Production and Cost 2:A - 1(51) Entertainment and Media: Markets and Economics Professor William...

Production and Cost2:A - 1(51)

Entertainment and Media: Markets and Economics

Professor William Greene


Economic Foundations for Entertainment and Media

Production, Cost and Organization of Firms in E&M Industries


Classical Economics Apply to the Market for Toasters

Costs of production Variable vs. fixed costs

Cost characteristics Economies of scale Economies of scope Technological change

Profit Firms in markets: market power and

brand identity, etc.


Familiar Market Outcomes in Commodity Markets

Market power Monopoly Competition Branding Market segmentation


Producing Experiences

Features of Entertainment and Media Firms Conventional economics explains much of

production There are special features of E&M production

Economic Foundations for Production Production functions – the technology Costs of production – an element of competition Economies of scale and scope – produce market

advantages Technological change – markets evolve


Characteristics of the Creative Industries

What do we mean by “the creative industries?” Not synonymous with experience goods: E.g.,

amusement park vs. art Are there distinguishing features?

Implications for the organization of market activities: Contracts among producers Market organizations for distribution


Caves on Creative Industries

Characteristics of production in creative industries that are unlike more conventional production

Uncertainty of demand – difficult to resolve using market research

Producers’ emotional connection to the output – art, music Assembly of widely diverse skills for production - movies,

sports) Differentiated products – different consumers have very

different interests in the same proeuct. The role of time in consumption Durable products and durable rent streams


Features of Production in Entertainment and Media

Multiple stages of production Outputs as downstream inputs

Content creation is often very labor intensive Labor intensive Little substitution Less Technologically Oriented Not always - animation is a major exception

Delivery – Exhibition, distribution Capital intensive Technological advance

Applications: Books, Movies, TV, Newspapers, Radio, Recorded Music


The Production Function

Output Inputs – The

factors of production

The “process”

Labor

Capital

Materials

The amount producted, Q, depends on “inputs” or factors of production.Conventional inputs: Capital, labor, materials used in making moviesUnconventional inputs: Music used in distribution and production in stores and offices.The crowd used to create big sporting events.


BB&B Production Function

Output: Distribution of things to consumers

Inputs: Capital: Physical, Financial Labor Energy Materials Music

How do they use music? Why do they use music? How do they pay for it?


Live Performance Production is Unconventional

Production function – One “stage” Simultaneous production and consumption Feedback between consumers and producers

Concerts Big Sports eBay watchers


About Production Functions Factors and Factor Intensity

Higher education is very labor intensive, but less so over time. Broadway (legitimate) theater – very labor labor intensive and there is almost no

opportunity to substitute capital for labor Creating Music – labor intensive, but some opportunities to substitute capital for labor. Major League Baseball – only the game on the field is labor intensive. Most of the rest

of the process is very capital intensive. Casino – capital intensive. It takes relatively few people to keep a casino working, and

fewer over time.


Production Processes Sometimes Allow Substitution

Substitution of Factors Live theater – the “cost disease” results from little opportunity to substitute capital for labor The trend toward animated movies is an example of substituting capital for labor.

The figure shows different combinations of capital and labor that can be used to produce 100,000 units. E.g., the USPS can use people or machines to sort 100,000 pounds of mail.


Now, after 500 performances, our producers have told us and our union that in order to cut costs they will chop our string section in half, releasing five musicians and “replacing” them with a synthesizer piped in from another room.


Multiple Output Processes Managing a multiplex – Two outputs

Concessions (the primary source of profits) Movies (the secondary profit center)

Casino: Gambling Food and entertainment

Professional sports performance The sport: Outcome on the field and the signal for broadcasting Concessions including food and merchandise Sky boxes in stadiums

Music Distribution Performances (public) that also distributed recorded versions plus

t shirts and souvenirs Music videos Music for private consumption


Mathematical Model for a Movie Theater

Tickets= Demand for movie tix: T(Pt,qm,M). Marginal cost = Ct

Food = Demand for food: F(Pf,T,M). Marginal cost = Cf

dF/dT > 0 More movie goers buy more food. Ignoring Food, the theater owner acts like a ticket monopolist:

