Introduction to the TV market
Introduction to the TV market
Part of the leisure industry, the TV broadcasting has a unique market structure. As well as competing with other forms of entertainment, large broadcasters compete with each other for viewers while using different ways to raise revenue. There are three aspects in the TV market in the UK, broadcasting, television production and TV manufacturing. These markets provide goods or services that are complements of each other because complements are in joint demand which means that in demanding one good a consumer is likely to demand another. Here in demanding TV set, a consumer is also likely to demand channels as well. And the demand for television production is derived from the demand for TV channels. Goods have a derived demand when the demand for one good is dependent on the demand for another good. Channels and their broadcasters derives demand for TV production as they need production to make a programme schedule.
The market for the viewing of TV is complicated by a number of factors:
- There is not a direct price for the purchase of commercial terrestrial TV.
- Public terrestrial TV is paid for by the licence fee.
- Commercial terrestrial TV is 'free to air' and it is funded through advertising revenues that advertisers pay who in turn receive their money from consumers.
- The product is not supplied under the normal market price mechanism, as the products are not individually priced; Consumers do not pay directly for the specific programmes they demanded, but to pay for a whole channel, which means that consumers are paying for some programmes that they don't actually want. However, the recent trend in 'pay per view' in cable and satellite means that viewers can pay directly for their demands.
The market for advertising airtime is very competitive, because airtime on one channel is a very close substitute to airtime on another channel. Nevertheless, airtime is not a homogenous product because channels can charge different prices according to their viewing figures. Advertisers are willing to pay £30,000 for a 30 second spot during Coronation Street. This is the reason why channels invest millions of pounds on programme production every year, as they want to boost their advertising revenue by increasing their viewing figures.
Broadcasters
In addition to the five terrestrial channels, BBC1, BBC2, ITV, Channel 4(S4C in Wales) and channel 5, there are also hundreds available on satellite and cable, however they are all provided mainly by BskyB, Ntl and Telewest, so there are in fact only 3 broadcasters in addition to the terrestrial channels.
Figure A
Figure A shows that in 1990 there were only 4 terrestrial channels and there were no satellite or cable. The market share was divided amongst 4 channels, two of which were supplied by the BBC. The market had a 100% 3 firm concentration ratio.
Note: BBC 1 and BBC 2 count as 1 firm, the BBC and the ITV network counts as a single firm although it was made up of many regional firms, 15, but they acted together and were not in direct competition with each other.
Figure B
Compared with figure A, there were two more competitors in the market in 2000, satellite/ cable, which gained a 16.6% increase in market share and CH 5 with a 5.7 % gain in market share. Up against the new competition from satellite/ cable, the losers were BBC 1 and ITV, whose market share shrank from 37 and 44% in 1990, to 27.2 and 29.3% respectively. This is a strong evidence that satellite/ cable is a close substitute to BBC1 and ITV, because while the market share of satellite/ cable has increased, the market share of BBC1 and ITV has fell. This has happens when two goods are in competitive demand which means they are substitutes of each other. This can be shown by demand and supply curves:
Figure C. Figure D
Figure E
However CH4 and BBC2 did not suffer from the competition from satellite/ cable or from CH5; the market share of CH 4 has increased from 9% to 10.5%, where as BBC 2 has increased from 10 to 10.8%. The reason for this is perhaps the programmes on CH 4 and BBC 2 are of distinct characteristics from the rest, satellite/ cable, ITV and BBC 1. Excluding cable and satellite, the market has a 3 firm concentration ratio of 77.8%, compared with 100% in 1990, which shows that the market for TV has become a more competitive environment over the last 10 years.
Terrestrial TV
BBC
The BBC is the main public service broadcaster, which is owned by the public and runs by a board of governors appointed by the government. It is regulated by the agreement under the Charter. Funded by the licence fee, the BBC provides two terrestrial channels and as well as it digital service, such as BBC knowledge and BBC choice. The BBC's main priority is to provide programmes that are of public interest. So unlike other broadcasters, it is funded by licence fee and not by advertising. It is not in the BBC's interest to advertise because commercial pressures would dictate its priorities instead of the general public interest. The licence fee maintains a wide range of public services that cannot always be financed by the economics of pay-TV or advertising.
