Price Wars in Two-Sided Markets: The case of the UK Quality Newspapers

1. Price Wars in Two-Sided Markets: The case of the UK Quality Newspapers NET Institute Conference on Network Economics 16.04.2010 Stefan Behringer, University of Mainz & Lapo Filistrucchi, Tilburg University and University of Florence

2. Motivation I • Price war in the 1990s in the UK quality broadsheet newspaper industry. • Rupert Murdoch‘s company NIN, acquired The Times in 1981. • The Independent was known to be in substantial financial difficulties. • On 6. September 1993 The Times initiated a price war with a cut from 45p to 30p and later to 20p.

3. Cover prices from 1990 to 2000

4. Motivation II • The Independent claims that the price of 20p per copy of The Times amounts to a „£30m a year subsidy“. • Following a complaint by the Independent, the OFT decides on the 21. October 1994 that price cuts does not establish the case for fomal action under competition legislation with a focus on „predatory pricing“.

5. Motivation III • Problem of definition of „predation“ in media marktets and, more generally in two-sided markets. • Because even a profit maximizing monopolist might find it optimal to charge a price below marginal cost on one side of the market (e.g. free newspapers), the standard Areeda-Turner rule does not hold. • A two-sided extension of the rule is required, e.g. for newspapers the sum of cover price and per copy advertising revenues below per copy maginal costs.

6. Questions • Positive: Can we explain the market data and behaviour using an adequate model of the industry taking the advertising side into account? • Normative: Can we provide guidelines for competition policy cases in media markets?

7. Setup • The UK quality broadsheet newspaper industry consists of 4 firms: The Guardian (G), The Independent (I), The Times (T), and the Daily Telegraph (DT). • Newspapers are differentiated by their political position, ranging from the political Left (G) via (I) and (T) to the political Right (DT).

8. Two-Sided Markets • Armstrong (2006) and Rochet & Tirole (2006): Two groups of agents interact via „platforms“ where one group‘s benefit from joining a platform depends on the size of the other group that joins the platform (and possibly also the own group).

9. Media Firms, e.g. Newspapers as Two-Sided Markets • Media Firms sell content to consumers readers/viewers/listeners and advertising space to advertisers. • Advertisers care about the number of consumers of the medium and consumers may care about the number of advertisers.

10. Previous theoretical work • Hotelling: Hotelling (1929) and correction in d‘Aspremont, Gabszewicz, & Thisse (1979). • Economides (1986) generalization of costs and (1993) linear cost with more than 2 firms. • Equilibrium calculations with more than 2 firms in the location-then-price Hotelling interval model with quadratic disutility require numerical methods as in Brenner (2005) and Götz (2005). • Two sided markets: Gabszewicz, Laussel, and Sonnac (2001, 2002) look at a newspaper market with location-then-price with 2 firms building on Armstrong (2006) general TSM model with 2 firms.

11. Previous econometric work • Structural: Rysman (2004) looks at the U.S. yellow page market and shows that network effects between advertisers and readers are present. • Kaiser & Wright (2006) look at the German magazine market, Hotelling on both sides measuring network effects. • Argentesi & Filistrucchi (2007) test for collusion in the Italien newspaper market using a nested logit. • Fan (2009) looks at the U.S. newpaper market with endogneous quality, mixed logit on the reader‘s side and Rysman typ advertising on the advertising side, evaluates mergers.

12. What is new? • We model the newspaper industry as a Two-Sided Market with differentiated products. • We extend Gabszewicz, Laussel, and Sonnac (2001, 2002) to 4 newspapers/publishers, and elastic demands, chosing political positions prior to prices and advertising rates. • Editors take into account the indirect network effects of circulation on advertising demand. • We will will provide a structural econometric analysis of the UK newspaper price war and test for predatory pricing in two-sided markets.

13. The Model –The readers side I • Utility of an individual j from consuming a newspaper i is: • Where i=G,I,T,DT and R is a reservation price and α a marginal disutility of price. • Assumptions: Newspapers are Hotelling differentiated, readers do not care about advertising and single-home.

14. The Model –The readers side I • From Hotelling: indifference of the marginal consumers, market shares for non-binding reservation prices and i=T,I are:

15. Demand elasticities are …

16. …which is very different from the logit Note: The zero restrictions are testable.

17. The Model –The advertisers side I • Advertiser‘s benefit from placing an ad in newspaper i is i.e. increasing in the newspaper‘s reader market where θ is the indirect network effect. • Assumptions: An advertiser‘s benefit from placing an ad in a newspaper does not depend on whether he/she already advertises in another newspaper and advertisers may multi-home.

18. The Model – The advertisers side II • From these, one obtains the advertising demand equation which extends Gabszewicz, Laussel, and Sonnac (2001, 2002).

19. A non-cooperative two-stage game • First political positions are chosen then cover prices and advertising rates. • The solution concept is pure strategy SPNE and the game is solved backwards. • Profits with differentiated products in stage II are:

20. Solving Stage Two I • From the F.O.C.s • and • and from the latter it follows that demand for advertising is linear in the newspaper‘s market share.

21. Solving Stage Two II • Lemma 2: The NE in cover prices can be calculated as a function of political positions (location) only.

22. Equilibrium Prices I Putting these 4 equations in 4 unknowns in matrix form:

23. Equilibrium Prices II • Now this system can be inverted and solved for equilibrium prices analytically. • As these equilibrium prices are still quite messy we do not write them down explicitly here.

24. Solving stage One The Two-sided market problem can be reduced: • The first stage equilibrium locations cannot be solved in closed form but can be approximated using a Newton-Raphson Algorithm in Mathematica, extending code by Götz (2005).

25. Symmetric Simulation I • The NR-Algorithm reveals equilibrium locations on the political line in the first stage of the game as: • Equilibrium prices in the second stage are:

26. Symmetric Simulation II The equilibrium market share vector of the reader‘s market is: Equilibrium profits are:

27. The Wapping dispute • Rupert Murdoch‘s company NIN, acquired The Times in 1981 and during the 1980s secretly equipped a new printing facility in Wapping where newspapers could be composed electronically. • When Print unions discovered it they announced a strike. • NIN activated the new plant with the assistance of the Electrical, Electronic, Telecommunications, and Plumbing Union (EETPU). • This led to the "Wapping dispute" (January 1986 to February 1987) which changed the history of industrial relations and of the newspaper industry in the UK. • By 1988 nearly all the national newspapers had abandoned Fleet Street for the Docklands and started to change their printing practices to those employed by NIN.

28. Asymmetric Simulation I A 60% drop in the cost of The Times reveals equilibrium locations on the political line in the first stage of the game as: Equilibrium prices in the second stage are: Note that location of the DT moves Right.

29. Asymmetric Simulation II The equilibrium market share vector of the reader‘s market is now: Note that all shares but that of T go down. Equilibrium profits are now: Note that profit of DT increases.

30. Comparing Simulation Results

31. The political position:

32. Conclusion I • We have built a structural model of the UK quality newspaper industry in the 1990s, in which publishers choose first political locations, then advertising tariffs and cover prices. • The next step is to estimate demand and use parameter estimates together with the model to explain the observed price war.

33. Conclusion II An „asymmetric production costs“ explains some observed characteristic of the data. Alternative explanations are: • A breakdown of a collusive agreement as tested for in Filistrucchi & Argentesi (2007). • Predatory behaviour as proposed in Behringer (2007). • A positive shock to advertising demand, changing the optimal newspaper finance mix. • We plan to investigate also these.

34. Predation I: Price-cost margin T

35. Predation II: Variable profit I