Producers’ Market Structures and Operations
Producers to be reviewed and their market structures
This report will focus on two of the leading companies in the cable television and film industries: Xfinity/Comcast Cable, in cable television, and Universal Pictures, in film. The two companies and their industries function within a monopolistic and oligopolistic market structure, respectively. Before exploring each of the companies and their industries in more detail, some background on their market structures is required.
In terms of monopolies, there are two general types: pure monopoly and natural monopoly. A pure monopoly is one in which a single company controls the entire market for a good or service because of high barrier to entry and/or exclusive access to a core resource or technology, such as with water or electrical utilities. A natural monopoly exists when a single firm is able to service a market more efficiently than multiple firms. This is the result of high costs, both private fixed/capital costs and social costs, to enter the industry, which in the long-run results in average costs declining as output increases (Samuelson, et al., 2014). In the case of cable television as a natural monopoly, this includes the laying of cable, integrating media feeds, and governance technology like transmission scrambling and cable boxes. However, unlike pure monopoly, a natural monopoly does not mean that only one firm is able to serve a given market; instead, natural monopoly is a legal assertion that allowing multiple firms to operate in a given industry/market is less efficient than allowing a single firm to operate. This assertion is used to justify the creation of statutory monopolies in which government prohibits competition by law, as is the case with cable television.
In an oligopoly, unlike in monopoly, a large portion of a market is dominated by a small number of firms firms rather than a single firm. This can be seen clearly in the film industry, colloquially referred to as “Hollywood,” which during its golden years in the 1920s – 1940s saw all of its production and distribution controlled by ‘the big five’ studios: 20th Century Fox, Loew’s Incorporated/MGM, Paramount Pictures, RKO Radio Pictures and Warner Brothers (Hirshorn, 2001). In 1948, the U.S. Supreme Court split production from operations for these companies in a landmark antitrust ruling. Today, there are ten dominant studios that exist (Said, 2013). It is important to note, however, that an oligopolistic market structure like the film industry is not very different from a monopolistic structure. As with a monopoly, the dominant firms can control supply and pricing for an industry, thereby making it a seller’s market (i.e. firms are price makers rather than price takers). Because there are multiple firms, some competition exists, but the goods are services are relatively undifferentiated. Differentiation and competition is created through heavy spending on advertising and promotion rather than on the market fundamental of pricing.
The producers’ operations
The two firms researched for this paper, Xfinity and Universal Studios are both owned by the same parent company, Comcast Corporation. Comcast was founded in 1969 as the result of a re-incorporation of American Cable Systems, a small cable television operator in Tupelo, Mississippi (Comcast, 2015). Today, it is the largest cable television company, the second largest pay-TV company, the largest U.S. home Internet service provider, and the nation’s third largest home telephone service provider. Comcast services U.S. residential and commercial customers in 40 states and the District of Columbia. The company’s headquarters are located in Philadelphia, Pennsylvania. Through its Xfinity cable operating unit, Comcast has diversified beyond its cable television monopoly into home and business internet, telephone, and security services, all delivered over the same cable infrastructure. Its ability to diversify was a result of owning the monopoly franchise to install cable lines and lease cable boxes throughout cities in which it is licensed to operate (Cassidy, 2014).
While Comcast is probably best known for its cable television operations, along with its broadband and home phone services, it has equally impressive operations in the content space. In 2011, Comcast acquired NBCUniversal, and that acquisition propelled the company into television programming, via NBC, and feature film production and distribution, via Universal Pictures. Universal Pictures, also known as Universal Studios, is a subsidiary of NBCUniversal, was founded in 1912, and the fourth oldest film studio in the world. Some of its most well-known products include Jurassic Park, Jaws, and E.T.: The Extra-Terrestrial. In 2014, Universal Pictures centralized its operations in Los Angeles, after having operated overseas during its ownership by Matsushita, Seagram, and then Vivendi, dating back to 1990 (Miller, 2014). Today, Universal Pictures produces and distributes mainstream movies, while subsidiaries produce everything from animation to ‘independent’ films. Universal also operates theme parks which integrate plot lines and characters from its movies through its Universal Parks & Resorts product. Universal Studios Home Entertainment unit handles the marketing and distribution of DVDs from its 4,000-film library (Hoovers, 2015).
