The New Economics of Media

1. The New Economics of Media Micromedia, Connected Consumption, and the Snowball Effect Umair Haque http://www.bubblegeneration.com Spring 2005

2. Media 1.0: Mass Media

3. Mass Media Value Chain Infra structure Production Publishing/ Marketing Distribution Retail Attention • 6 primary value activities • Infrastructure • Technology • Content • Creativity • Marketing • What media is bought and sold • Distribution • Transport & logistics • Retail • Where and when media is consumed • Attention • Why is attention part of the value chain? • Most media markets are 2-sided markets: they coordinate consumption by advertisers and audiences • Attention is how we will refer to this coordination process

4. Two Sided Markets Production Supply Demand Advertiser Media Audience Demand Supply Attention Supply coordinates demand on both sides of a two-sided market and sets equilibrium prices. Unlike in other markets, in the media marketplace, attention is a critical part of the value chain, because it is demanded by advertisers and supplied by consumers. On the other side of the two-side market, production is demanded by consumers and supplied (funded) by advertisers.

5. Media Orthodoxy • The Media Industry’s First Law: attention is scarce • Is this accurate? • Attention has always been getting absolutely scarcer as media grows • But… • We’re interested in • relative scarcity along the value chain • marginal scarcity at large scale • Relative and marginal scarcity are what count economically… • …because they define the structure, dynamics and expected value of differing strategies in the media industry • Is attention scarce? • Relatively… • …and at the margin? • It’s about to be • But it hasn’t always been…

6. Media Heresy • In fact… • Attention has remained relatively abundant for many years • What!? How can we prove this? • By asking how great the risk of losing audience actually is • The real problem facing the media industry • A zero-sum game: media’s grown quantitatively and qualitatively, but attention hasn’t • Attention’s about to become relatively scarce (fast) • Let’s begin by rewinding • And examining a non-networked world of pure mass media • In order to understand how attention abundance has shaped industry dynamics… • …and led to the creation of core competences and strategies which become core rigidities and errors in a Media 2.0 world

7. Attention Abundance • Attention is directly unobservable… • …and traditional share-based metrics shed no light on relative abundance • But indirectly… • The industry’s actions reveal abundant attention • Following deregulation, network TV ad time per hour increased exponentially from 6:48 in 1982 to 12:04 in 2001 • Similar figures for radio, newspapers and magazines (if we count ‘special supplements’ and advertorials)… • While production investment has increased linearly • Increasing ad time is equivalent to investing in attention • Because ad time is simply a marketing cost borne by players on the other side of the 2-sided market • The distinction between ad time and marketing cost is a figment of accounting – unimportant economically

8. Attention Abundance • What does hypergrowth of ad time tell us? • If attention was scarce, increasing ad time would be a dominatedstrategy • …Because marginal revenues from advertising would be less than marginal costs of viewers lost to rivals… • …And so returns to investing in attention (increasing ad time) would be dominated by investing in production (higher quality programming) or infrastructure (creating a technological cost advantage) • In fact, attention has been relatively abundant at the margin • Intuition: buying attention via ads is cheaper than attracting it via quality content • Proposition can only hold if attention isn’t scarce, since attention scarcity would increase marginal cost of lost viewers, offsetting marginal revenues from advertising

9. Mass Media Resource Dynamics • In a mass media world… • Downstream resources are scarce... • Distribution scarcity (Transport/inventory/broadcasting costs) • Retail scarcity (Spectrum scarcity, limited shelf/screen space) • Production scarcity (Infrastructure and human capital costs) • …and upstream resources are abundant • Attention isn’t scarce relative to other resources • Attention scarcity isn’ta driver of value creation, because barriers to media consumption are high • Limited supply of cinemas, radio stations, newspapers, tv channels, etc… • Implication: • Quality does not efficiently drive popularity… • …Because attention is cheaper than costly production, distribution, ideas, editing, finishing, etc…

10. Mass Media Industry Structure • Abundance is no surprise, given industry structure • Mass media businesses are cash cows… • …at least in a Media 1.0 world • Ask Warren Buffett (whose fav investment was local papers) • …because high entry barriers artificially or naturally limit rivalry • Broadcast media spectrum scarcity: auctions impose huge entry costs • Print media natural monopoly dynamics: average cost falls in circulation • So mass media players gain strong first-mover advantages • Which they use to acquire, pre-empt, or bankrupt competitors • Supply remains limited on both sides of the 2-sided market • For advertisers, prices rise: media inflation… • …Whose revenues are often used to drop prices on the other side of the market, and subsidize audience growth • Attention remains relatively abundant • Because total supply never grows…

