Monday, December 05, 2005

A la carte pricing for cable? A bad idea for diversity.

It’s clearly silly season at the FCC. Among other things, they are chatting up unbundled pricing for the cable industry. A very bad idea. Who says so? Well. Steve Yelvington, for one, who is no lackey of the cable industry. And not just because it would undo the industry’s business model with little gain for consumers. No, the bigger issue is with the notion of diversity that the same self-styled consumerists that are pushing a la carte pricing also hold dearly.

Here is why it’s a bad idea for consumers to be able to pick which cable channels they want to subscribe to. It’s called serendipity. It’s one of the remaining strengths of the print newspaper. That is, we don’t always know what we want until we see it. Some of you may not generally read the movie reviews in your newspaper. But once in a while your eye catches a front page teaser for a review about a movie that you might have a special interest in. Maybe you know someone who is wheel-chair bound. And you see something about the movie "Murderball." Or perhaps you tend not to follow international news, but in flipping the pages catch a reference to a town in Spain where you lived with a family your junior year in college.

What am I saying here? If we only bought the types of information we know we like, then we don’t get exposed to much variety. We can’t be forced to buy a book we don’t want or a magazine that has no interest (for me, Golf Digest—a good read ruined). But the technology and nature of the newspaper, of the Internet—and cable—makes it reasonably economical to bundle diverse types of content together. And we benefit from that.

It is generally true that each of us only views a core of five to 10 television networks, though for each of us there is some variety in what those are. I, for example, rarely watch anything on ESPN and thus tend to bristle that so much of my cable bill goes towards having access to that channel. Neither I nor anyone in my family typically watch Discovery, History, or Biography channels. And yet there have been times that I have seen a promotion for something on one of these and, because I had them, I watched them. And, honestly, in scanning through my channels I have, on occasion, stopped at something that caught my eye in that brief two second “evaluation.” And I’m glad I did: a bio of McDonald’s franchisor Ray Kroc or a piece on the history of the development of the aircraft carrier. Only recently my wife stumbled on the re-runs of the "Law & Order" series on USA Network and now watches them regularly. (Note: They were not re-runs to her, as she had never seen them before). Under a la carte we would not have had these channels to be exposed to them in the first place.

I admit there is a certain initial attractiveness to the notion of a la carte. But think about its logical extension: Why not apply it to the newspaper, which comes in readily identifiable sections in larger cities. If you don’t read the Business and Lifestyle sections, so why pay for them? Maybe at the newsstand they could have separate piles for the News section, Sports, Lifestyle, Arts, Business, Want Ads, Preprints. Pick only the sections you want (free preprints with any purchase!). But that defeats the social value of the newspapers—the diversity it provides in a bundle whose cost of production—and therefore price—would be little different if disaggregated.

Which brings me to a practical—read economic—side of the a la carte proposal. Factoring in the capital cost of cable systems, it is not a highly profitable industry (great cash flow, but high investments up front). If the average cable bill today is, say, $50 and the cable system has 1 million subscribers, that’s $50 million a month in revenue. Could that business survive if, through a la carte pricing, the average customer paid $30 per month? In short, no. So what will happen? The menu for channels will reflect what often happens with disaggregation: the sum of the parts will be greater than the whole. ESPN—the most popular cable networks-- might be offered for $10 per month. You want CNN, that’s $5. Disney Channel for the kids? How about another $5? MTV for the teenagers? Another $5. USA Network for popular off network programs? Yet another $5. Add $10 for the base of the broadcast networks and “connectivity" and you’re up to $40. So you save $10—and have access to only five channels plus the broadcast networks.

True, on demand technology might cushion some of the effects. If you don’t subscribe to the History Channel but want to watch a particular show, perhaps for $1 you could access that. Still, research suggests that most people are more comfortable paying a known fixed price for unlimited usage than variable “per use” charges, even if they would be financially better off with the latter. (Years ago researchers at the old Bell Labs found that phone customers preferred flat rate residential service even if they could be shown that based on their usage they would pay less most months with per-minute measured service. I wish I could find the citation for that study).

This was also tried—and failed--in magazine publishing. The Saturday Review was a high brow weekly magazine whose circulation was falling in the 1960s. So in 1971 two entrepreneurs, Nicholas Charney and John Veronis, bought the magazine and disaggregated it into four monthlies: one week it was Saturday Review Arts. Another week it was Saturday Review Books and so on. Subscribers could continue to subscribe, at say $40 annually. to all editions or just subscribe to one version, as a monthly, for perhaps $20. The experiment ended in bankruptcy in two years.

Oh, did I mention this unintended possible consequence: That this could also accelerate consolidation in the industry, as the remaining smaller operators who would like to stay independent might find that they cannot afford to finance their debt with reduced income, while the larger companies will find purchasing them more attractive given lower valuation.

One could also question the notion behind a la chart pricing on a philosophical basis, as did Adam Thierer. Asks Adam, Is there “An Inalienable Right to Video Programming? The unstated assumption underlying the drive for a la carte regulation and 'family-friendly' tiering mandates is that government can somehow magically create a “right” to video programming.”

Cable is a case where the social benefit of bundling is congruent with the economics. The ability of niche cable networks such as Oxygen or BBC America to have access to tens of millions of homes is largely subsidized by the bundled price of the more popular networks. There is no free lunch. A la carte would only result in less diversity and fewer choices for viewers with at best a net savings of maybe a few dollars a month. It’s a bad trade-off.

(Full disclosure: I have some personal investments in cable securities, with a total value of under $5000).

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