Profit = T*Pt - T*Ct. Maximize by equating marginal revenue to marginal cost: Pt + T*(dPt/dT) = Ct

Considering food, theater tries to maximize profits from tickets and food: Profit = T*Pt - T*Ct + F*Pf – F*Cf

They must equate MR to MC in both parts. For the tickets part, nowPt + T*(dPt/dT) + Pf*(dF/dT) = Ct

Pt + T*(dPt/dT) = Ct - Pf*(dF/dT)

Marberger, D., “Optimal Pricing for Performance Goods,” Managerial and Decision Economics, 1997, 18, 5, 375-381.


Movies and FoodTicket Price

Tickets

Food Effect

Demand

Marginal Revenue

Marginal Cost

Marginal Cost minus food effect

Pt|f

Pt

Pt is the monopoly price if the owner ignores the effect of tickets on sales of food.

Pt|f is the ticket price if the owner also considers the effect of tickets sold on sales of food.

Conclusion: To account for the effect of ticket prices on the demand for the main profit center (food), the theater owner drives down the ticket price.


Multistage Production Is Common

This is not the same as joint production of more than one product


Multiple Stages in Production

Players

Capital

Equipment

F(x)

Capital

Equipment

Labor F(x)

TV Sports

What’s better for this process, one firm or two?

Disney Pixar, or Disney/Pixar?

The game on the field Team

The TV broadcastNetwork

The viewerCable Operator


The Costs of Production

Fixed cost: Not a function of output. Capital Sunk cost: One time, nonrecoverable costs

(Often very significant in the movie business) Variable cost: Variable with respect to output

Labor Materials

Marginal cost: Avoidable cost of one more (less) unit Operating Profit = Gross Revenue - Costs


Movie Cost and Revenue Trends

2002-2004: Revenue growth from $115M to $130M 2002-2004: Cost growth from $111M to $130M

65% due to production and marketing 20% rising home video manufacturing costs 15% due to higher “talent participation”


Box Office Revenue


Production Costs


(2003)Marketing Costs: $ 85MU.S. Box Office: $ 150MWorld incl. US: $ 417M(#113 all time – on a list that does not correct for inflation, currency, or anything else.)Rights: WB 50M Sony 75M

http://www.slideshare.net/MissConnell/film-distribution-costshttp://www.edwardjayepstein.com/x-rar1.htm

2003


2004


2000

2001


Changing Economics for Stars

Before 2010: $10M, $15M, $20M, … Trend since about 2010:

Small or no up front Except for Angelina Jolie – first choice for Gravity but

could not agree on a deal. Sandra Bullock got $20M for signing. Unusual now.

CB 0 contract (Cash-Break zero – percentage after break even)

Far smaller total compensation for start Why?

Economics of film making Falling demand for star power in movies


Production cost $100MExhibitors At least $300MSandra Bullock $ 77M = $20M + 15% x Studio net (45% ) + Misc TV, DVD, etc.George Clooney ?Net so far $231M - ?Promotion and advertising ? Probably $50M - $100MOther distribution ?

SUCH “FIRST DOLLAR” GUARANTEED BOX OFFICE DEALS FOR ACTORS ARE BECOMING RARE, THE HOLLYWOOD REPORTER SAID, BECAUSE STUDIOS NOW WANT TO RECOUP ALL THE COSTS FOR EXPENSIVE PRODUCTIONS BEFORE SHARING THE PROFITS WITH TALENT.BULLOCK’S CO-STAR GEORGE CLOONEY, GRAVITY DIRECTOR ALFONSO CUARÓN AND PRODUCER DAVID HEYMAN ARE ALSO BELIEVED TO HAVE “BACK END” PAY DEALS.

HTTP://WWW.INDEPENDENT.CO.UK/ARTS-ENTERTAINMENT/FILMS/NEWS/GRAVITY-STAR-SANDRA-BULLOCK-SET-TO-EARN-70M-WINDFALL-FOR-OSCARNOMINATED-FILM-9157448.HTML


CD Costs and ProfitsCD a

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Record Label $10.80

Retailer $6.20

.75 1.40 2.15 .86 1.08 1.29 .70 1.94 .59 1.36 1.36 2.55 .97

Consumer

Fixed CostsVariable CostsSunk CostsOperating Profit


Production and Cost Functions?