Why each producer fits into its market structure
In the case of the film industry, there are three key characteristics of oligopoly as mentioned earlier: a few key sellers dominating the industry, high barriers to entry, a prevalence of advertising, and moderate pricing due to some competition (Samuelson, et al., 2014). For the cable television monopoly, there will be only a single producer in a given market, also high barriers to entry, and typically high prices and profits. (Samuelson, et al., 2014). As a natural monopolist, Xfinity/Comcast Cable fits into its market structure because its rights to monopolize production is the result of franchise agreements that have been granted at a city-by-city level along with being the sole seller of set-top-box devices that are able to decode the signals generated by Xfinity (Honan, 2011). Universal Pictures fits into an oligopolistic structure because of the few viable competitors it has today (Said, 2013) and the massive costs for celebrity talent and special effects production which make effective competition cost-prohibitive for new entrants (Abelson, 1996). A detailed profile of each producer is as follows:
|Table 1: Profile of Xfinity Cable Monopoly vs Universal Film Oligopoly|
|Number of Competitors||None (in the markets it serves)||Ten|
|Market Power||Being the only legal installer of cable services in its markets||Ability to control price and production of films|
|Barriers To Entry||Franchise rights provided by city governments artificially limits the ability for other installers to enter||Massive production and talent costs limit competitors’ entry|
|Pricing Strategy||Price discrimination (prices increase or decrease based on consumer risk of cancellation)||Price discrimination (by age, by city, by time of day, by day of week)|
|Profit||$8.47 Billion (Net FY2014, only available for Comcast Corp — company does not break out individual subsidiaries in 10-K or 10-Q reports)|
|Product Characteristics||HD cable television channels, along with non-television cable features including internet access, voice/home phone, and home security||Motion picture production and distribution in animated films, feature films, television productions, home video, theme parks|
Note: Data for table adapted from Said (2013), Abelson (1996), Lee (2012), Thompson (2012), Hirshorn (2001), and Comcast (2015).
In considering the profiles of both companies and Comcast overall it is important to note that for the cable television and film industries, consumer adoption ‘over-the-top’ solutions like AppleTV and television programming available via the Internet are beginning to erode cable’s monopoly (Honan, 2011), while the film industry has also seen some erosion to similar internet-based delivery solutions (Willens, 2015). So while the cable television industry and film industry fit into a monopoly and oligopoly structure, respectively, changes wrought through digital technologies and internet-based, user-generated media outlets such as YouTube are rapidly transforming these industries into something more akin to pure competition over time.
Advertising across the two market structures: Similarities and Differences
In a monopoly market structure, common theory holds that companies do not need to advertise, except for public relations or goodwill advertising, at least in the case of a pure monopoly (Petroff, 2002). The same does not necessarily hold for natural monopolies. A case study for the rationale of a monopolist that advertises is Xfinity/Comcast Cable’s primary rival, AT&T, who held a monopoly positions in landline telephones for much of the 20th century:
Although AT&T was a monopoly with no need to fight competitors for share of the market, it still recognized the crucial value of advertising to help build a relationship of familiarity and trust with its customers, both business and residential. In many ways, AT&T defined the special role of advertising for a natural monopoly. It used advertising to separate itself from the traditional bullying connotations of monopoly and portray itself as a benevolent servant working in the public interest and deserving of its special legal status (McDonough, 2015).
By contrast, Comcast/Xfinity’s advertising focuses on popular live events, sports, and concerts via sponsorships, rather than service; this furthers its mission of being seen not as a monopolist cable operator, but an entertainment provider (IEGSR, 2015). And as an entertainment provider, both the public and government may be more likely to perceive the business not as a monopoly needing to be broken up, but one of a few companies competing for position in an oligopoly, as we see with the film industry.
Similar to the monopolist, the oligopolist will undertake advertising emphasizing nonprice competition; however, one difference from the monopolist is that the oligopolist’s motive is to avoid risky price wars with its competitors, whereas the monopolist emphasizes goodwill or public relations given the lack of competitors. Film industry advertising is a classic example of oligopolistic marketing: it would be almost impossible to recollect any commercials that position a film’s benefits as being its ticket price versus another film’s price. Advertising within the framework of an oligopoly is intended to differentiate products and services on characteristics as mentioned earlier, as well as establish higher barriers to entry and economies of scale. For the oligopolist, the goal of these actions is to deter competitors and is a second point of similarity for the natural monopolist.
A second difference, in the case of an oligopolist, whose pricing and demand will be interdependent with its competitive set, is that marginal cost and therefore margin to spend on advertising is much more difficult to assess. But when advertising results in increased sales and in turn increased production, advertising will improve efficiency for the oligopolist only when savings from the economy of scale exceeds the cost of advertising (Economics Online, 2015). By contrast, because the successful monopolist’s marginal costs are always lower than the price (Samuelson et al,. 2014), every additional sale will help to increase its profit. The marginal benefit of advertising for the monopolist is equal to the increase in sales times profit on additional sales, and to achieve the profit-maximizing level of advertising, this marginal benefit must equal the extra dollar expended (Guell, 2008.).