Figure F
BBC
Figure G
These public services on TV can be considered as merit goods, because the social benefits that derive from the consumption of that good (or service) exceed the private benefits, in other words these goods have a positive externality. For example documentaries and news educate viewers and in some way increase their productivity at work. Under normal price mechanism, merit goods such as documentaries are under consumed because consumers do not fully appreciate their private benefits, so instead the BBC provides these services through license fee.
ITV
ITV is the commercial broadcaster which is funded through advertising. The ITV network centre commissions and schedules programmes, and as with the BBC, 25% of all programmes must be produced by other independent producers. The limit on the amount of advertising is set by the Independent Television Commission (ITC). On average there are 7 minutes of advertising in an hour, and the sale of advertising airtime is coordinated by two sales houses- Carlton Media and Granada media. Advertisers can choose to advertise nationally or regionally, in each of the regional companies of ITV. The national coverage of ITV is licensed by the ITC and is divided into 15 franchises, 14 regionally and 2 in London weekday and weekend, as well as GMTV. The most dominant companies in ITV are Granada and Carlton.
The ITV network as a whole has suffered from falling audiences in recent years, and next year's programme budget will be strengthened by 8% to £ 836 million. ITV needs to improve its viewing figures because it will determine the amount of advertising revenue. ITV cannot increase its viewing by lowering price because it is already free, so it must improve its quality of programmes, therefore ITV is investing heavily in programmes in the forthcoming year.
Channel 4
Channel 4 began in 1982 with a statutory duty to provide information, education and entertainment, and offers ...
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The ITV network as a whole has suffered from falling audiences in recent years, and next year's programme budget will be strengthened by 8% to £ 836 million. ITV needs to improve its viewing figures because it will determine the amount of advertising revenue. ITV cannot increase its viewing by lowering price because it is already free, so it must improve its quality of programmes, therefore ITV is investing heavily in programmes in the forthcoming year.
Channel 4
Channel 4 began in 1982 with a statutory duty to provide information, education and entertainment, and offers diversity and innovation appealing to the alternative tastes and interests from what is provided by the ITV. Like the BBC, channel 4 is owned by the public, but it is funded entirely by advertising where as BBC is funded mostly by licence fee.
Channel 5
The fifth terrestrial channel was launched in 1997 with a remit to show programmes of quality and diversity, and it is a success as it now broadcast to over 80% of UK's home. The government's decision in 1990 to establish a licence for the fifth terrestrial channel was to give UK viewers more choice of channels at no extra costs and also to increase competition amongst commercial broadcasters.
Figure H Source: adapted from BARB
Figure C shows that the number of homes with subscription TV has overall grown from 2.5 million in 1992 to 9 million in 2001. It also shows that over the time between 1992 and 2001, the proportion of homes with satellite or cable has changed: in 1992 there were 2.5 million of homes with subscription or pay TV, 2 million (80%) of which came from satellite: where as in 2001 when there were 9 million, only 5.5 million were satellite (61%).
Sky
Now that ITV digital has collapsed, Sky remains the only Satellite provider in the UK.
British Sky Broadcast is the largest subscription TV provider in the UK with over 6 million homes (6.4 million in 2002 from BARB). It is responsible for the broadcasting of hundreds of channels through digital satellite, including channels such as Sky One, Sky News, Sky movies and Sky Sports. BSkyB's main shareholder the News Corporation with 36% is one of the largest media companies in the world, which is controlled by Rupert Murdoch.
Ntl
Ntl is the main provider for cable TV, with 3.8 million subscribers by December 2002.
The company's principal activity is to own and operate broadband communications networks for telephone and Internet. Ntl's main shareholders are France Telecom 18.3%, Cable and Wireless 11.2% and Capital Research & Management Co 9.89%.
Telewest
A network provider for broadband internet, telephone as well as cable TV. It has over 1.3mil TV and 1.6 mil telephone users. Telewest's principal shareholders are Liberty media and Microsoft.