Economies of Scale

Working definition: Declining average cost Market based definition: Competitive advantage of

large size Sources

Supply based: Technical, Demand based: Networks Indivisibilities: Lumpiness


Economies of Scale in E&M

Cablevision Professional sports Publishing/Movies – Backlists of titles Casinos Movies Television


Economies of Scope

Cost effect C(Q1,Q2) < C(Q1,0) + C(0,Q2)

Cablevision and Newsday Applications

Cable TV, Internet Mobile phone network Basketball, Hockey

Not the effect behind vertical integration News media owning the sports team?

Sky News motivation for owning Manchester United


Technological Advance

(Marginal) Cost Reduction

Digital setup in newspapers

Synthesized instruments in Broadway Musical Orchestras

Digital distribution of movies

Less Cost Reduction in Performance Industries: Baumol’s Cost Disease of the service sector

Live theater, Orchestra, Education


Search Technology - The Long Tail

Reduces the marginal cost of distribution and promotion.

Locate the world market for small or obscure goods – books - information

A result of the Internet and search technology.


Labor Saving Technological Change in Card Games in Casinos


Digitizing Entertainment – Technical Advance in Delivery of Existing Forms

Music MP3 - affects distribution, not creation Pop music without musicians.

Literature: E-books – Kindle (Amazon), Nook (B&N) E-zines (Slate.com) Web based news services (NYTimes.com)

Movies: Creation – digital equipment, Pixar animation Distribution – digital transmission without film Distribution – mode Netflix Exhibition – digital projection (expensive)


“Book” Production Costs


Music Production and Distribution Costs Studio quality recording with free software and

without studio or graphic design. (XBloome: X Marks the Spot.

Distribution, bypassing the labels. iTunes, SoundCloud

From XBloome's X Marks The Spot website: As maybe the first album ever, 'X marks the spot' was produced exclusively using Free Software (Open Source) and without a professional studio or graphic designers. With this 'proof of concept' album, XBloome have debunked several prejudices about feasibility, professionality and quality of free and self-made productions.“(www.xbloome.com)


Who should bear the cost?(About $75,000/screen)Film makers? Distributors? Exhibitors? Equipment makers? New York State?The conversion is over 80% complete in the U.S.


http://www.rollingstone.com/movies/news/how-digital-conversion-is-killing-independent-movie-theaters-20130904


3D - The Next New Thing

2D Format: Existing projecting systems; 20 new movies in 2008-2010.

3D Format: About 1000 existing projection systems plus 250 IMAX. Requires digital projection.

“It’s not always as good as they say it is…”“I’m not so sure our customers even know we have it…” Theater owner, New Mexico.

Can it be priced?


PRICING MOVIE TECHNOLOGY

General Seniors ChildrenCabin in the Woods (Georgetown) 12 11 9Cabin in the Woods (7th & H)(Not digital) 12 9.25 9Loews on 84th St. New York 13 9.50 9.50Titanic Imax 18 17 15Titanic Real 3D 16 15 13Wrath of the Titans in Real 3D 16 15 13

Theater owners cannot price digital.


http://www.marketplace.org/topics/business/movie-theaters-move-beyond-ticket-price

The simple explanation is that fewer people are going to the movies, but they are paying more for their tickets. Mostly we're talking about 3-D movies, which are more expensive. But higher ticket prices aren't necessarily great news for theater owners. Theaters have to share box office revenue with studios, says business professor William Greene of the Stern School of Business at NYU.


3D Economics

30 3D Movies “Avatar” - $250M Benefit: Net addition to profit $80M (Dreamworks)

Obstacle: Digital Projection Insufficient screens (3000 needed for an opening) Uncertain financing for theater digital projection (financial crisis) Pricing the Upgrade ($25 tickets)


3D

2D

3D can be priced. “Digital” cannot.

Production and Cost 2:A - 1(51) Entertainment and Media: Markets and Economics Professor William...

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