Principal-Agent Problems: Which Firm Has Fewer and Why
The principal-agent problem is typically associated with large firms where ownership and control/management are separated between the principal and agent, respectively. This separation causes information asymmetry, in which the agents know more than the principals do. To address this, owners construct mechanisms to monitor and check the performance of managers (Samuelson et al., 2014).
In the case of monopolies, their ability to operate is a function of government license/franchise as described earlier for cable television. Because of this relationship, the principal is the government and the agent is the monopolist firm. The monopolist will invariably have better information than the government on the most efficient pricing, because the monopolist’s goal will be profit maximization, while the government’s goal would be to maximize public welfare. However, while the agent monopolist in this case has better information than the principal, it has no intrinsic incentive to maximize public welfare. As a result, the government will construct schemes as part of the the licenses to operate that ensure consumer-benefitting pricing controls exist (Vogelsong, 1990).
With oligopolies, the principal-agent problems are relatively more intractable than with monopolies. Wherein a government can grant or rescind a license to operate when public welfare becomes misaligned with the agent firm’s activities (by invoking antitrust action for example), with an oligopoly, alignment of incentives between principal/owner and agent/employee have the additional complication of competition between firms. While economic theory treats firms as economic agents with the sole objective of profit maximization, with oligopolies, the principals will frequently not index incentives to profits but rather strategies that address the actions of the principals and agents of the rival firms:
We found a principal (firm owner) will want to distort the incentives of his agents (firm managers) in order to affect the outcome of the competition between his agent and competing agents…. This paper has demonstrated that competing firms’ owners will often distort their managers’ objectives away from strict profit maximization for strategic reasons. (Fershtman, et al., 1987).
In other words, even though the oligopolistic owner should care only about profit maximization, the owner will not direct its managers to maximize profits since each manager is habituated to react to the incentives of competing managers. Because of this information asymmetry caused by principals on setting goals, and the natural asymmetry that exists as a result of agents having better access to information (Samuelson, et al., 2014), oligopolies will have more problems than monopolies in addressing principal-agent problems.
Benefits of Monopolies
There exists three core benefits of monopolies: international competitiveness, revenue for governments, and massive profits for the monopolist’s investors. (Economics Online, 2015). Regarding international competitiveness, a firm may have monopoly power in its domestic country but face effective competition in global markets. As markets have increasingly globalised, it may be necessary for a firm to have a domestic monopoly in order to compete internationally. The ability to compete on an international basis is important because international competitiveness improves export revenues for the government and the economy in which the monopolist operates. Ironically, international competitiveness on the part of the monopolist requires investment for the monopolist and increases comparative advantage, which means that prices are theoretically lower in the long run (Bacchiega, 2011). In addition to international economic power, the domestic government realizes revenue in the form of taxes and fees, both at the federal and state levels. These taxes are not just in the form of sales taxes, but through the issuance of licenses, such as franchise licenses to cable television companies. The third benefit, massive profits for investors, particularly in the short run, is due to the absence of competitors and the position of the monopolist as a ‘price maker’. As mentioned above, in the long run, the massive profits realized may be used to increase international competitiveness, launching new products, or carrying out research and development (Economics Online, 2015).
Market Structures and Consumer Surplus
Neither monopoly nor oligopoly are optimal for the creation of consumer surplus when compared to pure competition. Both structures result in the creation of some deadweight loss, due to their lack of efficiency and competition, which minimizes some of the surplus left to consumers. However, between the two, oligopoly allows for more consumer surplus than monopoly. This is because, as stated earlier, the monopolist is able to function as a ‘price maker’ rather than a ‘price taker’ (from the consumer) as with perfect competition. As a price maker, the monopolist will optimize to generate producer surplus, benefitting itself, rather than generating consumer surplus (Samuelson, et al., 2014).
While the oligopolist is also able to benefit from greater producer surplus like the monopolist, the level of competition and interdependence that exist with other firms in the oligopoly results in some level of price competition — when one producer reduces price, rivals will also reduce prices (Samuelson, et al., 2014). This competition increases potential consumer surplus, which is simply the difference between what the consumer is willing to pay and what the consumer actually pays. If each of the rivals begins a price war, a risk stated elsewhere in this paper, the result is a driving down of market price not based on consumer demand, and therefore following having price move along the demand curve, but reaction to rivals’ decisions (Economics Online, 2015), which results in a shift of the curve, thereby increasing the probability of generating greater consumer surplus.
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