is reined back when company
profits are under pressure.
Classified advertising expenditure is dependent on a variety of factors,
such as the state of the housing market, the second-hand car market and
Economics of advertising 49
’52 ’54 ’56 ’58 ’60 ’62 ’64 ’66 ’68 ’70 ’72 ’74 ’76 ’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96
1
1.5
2
0.5
0
%
FIGURE 3.2 UK advertising as a percentage of GDP, 1952–97
(NTC Research, Advertising Association, 1998: 21)
employment levels. Statistics published annually by the Advertising Association
suggest that the level of unfilled job vacancies is a key determinant
of recruitment classified expenditure (2000: 23). It is mainly recruitment
advertising which pushes up classified and, thus, total advertising expenditure
during economic booms.
The strength of the relationship between advertising cycles and the
state of the economy has been questioned and some would argue that
advertising expenditure should continue to grow, irrespective of the performance
of the economy. Patrick Barwise of London Business School,
for example (cited in Tomkins, 2000), suggests that advertising by firms
with established brands is essentially a defensive activity, carried out in
order to protect their market share rather than in the hope of boosting sales.
Likewise, according to Andrew Ehrenberg of South Bank University,
‘[m]ost advertising is not trying to sell. It’s just maintaining your position
in a competitive market’ (cited in Tomkins, 1999a). Be that as it may,
historic trends in advertising clearly demonstrate the prevalent tendency
for firms to cut back on advertising expenditure as soon as an economic
downturn looms into view. As John Hegarty, Creative Director of advertising
agency Bartle Bogle Hegarty, has explained: ‘[r]ecession is always
a problem for the advertising industry, in the sense that clients feel that
advertising is the first thing they can switch off’ (cited in Smith, 1998: 1).
The apportionment of advertising between different sectors of the
economy is not static, but varies in response to alterations in the market
structure of particular industry sectors. These alterations may reflect policy
changes that are designed to promote or limit competition in a particular
market. For example, advertising expenditure data by product sector in
the UK in the 1980s shows how the deregulation of the UK financial
services industry in the mid-1980s and the accompanying increase in
competitive behaviour on the part of banks and building societies was
reflected in an immediate and sharp increase in advertising expenditure by
banks and building societies. In the 1990s, international deregulation of
telecommunications brought about a great upsurge in advertising expenditure
within this sector as new rivals emerged to compete with longstanding
incumbents in the UK, across Europe and elsewhere.
The emergence of markets for successful new products or service
innovations often has reverberations in the advertising sector. In the early
part of the year 2000, a boom in the number of Internet start-ups created
something of a bonanza for the advertising industry as many new ‘dotcom’
companies launched campaigns (using conventional media, such as billboards
and television) as a means of raising awareness of themselves and
their online businesses. A subsequent downturn in investor confidence
in dotcom start-ups has since diminished some of this rich vein of new
billings for advertising agencies. Even so, it is expected that expenditure
50 Understanding media economics
on advertising by dot.com companies will, by itself, add around 3 per cent
growth to total advertising in the USA and the UK in the year 2000
(Killgren, 2000: 7).
THE FIRM’S ADVERTISING DECISION
The decision each firm takes about how much of its resources to devote
to advertising depends on what it believes this investment can achieve.
What companies expect in return for their expenditure on advertising
varies: whereas some simply want an effective marketing campaign, others
believe that advertising agencies play a broader role in creating and
managing their long-term brand strategies.
Systems of remuneration for advertising agencies have changed
considerably in the UK over the last 10–15 years. Up until the late 1980s,
most agencies expected to be paid a commission on ‘gross billings’ (i.e. the
cost of all advertising space purchased on behalf of the client), usually
at a rate of 15 per cent. US radio comedian Fred Allen coined the definition
of an advertising agency as 85 per cent confusion and 15 per cent commission.
The commission-based mode of payment not only encouraged
agencies to concentrate their efforts on expensive media outlets but, more
significantly, it ignored whether the advertising campaign supplied to the
client was in any way effective or not. Nowadays, advertising agencies
are generally paid on a flat fee basis and, in the UK, around one-third of
their clients favour the concept of ‘payment by results’ (Hall, 2000b: 5).
This approach raises a perplexing and long-standing question surrounding
firms’ expenditure on advertising – namely, how can the effectiveness of
advertising be measured?
Many advertising clients put the ‘payment by results’ approach into
operation by means of a sales-based model of compensation. In other
words, the fee the advertising agency receives is calculated by reference
to the impact of the advertising campaign on client sales. This seems fair,
to the extent that the motivation behind advertising is simply to sustain
or improve demand for the firm’s products or services. However, some
advertising clients regard this approach as too simplistic and prefer to
measure their agencies’ success by, for example, tracking studies that focus
on perceptions of the firm and its brands.