11. Mass Media Value Equation • Mass media value capture is a function of… • Distribution and retail scarcity • Whoever controls these scarce resources… • Can exert market power along the value chain • …increase share and control how value is captured • Retailers and marketers achieve control via consolidation: acquisitions, partnerships, & alliances which realize economies of scale and scope in marketing • Retail & marketing control how value is captured • By leveraging marketing economies of scale and scope to control downstream resources, they can exert market power along the value chain • Canonical examples: vertically integrated Hollywood Studio System, major labels, broadcast networks 1950-1990

12. Quality Doesn’t Scale • The problem is… • At large scale, marketers and retailers have little incentive to invest in quality • Since production costs don’t realize scale and scope economies, but marketing and retail costs do • Production costs grow in output because risk accelerates • Example: films & records going ‘over budget’ • Marketing costs decrease in output because risk decelerates • Returns dominated by production scarcity, not attention scarcity • Highest returns to player who can most efficiently allocate scarce production resources • What’s the profit-maximizing strategy? • Invest in attention, don’t invest in production • Unintended consequences: • Quality drives popularity inefficiently • Because attention isn’t scarce, but production is

13. Marketing Cost Explosion Hollywood Nominal and Real Marketing Costs, 1981-2004 Real marketing expenditure has quadrupled, while real production expenditure has only doubled: firms have cumulatively invested twice as much in attention as production. Since this strategy has persisted for 25 years, investing in attention must realize superior returns to investing in production. Why is this strategy dominant? In a mass media world, producers realize marketing economies of scale and scope, and production diseconomies of scale and scope:

14. Popularity and Quality …Quality drives popularity hyperefficiently Media 1.0 Popularity Quality Quality drives popularity inefficiently

15. The Blockbuster Effect

16. The Blockbuster Effect: Downstream Scarcity & Strategy • What’s the dominant strategy in a world driven by downstream scarcity? • Reuse the same expensive content across as many media as you can… • And price discriminate while you do it • Film release windows: Cinema, DVD, Video, TV, Ads • …And across as many market spaces as you can • Via tie-ins, promotions, etc… • Think Star Wars: happy meal toys, action figures, books, posters, t-shirts, breakfast cereal • Aka: Blockbusters • Blockbusters are a strategy to maximize returns on content • By reusing and leveraging it to realize marketing economies • Most efficient allocation of scarce production resources

17. Mass Media Returns: The Blockbuster Effect Consumer goods tie-ins Motion picture revenues TV & Cable syndication Value Demand Output DVD, VHS Cinema

18. The Blockbuster Effect Example: Jurassic Park Merchandising: $50m Revenues Syndication: $50m Value Demand Output Video: $405m Box Office: $480m

19. Blockbuster Economics • Blockbusters are a natural result of mass media economics • Downstream resources scarce, upstream resources abundant • Which is why we see this strategy emerge in all mass media • How do we maximize expected profits of costly production? • Diversify risk by expanding revenue streams across scarce retail and distribution channels (in audience segments) • Price discriminate by cost of retail and distribution channels relative to total segment value • Marketers and retailers realize scale and scope economies via these tactics… • By reusing and leveraging marketing assets across segments • …Which are implicit ways to allocate scarce production resources • …by buying attention, which is cheaper than attracting it via investing in quality • Since attention is relatively abundant

20. The Problem with Blockbusters • Buying attention: marketing economies hit diminishing returns • Each segment is less and less valuable and saturated faster • But since attention is cheap… • Rivalry to economize on production and invest in attention creates marketing cost spirals • Marketing wars between blockbuster marketers, each of whom thinks attention will be cheap • Prisoner’s dilemma: each is better off marketing less • …Quality erodes • As marketing costs spiral and relative production costs shrink • Where have we seen this dynamic? • Hollywood marketing cost explosion, major label sales declines, magazine subscription erosion…everywhere! • These unintended consequences are costless as long as attention is cheap, since quality does not drive popularity • But what happens if attention becomes more expensive… • …and returns to marketing decline?

21. Attention & Production Costs at Large Scale Production is cheaper than attention Media 1.0 Production Cost Production and attention are equally costly Attention Cost Attention is cheaper than production

22. Attention & Production Costs in Rivalry Production is cheaper than attention Media 1.0 Production Cost Production and attention are equally costly Attention Cost Marketing cost wars make attention increasingly relatively costly

23. Attention & Production Costs At high levels of output, investing in attention is profit-maximizing… Value Attention costs Production costs …And investing in production is dominated Output Why do attention and production costs scale differently? Marketing economies of scale and scope are the result of leveraging and reusing content across distribution and retail channels to achieve price discrimination and diversification of risk. Production scale or scope economies aren’t realized because of high costs of contractual completeness, which makes risk increase in output, and high technology costs.