Figure I
Figure D shows that overall the growth rate of subscription TV has slowed down from over 30% in 1993 to just fewer than 20% in 2001. The growth rate of satellite began to fall from 1993, and between 1998 and 1999 the growth rate has fallen to 0. Then between 1999 and 2000 satellite began to recover and by 2001 the growth rate was near 30%,
which shows how much of an impact Sky digital has been.
The Market for TV
Demand
In general, TV is demanded for two purposes, one for entertainment and information for viewers, and two for advertising airtime for firms (or advertisers). Alternatively we can say there are two types of customers in the television market, and some broadcasters raise revenue by charging only the viewers (the BBC), some broadcasters charge only the advertisers (ITV, CH4) and some charge both viewers and advertisers (Sky, Ntl)
Supply
By the supply of TV, I am referring to the supply of programmes and advertising airtime. The quantity of programmes supplied by a broadcaster, can be measured by the number of channels on air and the number of hours a channel is on. The number of channels on terrestrial is limited to 5 channels because analogue cannot provide enough frequencies. There is also a limit on the amount of adverts because there are restrictions, set by the ITC, on the length of advertising airtime. On average there are 7 and half minutes of advertising per hour on ITV. These legal restriction and technical restriction on supply have caused the price elasticity of supply to be very low as in short run, broadcasters cannot increase their supply in respond to demand. For example if there is an increase in the demand for airtime due to increase of population, ITV will not be able to increase the supply of airtime because there is only one channel available and the length of airtime is limited. This can be represented by a vertical supply curve.
The development in digital technology has allowed hundreds more channels to be broadcasted, which can be illustrated by a shift in the supply curve to the right, and as a result the prices are lowered. For the viewers, the price per channel has gone down; as Sky subscription was the same for analogue and digital, while digital offers hundreds more channels. This can perhaps explain why there was a high growth rate in the number of Sky subscribers since 1999 when Sky digital was first launched. For the advertisers, the price of adverts would fall as well as there are more channels offering substitutes for airtime on ITV. This would not be a problem to ITV as long as there are only a small proportion of Sky viewers, because airtime on Sky will not be a close substitute to airtime on ITV, as Sky has a significantly lower audience reach compared with ITV. However, the rapid growth in the number of Sky viewers (now 6 million homes in the UK) has become major competition to ITV.
The market for airtime in Short Run
The Merger
The two biggest companies of the ITV network, Granada and Carlton, have recently agreed a merger deal estimated to worth £ 2.6 bn. With 54% share of ITV advertising revenue, Granada Enterprises is the largest commercial sales house in the UK. Granada owns 7 of the 15 franchises: Granada Television, London Weekend Television, Yorkshire Television, Tyne Tees Television, Anglia Television, Meridian Broadcasting and Border Television, broadcasting to over 60% of UK's homes. Carlton Television owns the license in five regions, Carlton London, Central, West Country and with the recent acquisition of HTV, Carlton will broadcast to over 26 million homes - almost 50% of the UK population. However, the ITV is highly regulated in the quality of its programmes and also in ownership regulations, and as the law stands:
* No single company can have more than 15% audience share in order to prevent consolidation of ITV into a single company and monopoly in commercial TV This covers ITV, CH5 and satellite and cable licences, where as in other markets 25% is considered to be a monopoly.
* The two London licences cannot be owned by the same company
The government has promised that the law will be changed as the draft of the new Communication Bill published on 6th May 2002 will lift the current ban on a single company running ITV. This clears the way for Granada and Carlton, in spite of this; the deal will still have to be approved by the Competition Commission. The deal will improve both companies' balances as ITV has suffered from a downturn of advertising revenue due to the increase in competition from Sky.
Why do firms want growth and mergers?
Economies of Scale
All profit maximising firms in general grow for three main reasons: Firstly, a larger firm can exploit potential economies of scale, which are factors that cause average cost to reduce as the scale of production increases, illustrated by the diagram below.
There are many sources of economies of scale:
Purchasing economies: for example bulk buying, the merged firm can buy programmes in larger quantities from production companies which will cost less on average. As the merged firm will be a big buyer of programmes (40% of national viewing), it will enjoy some characteristics of a monopsony, which is a sole buyer of a good. The merged firm can use its bargaining power to force down prices of programmes, therefore reducing its costs.
