The Economics of Online Video Entertainment. Ryland Sherman and David Waterman

Transcription

1 The Economics of Online Video Entertainment by Ryland Sherman and David Waterman Dept. of Telecommunications Indiana University Bloomington, IN Working draft Feb. 15, 2013 Handbook on Economics of the Internet Edited by Johannes M. Bauer and Michael Latzer *corresponding author 1

2 DRAFT I. Introduction Although online video entertainment dates back to the mid 1990s, its business models, market structure, and programming content continue to evolve. Driving these changes have been dramatic technological advances, accompanied by a growth in adoption of broadband Internet access, from about 3% of households in 2000, to about 2/3 of households in 2012 (Pew, 2011), and by a growing migration of consumers from offline to online media delivery systems. In this chapter, we address some broad questions about this industry in order to provide a framework for thinking about its economic future. Has Internet distribution of video entertainment created real economic value for consumers, relative to established offline media? How are its market structure and business models evolving? How does Internet entertainment programming differ from offline media? While our answers are necessarily incomplete, patterns of market organization, income sources, programming content, and other characteristics of this industry have now emerged. For our purposes, we consider online video entertainment to be the streaming or downloading of videos to a personal computer or other internet connected media device. Our main focus is on professionally produced content, but user generated video is a remarkable part of the online video entertainment landscape, and is also part of this study. Video games and music videos are an important part of online commercial entertainment as well, but their online business patterns are distinct from those of online video. We thus focus on television, movies, and similar forms of video entertainment, or what is widely regarded as the over thetop video industry. Finally, our geographic focus is on the United States, although we recognize that Internet technology fells international boundaries, and that parallel changes to those in the U.S. are occurring in many other countries (Simon, 2012; Fontaine, et al, 2010). 2

3 A number of scholarly works on the economics of online media provide a foundation for this chapter. Among earlier works, Owen (1999) addressed the economic and technological potential of the Internet for television delivery. Shapiro & Varian (1999) discussed how firms could take economic and technological advantage of digital technologies, including the Internet, more generally. Several authors of an edited volume by Kahin & Varian (eds, 2000) discussed economic and legal aspects of Internet media delivery. A Harvard Business Case (2000) identified basic economic characteristics of online content providers and how they could potentially create value for consumers. A National Research Council report, The Digital Dilemma (2000), analyzed the economics and technology of the Internet from the standpoint of copyright and other government policy questions. Among more recent works, several edited books, notably Noam, Groebel and Gerbarg (2004), 1 Gerbarg (ed, 2008), Noam (ed, 2008) and Gannes (ed, 2009) have addressed the emerging technology, economics, and content of Internet television and video, including the economics of P2P file sharing.. Several recent Harvard Business cases (see, e.g., 2008, 2010a, 2010b, 2012), as well as Screen Digest and publications of SNL Kagan Media Research, provide extensive data and insightful discussion of economic and technological features of Internet television in a business context. We begin in Section II below with the history and current state of the industry. In Section III, we turn to the subject of value creation by comparing the economics and technology of online and offline media delivery systems. Then in Sections IV and V, we explore empirical development of online video, first in content aggregation and market structure, then in business models and programming.. In Section VI and VII, we briefly discuss the industry s economic future and some directions for research. 1 A chapter by Waterman (2004) in this book provides a basis for the present work. 3

4 II. Industry development The history of online video entertainment reflects vibrant industry response to continuously unfolding opportunities that developing technologies, especially in transmission speeds, have made possible. 2 In the mid to late 1990s, before the broadband era, a flurry of Internet content providers, most of them now defunct (e.g., icebox.com, entertaindom.com, ifilms.com, atomfilms.com) began experimenting with online video entertainment. Many were Internetoriginal productions, but disproportionately were brief in length, such as TV mimicking webisodes, and short films, and they tended toward bandwidth lean animation to permit streaming or to shorten tedious download times. Many were professionally produced, with at least a hope of future profit, but many others were user posted amateur productions. At the other end of the spectrum were some theatrical features; most were old and time worn, but in one 2000 experiment, sightsound.com offered recent films from a major Hollywood producer, Miramax. Other providers, including NBCi.com, offered promotional clips of current TV series. These early online activities were characterized by experimentation. Sony s screenblast.com, for example, allowed viewers to determine future plot direction interactively or to piece together their own stories from readymade clips of popular TV series. The dot.com bust in swept away most of the early experimenters. The realityinducing recovery in the early 2000s and the promising dawn of mainstream household broadband adoption marked a new phase in online video entertainment. In 2002, a consortium of five major Hollywood studios started Movielink.com 3, which offered a selection of recent movies for download or rental. With less fanfare, itunes began offering recent TV series 2 See Greenstein (2012) for economic development and analysis of the Internet infrastructure. 3 After spending $ million to develop VOD services, these 5 studios sold Movielink to Blockbuster in 2007 for $6.6 million (Ali, 2007). 4