The question of how to measure the effectiveness of advertising expenditure
is important since, unless some idea can be gained about what return
advertising will bring, firms will naturally find it very difficult to decide
how much to spend on this activity. The two most common ways of
researching the effectiveness of advertising involve either measuring the
Economics of advertising 51
success of advertising in communicating its message, or direct tests of
the effects of advertising on sales or profits. Both of these methods, however,
have serious weaknesses.
In the case of testing people’s ability to recall advertising messages,
the obvious weakness is that this approach doesn’t yield any reliable
information about the impact on sales. How often does a clever visual
or punch-line in an advertisement create a lasting impression but without
successfully projecting the brand or having a discernible effect on demand?
Studies that look more broadly at how advertising has affected perceptions
of the firm and its brands suffer from the same problem – the impact
of this expenditure on the firm’s financial performance is not addressed.
The capability for interactive advertising (e.g. on the Net) brings another
way of measuring effectiveness: the number of responses an advertisement
elicits can be counted. All in all, however, proof that advertising has
engaged viewers’ attention, has communicated a message successfully or
has improved a brand or a corporate image is not the same as demonstrating
an impact on profits.
So, for many advertisers, the second method – looking directly at sales
– seems more useful, since the whole point of advertising is usually to boost
sales. But there are also problems with this second method, to do with
establishing any direct causal link between what a firm spends on advertising
and what happens to sales. One immediate problem to be taken into
account with direct testing is that advertising is not, itself, a homogeneous
product. The effect on sales that a given expenditure on advertising will
achieve depends, to a great extent, on the quality of the advertising
campaign that has been purchased. Not all advertising agencies have equal
talent. In the UK, for example, those advertising campaigns which seem
to most clearly demonstrate a profitable return for clients are acknowledged
each year by the Institute of Practitioners in Advertising (IPA)
effectiveness awards competition. The way in which a firm’s sales move
or fail to move as a result of a campaign devised by one particular agency
may not be a reliable indicator of how sales will typically or more generally
respond to investment in advertising.
Another problem is that of time lags. It may take some time before
advertising starts to have the desired impact on sales. Advertising might
inspire an initial trial which might then result in positive recommendations
to friends and, in turn, be followed by further purchases. Advertising
may communicate its message successfully but at a time when the consumer
is not yet in a position to make a purchase. So it may take some
time before advertising has a visible impact on sales. It is often argued that
consumers need to be exposed to a certain amount of advertising before
they will respond but once they do respond, not much advertising is
required to retain their loyalty. Advertising gradually builds up and then
52 Understanding media economics
reinforces the positive perceptions of a product or brand or, in a sense, the
‘goodwill’ that is needed to ensure habitual purchasing of it. Indeed, the
future earnings potential that investment in advertising is thought to have
generated for a firm is sometimes recognized when famous brands are
valued and accounted for as assets on a company balance sheet.
To deal with time lags, a regressive model is sometimes used to measure
the effect of advertising. Advertising which has taken place in a previous
period (say, the first quarter of 1999) is compared with current sales (in
the first quarter of the following year). But a further and more insurmountable
difficulty with measuring the effectiveness of a firm’s expenditure
on advertising is that of the behaviour of rivals. How do you disentangle
the effect of advertising on demand for your product from the effect caused
by whatever your rivals have been up to simultaneously in terms of
advertising or not advertising their own wares, or implementing competitive
price reductions, or instigating product changes or other special
promotional efforts? It is virtually impossible for any firm in an oligopoly
or a competitive market situation to isolate the impact of its own advertising
investment from the impact on demand caused by the behaviour
of its rivals.
So, the problems of measuring the effects of advertising are not simple
and, in particular, it is very difficult to establish proof of some degree of
causality, i.e. that x expenditure on advertising will have y given effect
on sales (Carter, 1998: 6). How, then, do firms decide on their advertising
budgets?
Economists who have considered this question – especially Cowling et
al. (1975), Chiplin and Sturgess (1981) and Duncan (1981) – acknowledge
that many firms simply use some kind of ‘rule of thumb’. The decision taken
about what level of resources to devote to advertising is often based on
customary practice or what amounts to intuition rather than on any attempt
to calculate expected returns. Sometimes advertising is regarded as discretionary
rather than necessary expenditure and firms simply spend whatever
they think they can afford at a given time. This approach is reflected
in historic data, discussed above, which demonstrates the sensitivity of
overall levels of advertising to company profits and to fluctuations in the
economy at large. But the discretionary approach is often criticized on
the basis of being too unscientific and unlikely to achieve great results.