Marketing economies: for example if two companies were to merge they will only need to advertise one brand name, where as two individual companies need to advertise two brands.
Technical economies: resources are often more efficiently used in a larger the scale of production rather than a small scale. For example Granada might have a studio which is used only a few hours a day, but the merged company might be able to use the studio far more intensively because it more programmes to produce.
Managerial economies: a larger firm can afford to hire specialist staff which is likely to increase efficiency. Granada and Carlton can share specialist departments, which can lead to greater output with the same resource.
Financial economies: a larger firm will find it easier and also cheaper to take a loan for investment than smaller companies. This will encourage the merged firm to make more investments as it can borrow loans at lower costs.
Diversification
By growth, a firm can also increase its ability to control the market, because as a firm has more market share, it can restrict the supply in the market by controlling its supply, therefore can influence the market price. The other reason for growth is to reduce risks by diversification.
How will the merger change the Market Structure?
A market structure is the key characteristics of the market that affect the behaviour and performance of firms. These characteristics include:
The number of firms and their size in relation to their competitors:
In a perfectly competitive market there are a large number of small firms, in a monopolistic market and oligopoly there is a smaller number of firms, but in a monopolistic market the firms are of similar sizes, whereas in oligopoly a few firms supplies most of the output of the market. A monopoly can be consisted of up to 4 firms as the government defines a monopoly as having more than 25% of market share. A Pure Monopoly exists when there is a single supply in a market. The merger is going to decrease the number of firms and ITV and CH 5 will be the only channels operating in commercial terrestrial TV. The new firm is also going to have the largest audience share after the BBC.
Barriers to entry and exit
Barriers to entry are factors that prevent potential competitors from entering the market. Sunk Costs are the costs that are non-recoverable. High Sunk costs can act as a barrier to entry because a new firm will pay high costs if it enters a market and fails. (This will also be allocatively inefficient because a firm will continue production despite making a loss because the loss would be greater if it decides to leave the market.)
Capital costs are very important barriers to entry, because when the cost of entry is very high only a few large firms can pay them. Economies of Scale can also act as a barrier to entry because if an industry has large economies of scale, then only the firms operating on a large scale could have the lowest average cost, therefore new firms that are producing in a small scale will not be able to compete with the larger established firms. In some industries only producing at very high levels of output can fully exploit economies of scale and achieve the lowest point on the LRAC. The broadcasting industry is a good example of this because the marginal costs are low, as it will cost ITV exactly the same to broadcast to one home as opposed to one million homes. So the broadcasting industry achieves economies of scale very easily and it is difficult to experience diseconomies of scale. An argument in favour of the merger therefore is that it will allow the new company to move closer to the minimum efficient scale.
Legal barriers may prevent new competitors from entering the market as the law may give particular firms exclusive rights to production. In broadcasting only firms with a licence is allowed transmit radio signals on air.
The TV market has many of these barriers to entry. Capital costs are high in buying the equipment to broadcast a channel on a large scale and also the costs of producing programmes can be high. Economies of scale can also be s factor, for example a large firm can often achieve financial economies of scale because a large firm can raise funds more cheaply than smaller firms because small firms are more likely to pay higher interest rates. There are also legal barriers because a firm must have a licence to broadcast legally. The merger is likely to produce a higher barrier to entry because the new firm can exploit economies of scale and lowering the average cost ( the new firm can save around £50 million a year). The new firm can therefore invest more in TV production and improves it programmes quality (8% increase in the budget for production in 2003). This will make new firms more difficult to compete with the new ITV firm because it will need more capital to produce higher quality of programmes to compete efficiently with ITV.