24. Attention & Production Costs At low levels of output, investing in attention is dominated… Value Attention costs Production costs Output Why do some media firms invest in production, and others in attention? Because the scale at which they operate dictates different profit-maximizing decisions about which inputs to invest in. …And investing in production is profit-maximizing

25. Attention & Production Costs Production is more expensive than attention: invest in attention Attention costs Value Production costs Marginal cost of production exceeds marginal cost of attention Output Media firms producing at different scales will choose different inputs. Small scale producers will invest in production, and large-scale producers will invest in attention. Hollywood vs Cannes… Attention is more expensive than production: invest in production

26. Media 1.0 Total Cost Function The shapes of the attention and production cost curves… Value Cost of all inputs …create an S-shaped total cost function Output The S-shaped total cost function means large-scale producers are naturally more efficient than small scale producers, because attention costs diminish due to marketing economies of scale of scope.

27. Marketing Spirals Erode Quality Marketing wars increase the cost of attention… Attention costs Value Production costs ..Since production costs don’t decline, production investment declines: fewer production inputs are used at equilibrium price Output Marketer and retailer consolidation realizes economies of scope and scale in marketing. Production scale or scope economies aren’t realized. Marketing spirals act as an entry barrier. They raise attention costs, while marketing economies of scale and scope are still realized proportionally (the flattening of the green curve). The result is a shakeout and increased industry concentration, because returns to attention remain high only for large-scale players. Quality erodes as production investment is traded for marketing investment.

28. Popularity and Quality …Quality drives popularity hyperefficiently Media 1.0 Popularity Quality Marketing cost spirals mean quality erodes as relative investment in production declines, and becomes even less correlated with popularity

29. Summary: Mass Media Value Dynamics Attention In a non-networked media world, retail & marketing capture the most value. Producers and distributors remain fragmented because production returns don’t scale: they don’t realize significant economies of scale or scope by consolidating. Attention Attention Infra structure Production Distribution Marketing Retail Attention Attention Marketing and retail returns do scale: by consolidating, retailers and marketers exert power over downstream resources by realizing economies of scale and scope in marketing and retailing, and power over upstream resources by limiting media supply (and consumption choices). Attention Attention

30. Summary:Mass Media Value Dynamics Blockbuster strategies emerge due to the natural economics of mass media: production is costlier than attention, so the dominant strategy is to invest in attention (marketing cost wars), and economize on production (quality erosion). The result is a smaller and smaller number of concentrated players, who are forced to invest more and more heavily in marketing as attention becomes scarcer. Attention Attention Attention Infra structure Production Distribution Marketing Retail Attention Attention When attention is abundant and production, distribution, and retail are scarce, blockbusters achieve an efficient allocation of scarce production resources, by supplying media valued the most highly to the greatest number of consumers within each retail/distribution channel: mass media. The unintended consequence is that quality doesn’t drive popularity. Attention Attention

31. Media 2.0: The Age of Plasticity

32. The Age of Plasticity • Media 2.0 is plastic • …atomized media be reshaped, remixed, tweaked, cut, split… • …and aggregated, filtered, distributed, delivered, stored… • …almost any way/to any time/at any place consumers prefer • Plasticity makes Media 2.0 personal • No clear distinction between professional and amateur media… • …because all media can be unbundled/rebundled • The distinction shifts from professional/amateur to mass/personal • Media will be unbundled and rebundled at the personal (not mass) level • Beyond narrowcasting, nichecasting – personal control over the ‘cast • In an atomized environment, what becomes valuable? • What are the economic effects of plasticity? • Or: what does broadcatching really mean? • Let’s begin by understanding the economics of micromedia

33. What is Micromedia? • Micromedia is… • Media that can be consumed in unbundled microchunks… • Microchunks of media unbundled from traditional media goods • Blogs vs newspaper articles • Tracks vs albums • Vlogs vs network news • ..and aggregated and reconstructed in hyperefficient ways • Blogs, vlogs, podcasts, mp3 tracks, RSS feeds • Micromedia can be unbundled and rebundled for consumers… • EG Blog entries can be aggregated and reconstructed by topic • …to create orders of magnitude more value than mass media • Micromedia explodes media supply • The total quantity of media goods explodes • …And atomizes it • The average size of media goods shrinks

34. Micromedia Drivers • What drives the micromedia explosion? • And the shift from downstream to upstream scarcity? • Technology • Falling barriers to production • GarageBand • Unbundling: Falling barriers to distribution & retail • p2p, iTunes, BitTorrent, convergence of connectivity & platforms, micropayment • …And retail/distribution channel growth and fragmentation • Cinema vs VHS, DVD, VCD, MPEG • Regulation • Creative Commons • Fair Use (applicability grows in networked media) • Changing consumer preferences • The rise of connected consumption • The rise of peer production

35. Media 2.0: The Long Tail • Micromedia disrupts the media landscape… • Upstream resources become scarce and downstream resources become abundant • Value capture is a function of attention scarcity • Retail and distribution are not drivers of value creation, because barriers to media consumption are low • Unlimited supply of tv channels, newspapers, radio stations, everything over IP, etc • Retail and distribution aren’t relatively scarce • Hypertargeted, microdifferentiated content is valuable • New market spaces emerge to control how value is captured • …which will be won by players who can realize economies of scale and scope in production or distribution (not marketing) to efficiently allocate scarce attention