Many firms set their advertising budget as a given proportion of sales
or of assets. The pre-determined percentage of either previous or predicted
sales is a particularly popular method – e.g. this year’s advertising budget
may be set at the rate of 10 per cent of last year’s sales – and it offers
various advantages. It is easy to calculate and it is quite manageable in
financial terms, in the sense that the advertising budget will go up or down
directly in accordance with the firm’s fortunes.
Economics of advertising 53
But how does the firm decide what proportion of sales the advertising
budget should represent? Analysis of historic sales and advertising figures
reveals some very wide disparities between the proportions opted for by
different firms. For example, according to statistics compiled by the
Advertising Association (1996: 226), advertising accounted for just 5 per
cent of what consumers spent on babycare products in 1994 but for a
massive 44 per cent of consumer expenditure on double-glazing! Should
the advertising budget be set at 5 per cent or 44 per cent of sales? Many
firms examine what their competitors are spending and set their own
advertising budget as a similar proportion of sales or assets. But there is
no guarantee that the level set by competitors is optimal.
Some economic theorists have tried to provide a more scientific answer
to this question. Dorfman and Steiner have suggested that, when it comes
to deciding what proportion of sales income to devote to advertising, there
are two things that firms should take into account: first, ‘advertising
elasticity’or how responsive sales are to changes in advertising expenditure
and, second, ‘price elasticity’ or how responsive sales are to any change
in price (Chiplin and Sturgess, 1981: 45). The reason why consumers’
reactions to any price change should be taken into account in setting the
advertising budget is because it would be inefficient to spend money on
advertising if the same money invested in a price reduction would boost
sales by a greater amount. If sales are more responsive to fluctuations in
price than to changes in levels of advertising, this implies that a lower
proportion of sales income should be devoted to advertising.
The Dorfman Steiner approach may have merit in theory but it is by
no means easy to put into operation. Price elasticity refers to the responsiveness
or sensitivity of demand to upward or downward movements
in the price of a product. Likewise, the concept of advertising elasticity
refers to the responsiveness of demand to changes in levels of advertising
expenditure on that product. The problem is that it is virtually impossible
to calculate advertising elasticity in ‘real world’ circumstances because
of constant changes and the unpredictable behaviour of competitors.
ADVERTISING AND NEW MEDIA
The growth of new media such as the Internet and digital television has
provided advertisers with a range of new communication channels through
which they can address messages to their target audience groups. At first
glance, the arrival of additional supplies of audience access seems to be
a positive development, allowing for more specialist targeting and, potentially,
lower advertising costs. However, the growing popularity of new
54 Understanding media economics
media inevitably erodes mass audiences which, from the point of view
of many advertisers, makes consumers more difficult to reach.
Just as newspaper proprietors were concerned about the development
of advertising-supported broadcast media in the 1940s, so too the current
generation of media players is anxious to assess the likely threat to
commercial revenues posed by the development of the Internet, interactive
television and other new multimedia products and services. The question
they face is to what extent the rise of alternative avenues of communication
with consumers may come at the expense of conventional advertising
media and to what extent they may simply expand the overall advertising
market. Will the growth of advertising in new media be incremental to
or a substitute for traditional mass market advertising?
The capacity for interactivity facilitated by digital technology is a major
concern for traditional advertising media. The Internet has already
established itself, especially with younger audiences, as an important
medium and interactive television is also well on its way towards gaining
acceptance. Interactivity is, of course, driving the process of fragmentation
of audiences into ever narrower niches and specialisms. More significantly,
interactivity has the potential to provide advertisers with extensive
information about the tastes, preferences and habits of particular sections
of the audience. The facility for advertisers to get to know their target
customer base – to learn about and speak to individual tastes amongst
niche audiences – is a valuable advantage that conventional mass media
cannot provide.
The Internet is now beginning to compete with traditional media for
a share of some major advertisers’ marketing budgets. According to the
UK’s Institute of Practitioners in Advertising, ‘the number of companies
allocating more than 5 per cent of their budgets to Internet marketing rose
from 8 per cent to 14 per cent in the third quarter [of 2000]’ (cited in Hall,
2000c: 6). The Internet is clearly better suited to some forms of advertising
than others; for example, to provide classified rather than display advertisements,
and to aim commercial messages at specific audience subgroups.
Consequently, some conventional media – particularly those
newspaper and magazine publishers who rely on targeted classified
advertising – will find that their revenues are more threatened by the
growth of the Internet than others.
