Price Discrimination and Audience Composition in Advertising-Based Broadcasting

Abstract

In this article, a model is introduced that has 2 distinguishing features. First, the multidimensional nature of competition in media markets characterized by free access and advertising is acknowledged, through explicit modeling of vertical and horizontal differentiation. Second, the price of advertising depends on the expected audience composition, not simply on its magnitude, and the amount of price discrimination. It is found that market equilibria depend on a number of critical factors: the amount and type of price discrimination in advertising, the correlation between formats and audience composition, the relative profitability of the different market segments, and diseconomies of scale in program quality. For a variety of market structures, the ability to discriminate on the price of advertising encourages a higher level of quality in broadcast media.

ACKNOWLEDGMENTS

Marco Gambaro introduced me to this topic and helped me with various suggestions on earlier drafts of this article. Steve Wildman and four anonymous referees provided valuable remarks, pointed out errors, and suggested alternative formulations for the model. The usual disclaimer applies.

Notes

¹ Beebe (1977) found that, if consumers have second-best alternatives, monopoly may be worse than competition because of the tendency of providing “common denominator” programs. Program variety may be too little.

² Spence and Owen (1977) compared pay TV with free, advertising-based TV. They identified sources of market inefficiency in the two cases.

³Several variants of the basic Hotelling model have been proposed in the literature. These results are not generally robust to changes in the basic assumptions (e.g., more than 2 actors, non-linear space, etc.). The interested reader may refer to Beckmann and Thisse (1986).

⁴For a survey of the two-sided markets literature, see Roson (2005).

⁵ Bagwell (2003) provided a very comprehensive survey of the theoretical and empirical literature on advertising.

⁶ Wildman (2003) considered more realistic hypotheses about the value of advertising. First, although more advertising may increase the probability of buying a good or service by a customer or viewer, the relation between buying probability and exposure to ads is not generally linear (and it could well become a negative one, above a certain threshold). Also, the value of a certain viewer on the advertising market may depend on the total range of products he or she may buy, rather than on the profit mark-up of a specific advertised good. When these aspects are taken into account, maximizing advertising value does not imply maximizing audience.

⁷A model sharing the same perspective is in Dukes (2004). There are oligopolistic markets in media (advertising based) and products. Consumers are virtually located on two circles, for product and program types. There are nuisance costs of advertising, but advertising is informative (consumers can access 1 product only if reached by a specific advertisement, distributed by some station).

⁸On the other hand, Kim and Wildman (2006) addressed other issues, like ad addressability and nuisance costs.

⁹This does not mean that channels must have only one type of program (e.g., “all news”). This hypothesis could be interpreted as focusing on one specific time segment (e.g., “prime time on Tuesday”).

¹⁰It would be more correct to say “profitable” computers.

¹¹In principle, competition could be played through the amount of ad time, affecting perceived quality. Here, however, demand for advertising is discrete and binary (either 1 spot for a specific good in a program, or none).

¹²In most of the numerical examples shown later in the article, it is assumed that costs are quadratic (C = F + ²/2).

¹³Quality is set after location in the circle.

¹⁴It could have been set by a market regulator beforehand.

¹⁵Perfect price discrimination is efficient in a monopolistic market. Bashkar and To (2004), however, showed that perfect price discrimination may lead to excessive entry in a monopolistically competitive setting.

¹⁶An implicit assumption here is that the number of spots per program is unrestricted.

¹⁷Notice, however, that propositions in the article state general results not dependent on numerical simulations.

¹⁸This result is not general. In particular, it is due to the discontinuous nature of the demand curve for advertising.

¹⁹Even higher quality is expensive to produce and brings no gains in terms of intra-type market area. It could attract more external consumers toward sports programs, but this is not sufficient to justify the cost increase, as quality is already above the monopolistic optimum.

²⁰Price discrimination in the advertising market is assumed.