36. Media Hyperdeflation • What are the consequences of the micromedia explosion? • As micromedia explodes supply relative to demand, equilibrium prices fall • Production, distribution, and retail become relatively abundant… • …And attention becomes relatively scarce • Consumers can afford to consume greater quantities of smaller chunks of media • Assuming demand for media goods is relatively inelastic… • Or: falling prices don’t command proportionally more attention • Or: media spending/discretionary spending stays stable • As it has been for the last 20 years… • And assuming industry cost structures don’t adapt… • …Average returns fall • Where are we seeing the beginnings of media deflation? Everywhere • Falling ad revenues across mass media, falling circulation in newspapers, etc • Where does the value go? • It’s appropriated by consumers, who can consume more media more cheaply • Unintended consequences: this creates a further incentive for average quality to remain low

37. Attention & Production Costs at Large Scale Production is cheaper than attention Media 1.0 Production Cost Media 2.0 Production and attention are equally costly Attention Cost Attention is cheaper than production

38. Attention & Production Costs At high levels of output, investing in production is profit-maximizing… Attention costs Value Production costs …And investing in attention is dominated Output Value shift: in a Media 2.0 world, producers realize production economies of scale and scope in production, and marketing diseconomies of scale and scope. Attention becomes more expensive than production, because technology vaporizes production (distribution, and retail) costs, exploding media supply (relative to a mass media world, where media supply is fixed), which creates intense rivalry for attention.

39. Strategy Decay: The Consequences of Hyperdeflation • What are the consequences of these economics? • Media 1.0 strategy decay… • The blockbuster and all other dominant Media 1.0 strategies fail in a Media 2.0 world • Why? • Blockbusters are a strategy to realize marketing scale & scope economies • Which is dominant because cheap attention makes marginal returns to marketing more attractive than marginal returns to production • But blockbuster marketing costs increase in rivalry, because rivalry accelerates attention scarcity • Attention becomes more expensive than production, and returns to marketing erode • Implication: marketing costs for blockbusters will explode and returns will implode, as micromedia explodes media supply and accelerates rivalry

40. The Blockbuster Effect & Media Hyperdeflation Consumer goods tie-ins Mass media revenues TV & Cable syndication Value Hyperdeflated revenues Output DVD, VHS Cinema

41. Value Shift and Strategy Decay • More simply… • As competition explodes for attention from newer, cooler, hotter content, attention becomes relatively scarcer, so marginal marketing costs don’t diminish in scale, but begin to increase in scale instead • Or: price of media falls in a hyperdeflationary environment, which means costs must fall or margins must erode • Even more simply… • As attention becomes scarcer, it becomes more costly … • …and so economies of scale and scope in marketing erode because returns fall • …while production becomes more abundant and less costly, and so can realize greater returns • Value shift: • Media 2.0 dominant strategies are based on economies of scale and scope in production, distribution, and search • Which can realize superior returns to relatively abundant and cheap production resources by efficiently allocating scarce attention

42. A Quick Review

43. Media 1.0 Supply & Demand Inelastic demand… Demand Price Supply Quantity …And inelastic supply mean media spending stays stable as % of GDP

44. Understanding Media 2.0 Demand Demand Price Supply Quantity The Long Tail: cheap information shifts demand outwards by the value of distribution and search costs saved

45. Understanding Media 1.0 Supply Indie record labels Pixar Price Clear Channel Aggregate supply curve is inelastic… Quantity …because ownership of scarce production, distribution, and retail resources creates increasingly inelastic firm supply curves

46. Understanding Media 1.0 Supply Price Attention costs Production costs Quantity Because attention costs are relatively low, returns to marketing are economical, and marketing wars occur …production costs dominate attention costs, because content, production, and retail resources are scarce, and attention is abundant

47. Understanding Media 2.0 Supply bloggers podcasters Price Pixar Aggregate supply curve shifts outwards Quantity …Micromedia supply curves are more inelastic than traditional media, because of hyperspecialization. Exampe: bloggers

48. Understanding Media Hyperdeflation Demand Micromedia explodes media supply more than cheap information shifts demand outwards… Price Supply Quantity …and the equilibrium price of media falls: media hyperdeflation

49. Understanding Media 2.0Returns & Scarcity Micromedia explodes media supply… Price Production costs Attention costs Quantity …attention costs dominate production costs, because technology ends production, distribution, and retail scarcity, and so attention becomes relatively scarce… …Marketing wars become uneconomical because returns to costly attention are low

50. Media 2.0 Models:Aggregators, Platforms, and Reconstructors