New media such as the Internet, digital television and WAP2
mobile
phones offer users more choice and control over what sorts of entertainment
or information services they wish to receive. On the one hand,
Economics of advertising 55
2. WAP or Wireless Application Protocol is a technology that allows consumers
access to the Internet on their mobile phones.
personalized and interactive media consumption make it possible for
advertisers to collect useful feedback and to foster closer and more effective
two-way communication with relevant consumers. On the other, the cost
of attracting the attention of large audiences via tailored one-to-one
marketing is much more significant than via a campaign conveyed across
conventional mass media. The price of advertising on the Internet, for
example, currently running at around £30 per thousand ‘page impressions’
in the UK, is not far behind the price of a direct mail shot and is
considerably more expensive than the cost per thousand (of around £10
and £3 respectively) for a 30-second commercial either on network
television or radio (Oliver, 2000: 57). On a cost per capita basis, ‘micro’
marketing may prove expensive but, for some advertisers at least, it is also
less wasteful than mass advertising in mainstream media.
Paradoxically perhaps, as audiences for traditional media have
fragmented, the cost of reaching a mass of consumers has increased. The
growing price and waning influence of advertising expenditure on mainstream
television channels such as the four main ‘over-the-air’ networks
in the US or the ITV network in the UK is a source of frustration for
many advertisers, yet they are powerless to reverse the changes in lifestyle
and in patterns of media consumption which make mass marketing an
increasingly expensive exercise.
We live in an era in which famous brands are highly valued. So, even
as audiences fragment across media catering to ever narrower sets of tastes,
many advertisers continue to rely primarily on mainstream conventional
media to create the mass consumer brands of the future. The greater ability
of conventional media to reach mass audiences and to establish famous
brands still remains a strong selling point. According to Hegarty, ‘[w]hat
makes a brand is fame, and that comes from communicating with people
en masse’ (cited in Smith, 1998: 1). So, despite the fact that, in the UK
as elsewhere, newspaper circulations are declining and television audiences
are beginning to fragment, ‘advertising prices are still being pushed up
because the advertiser’s need to find fame is more urgent than ever’ (Hall,
2000a: 3).
So far at least, it seems that extra channels of communication and better
opportunities for tailored marketing have stimulated incremental demand
for advertising rather than diminishing appetites for commercial space
in traditional media. For this reason, the arrival of new media is seen by
many as a complement to rather than a substitute for conventional mass
media. The effect of the Internet on advertising markets has been likened
to ‘adding a couple of lanes to the motorway – it just means that overall
traffic levels get higher’ (Gottlieb cited in Hall, 2000a: 3). ‘Micro’
marketing via new media is adding extra volumes of advertising activity
rather than replacing mass marketing.
56 Understanding media economics
But new digital and interactive media are still in their infancy and until
their full capability as marketing vehicles is understood, the future for
advertiser-supported conventional media like television, radio and newspapers
is uncertain. Traditional media are protected only so long as they
remain the most convenient route to mass audiences. As new niche services
continue to splinter audiences, the perceived level of substitutability
between new and traditional advertising media will inevitably increase.
A fragmented audience is not the only problem facing advertisers. Some
new media offer users the ability to bypass advertising altogether. For
example, the emerging generation of digital video recorders, such as those
offered by TiVo (manufactured by Royal Philips Electronics of the
Netherlands) and ReplayTV (manufactured by Panasonic, a subsidiary
of Matsushita of Japan), allow viewers to skip over the advertisements
when they watch recorded television. Digital video recorders – also known
as Personal Video Recorders (PVRs) – can record and store programmes
by type in response to pre-selected choices made by the individual viewer
and, at the same time, can edit out programme credits or other unwanted
interruptions, including commercial breaks.
The ability for viewers to skip advertising has been heralded by some
as ‘the end of commercial television’ (Lewis, 2000: 2). But opinions vary
on how exactly PVRs will affect viewing habits. Video cassette recorders
have always offered viewers the option of fast-forwarding to avoid
commercial breaks in recorded material and this has not undermined
advertiser-supported television broadcasting. PVRs, however, make it
much easier to side-step advertising. The question is, to what extent will
audiences continue to watch much of their television ‘live’, in spite of
the greater convenience of recording thanks to PVRs?
According to Ave Butensky, President of US industry body the Television
Advertising Bureau, (cited in Tomkins, 1999b: 19), viewers ‘will
figure out how to switch the television on and how to change the channel,
but beyond that, they don’t want to know. Basically, they’re couch
potatoes.’ If, as Butensky suggests, most viewers ignore the arrival of the
PVR and continue to flick passively between ‘live’ television channels, then
audiences will not be able to skip over advertising breaks and commercial
broadcasters have little to worry about. Many viewers will, however,
undoubtedly be tempted by the possibility of their own customized prerecorded
programme schedule, and so PVRs will continue the process of
erosion of audiences for conventional broadcast channels as well as
making it progressively more difficult to entice audiences to watch television
advertising.
Economics of advertising 57