Homogeneity of products
Homogenous goods are identical products. However, by differentiating their products firms would have more control over the market, because it causes their products to become more price inelastic. Firms usually differentiate their products through branding, which allow them to build a brand image and loyalty. Despite the fact that a branded good might be very similar to its competitors, a consumer would think it is a very different product and there are no close substitutes to it. Therefore the firm can rise its price and still gain revenue (price inelastic). The TV market supplies a wide range of products, which can be close substitutes or unique; ITN news and BBC news are very close substitutes but some programmes are exclusive to some channels because of agreements, e.g. soaps and football TV rights. Therefore the channels that show popular and exclusive programmes can increase their prices, e.g. Premiership + and Sky Movies
Consumer sovereignty is said to be highest in perfect competition where consumers have a direct influence on the price, quantity and what is produced. This means that a perfectly competitive market is allocatively efficient. Consumer would have less influence, as fewer firms are responsible for more of the market supply because larger firms can control the price by restricting output. Consumer sovereignty is not going to change because ITV is still going to be 'free to air', and because ITV's revenue is determined by the number of viewers, the viewers will have the vote on which programmes are going and which ones are staying.
How will the merger affect Price Elasticity of Demand in TV?
The price elasticity of demand of a good measures the responsiveness of changes in quantity demanded to changes in price and its is calculated by the formula:
Percentage change in quantity demanded
Percentage change in price
A good with a price elasticity of demand greater than 1 is said to have an elastic demand, which means the quantity demanded is proportionally more responsive to change in price. Where as a good with a price elasticity of demand less than 1 has an inelastic demand, which means the quantity demanded is proportionally less responsive to change in price. And a good with unitary elasticity has a price elasticity of demand of 1, which means that demand is equally responsive to change in price. Price elasticity of demand is normally determined by the availability of substitutes and time period. Goods tend to have higher price elasticity when there are close substitutes and vice versa. Similarly, time period also affects elasticity because in the short term, consumers cannot switch to substitutes quickly where as in the long term they can. In the case for oil, in the short term, there are no close substitutes but recently consumers can choose to use LPG.
Price elasticity of demand for the TV licence
* Currently there are approximately 23.5 million licensed addresses in the UK.
* In 1992, there were approximately 19.5 million licensed addresses in the UK.
* At present a colour TV Licence costs £112 and a black and white licence costs £37.50. In 1992 the same licences cost £80 and £26.50 respectively.
Adjusting for inflation (1987 January= 100)
* 2002 (September)- 177.6
* 1992 - 139.2
Actual Price of TV licence in 2002= £112
Real price of TV licence in 2002 (in 1992 prices)= £112 x 139.2
177.6
=£87.8
=(23.5mil-19.5mil)/19.5mil
(£87.8-£80) / £80
= 20.5%
9.75%
= 2.1
In general market conditions, the figure for price elasticity is always in fact negative because a rise in price (positive) causes a fall in demand (negative) and vice versa. Here the price has rise but the quantity demanded has also rise. Therefore we can dismiss the idea that price is linked to the demand of the TV licence but instead links to other factors:
* Change in law and regulation means that more people are legally required to have a TV licence, students living away.
* The trend in the increase of single parent families, more people choose to live on their own means more TV licence are required.
Price Elasticity for different channels
In the TV market, price elasticity is very complex, because broadcasters uses different pricing methods, some channels would be more price elastic than others. Firstly, to gain legal access to television all consumers will have to pay for the TV licence, which can be considered as a direct and also regressive tax, because TV these days is a necessity and the proportion of income paid as the licence fee falls as the income of the payer rises. However, we also consider the TV licence to be a good as well because by buying the licence consumers can have legal access to BBC, ITV, CH4 and CH5. Therefore these channels are supplied collectively as one product as consumers have no choice of paying for which individual channels they want but to pay for all of them. We must also assume that the consumption of TV licence is not only due to the demand for the BBC but also legal access to other TV channels as well. However, the BBC, ITV, CH4 and CH5 are not complements because for example the demand for the BBC will not lead to a demand for CH4. On the other hand, terrestrial channels are in competitive demand. Currently at £112 for colour and £37.50 for black and white, the price elasticity of demand for the TV licence is price inelastic, because there are no close substitutes to TV, and effectively there is only one supplier, because getting a TV licence is the only way to watch TV. Commercial channels, such as ITV, CH4 and CH5 are apparently free to air, but consumers are likely to pay hidden costs because there is no such thing as free good in economics. Commercial channels are funded through advertising; firms pay them to advertise their products on TV, which becomes part of their costs. These costs are then passed on to consumers because firms will sell their products at a level, which are able to cover their costs and even make profits. Also consumers can be made even worse off because through advertising, firms can build up brand names, which are able to charge consumers more.
The price elasticity of demand for cable and satellite is less price elastic than for terrestrial TV, because we cannot legally have satellite TV unless we already have a TV licence, i.e. terrestrial TV. Therefore satellite and cable are complement goods to terrestrial TV.
The merger can affect the price elasticity advertising airtime: Airtime is likely to become more price inelastic because as the merger reduces the number of firms in the TV market, Granada and Carlton to become a single firm, it reduces the number of suppliers and therefore substitutes in the market for airtime. Therefore if the prices of airtime were to rise, the proportion of advertisers who will stop buying ITV airtime would be less than the proportion the price has risen by.
Evaluation of the Pros and Cons of the merger
The recent developments in digital TV have increased the amount of competition the TV industry by giving consumers more choice of what to watch; in economics term it has lowered the barrier to entry for the TV market because digital technology is capable of broadcasting more channels. Digital TV has also shifted the supply curve to the right, as it is more efficient to broadcast many channels. Where as in the 1980's, there were only 4 channels; so then, ITV and CH4 were able to charge advertisers much higher prices that were passed on to consumers.
Although in the consumers' point of view, increase in competition in TV may not always mean good news. Do consumers want a monopoly supplying a range of differentiated goods, or a perfect competition supplying a homogenous good? In TV this would mean one channel supplying a range of programmes or a number of channels supplying the same programme. In reality this will never happen, but if there were more competition, then on average each channel would have less market share and therefore lower advertising revenue and consequently less funds available for investment in programme productions. Therefore, instead of a few channels providing high quality programmes before, there may be a large number of channels providing poor quality programmes. Such an example can be found in the United States, where viewers have plenty of choice of channels but most of which were poorly produced, arguably due to lack of funding (for example talk shows, shopping channels and reality TV).
What is most likely to happen in the UK is that as Sky's audience share grows, it will cause a huge problem to the terrestrial commercial channels' advertising revenue. In the long term, the terrestrial channels will have less money available for production. This could mean that high quality programmes are only shown on Sky, therefore only available to the people who can afford it. The merger between Granada and Carlton could prevent this from happening, because it reduces the number of firms in broadcasting, in other words less competition and therefore advertising revenues are more concentrated in a fewer number of firms (increase the concentration ratio). Also, the merger by producing a single ITV company, economies of scale can be more fully exploited therefore reducing costs which means potentially more money to be invested in programme schedules and higher quality programmes that are available to more people. Some analysts estimate the merger would be able to save approximately £50 million per year, which will increase productive efficiency (if the average cost of production falls as well), and savings can be passed on to consumers. However, in reality evidence (G Meekes or K G Cowling) suggests that most mergers or takeovers actually lead to losses of economic efficiency, and it can be measured in a number of ways:
* The profits of the combined company are lower than expected or even lower than the sum of profits of the companies, indicated by the stock market where the share price of the company taking over another falls when the takeover is announced.
* Mergers lead to rationalisation of plant, which means lowering the productive capacity of the firm (shifting the supply cure to the left), and if the improvements in other areas of production do not compensate this lose, it will leads to a fall in the total revenue.
* Employment falls because rationalisation of plant involves downsizing of the firm and cutting jobs.
Conclusion
A summary of the key arguments:
The key arguments suggesting that the merger will increase competition
The key arguments suggesting that the merger will reduce competition
The market could actually become more competitive with fewer firms: the merger of Carlton and Granada will reduce the costs of ITV; therefore this also reduces average costs. This will put pressure on other competitors such as Sky to reduce their costs as well, making the whole market more competitive.
A reduction in the number of firms.
Barriers to entry become higher in a number of ways (see How will the merger change the Market Structure?), which prevents potential companies from entering the market.
The new firm will enjoy some monopoly power, as it will be the largest commercial terrestrial channel. The firm can potentially abuse this power, for example it can rise the prices for airtime and the costs would eventually be passed on to consumers.
Title: How will the proposed Granada -Carlton merger affect
competition in the TV market in the UK?
Toby Lee Page 2 Economics