5 episodes and, soon after, movies for direct sale in The debuts of Movielink, itunes video, and later entrants were enabled by the preceding development of secure DRM encryption systems for IP delivered commercial video. Outside of the industry s control, however, was another landmark event: the introduction of Bit Torrent technology in 2003, whose robustness and decentralized coordination of distribution greatly facilitated illegal P2P file sharing of movies pirated from DVDs or theater prints. A phenomenal and enduring response to YouTube s launch in 2005 marked another major technological breakthrough: the seamless uploading of user generated video. Amid a growing ocean of amateur content on YouTube, full episodes of recent major network series were soon being posted illegally by users. After an initial period of tolerance, the networks and program suppliers issued takedown orders under the 1998 Digital Millennium Copyright Act (DMCA) (see 17 USC 512(c)), and were largely successful. With accelerating broadband diffusion and network speed advances enabling seamless video streaming, professionallyproduced online video distribution began to take off. Netflix launched its instant streaming subscription video service in 2007, relying mostly on older movies and TV programs. In 2008, NBC and Fox (later joined by ABC) launched Hulu.com and in 2009, CBS started TV.com (later CBS Interactive), primarily as outlets for time delayed, ad supported exhibition of regular prime time series programs. In 2009 and later, entry into online video entertainment has proliferated, with subscription or VOD services developed by Amazon, Sony, and others, or purchased and relaunched, like Wal Mart s 2010 acquisition of VUDU. Several cable operators and other multichannel video program distributors (MVPDs) also launched TV Everywhere video, an umbrella concept for services that give offline subscribers free access to a menu of online programming they already receive with their monthly subscription. YouTube made a move toward the top 5

6 down professional production model with the financing of 100 channels of niche programming in late 2011 (Bond and Szalai, 2011). Though begun experimentally at an early date, multi cast streaming of live television programming over the Internet has also become increasingly viable as network capacity has expanded, as evidenced by the ESPN3 s streaming of specialized sports events after 2007, and the first streaming of the Super Bowl by NBC in The state of the online video entertainment industry as of early 2013 is summarized in Table 1. The list of providers is not intended to be comprehensive. Rather, it is a snapshot in Internet time intended to illustrate the variety of business and content models offered by leading industry players. 4 Table 1: Some major players in the online video entertainment industry, 2013 Notable from the launch date column of Table 1 is how new the online video entertainment industry is at this writing; no significant players in the current market were present before Its novelty is also reflected by sobering comparisons between the usage and the economic resources of online video and offline television. According to Nielsen (2012), the average individual in 2011 watched almost 34 hours of television per week, compared to 30 minutes of watching video on the Internet, and 8 minutes watching video on a mobile phone, a ratio of offline to online viewing of about 53 to 1. 5 One industry analyst estimated that about 5% of all prime time TV program viewing in 2010 was online (Convergence Consulting 4 A recent FCC report (released July, 2012), on the status of competition in the video industries provides a detailed description of the recent events in the online video industries and discusses the wide variety of revenue models, content, and levels of aggregation in this industry. 5 Online viewing is relatively concentrated among a small group, but offline TV viewing is pervasive among a broad majority of the population. Nielsen reported that 12.4% of all individuals (the highest quintile among the 61.9% of individuals who stream at least some video) watched an average of 20.7 minutes of video per day, which accounted for 84.1% of all video streaming minutes, but this group also watched roughly ten times as much offline TV per day (241.2 minutes), nearly as much as the average U.S. individual (264.7 minutes). (Nielsen, 2012, Table 8a). See also Liebowitz & Zentner (2012), who found the impact of Internet use more generally on television viewing to be relatively low, but higher among younger Americans. 6

7 Group, 2012), and another that 8% of all U.S. TV viewing was online in that year (Screen Digest, 2011, p.210), but this is surely rising. Online video entertainment revenues are also low, but growing. Waterman, Sherman, and Ji (2012, p.15) estimated that online television program revenues from advertising, subscriptions, and VOD accounted for less than 2% of television industry revenues in A research firm reported a similar ratio, 2.35%, of allonline video advertising to the total sum of offline TV and online video advertising in 2010, and this increased to 3.2% in 2011 and 4.3% in 2012 (emarketer, 2012). Though still dwarfed by theaters, DVD/Blu ray, and license fees from offline television, revenue from online distribution of movies has grown steadily since the mid 2000 s, reportedly accounting for over 7% of studio domestic market revenues in 2011 (Kagan Research, Sept. 26, 2012, p.2) Table 1 also highlights the development of 5 basic online video business models: a la carte rentals and purchases, or video on demand (VOD), subscription, ad supported professional content, ad supported user generated content, and verification dependent, bundled content. At least in the first four of these segments, a leading or dominant firm has emerged. With 63% of the total online movie downloads in the first half of 2011 (Screen Digest, 2011, p.294), itunes is the leader in the VOD category. In the monthly subscription category, Netflix dominates. The bandwidth demands of its 25 million subscribers as of July of 2012 were 18 times greater than those of Amazon, it main apparent competitor (Sandvine, 2012, p.20 21). In the ad supported professional content category, Hulu.com is the leading firm, earning the 4 th highest comscore ranking for total ad minutes viewed during December, 2012 (comscore, 2013). 6 In the ad supported user generated segment, YouTube has notoriously dominated since its launch, accounting for 33.7% of all video minutes per viewer recorded by comscore in Dec., 6 Comscore ranks the top 10 sites by the number of video ads viewed. The 4th ranking in terms of ad minutes viewed is the authors inference. 7

8 2012, with its competitors (e.g., Vimeo and Dailymotion) struggling to achieve even consumer awareness. In the verification dependent offline/online bundling category, competition is at the local market level, and except for DBS based services, the mix of competitors varies by market. No information about performance of these nascent services was available, but it is notable that the websites of a few major cable networks, such as HBO GO, also require users to authenticate an offline subscription to a participating MVPD. In following sections, we seek to unfold the economic basis for the industry as it has so far developed. Unsurprisingly, there has been relatively little economic research about the online video entertainment industry itself. We rely primarily on descriptive information we have assembled for this chapter. III. Comparisons to offline media A first step to understanding the economic prospects of the online video entertainment industry is to ask how online video creates or reduces value for consumers, relative to off line media, in terms of costs or product attributes, including interface characteristics and the quality and variety of the programming itself. Clear cut comparisons are often difficult, in part because established media delivery systems, notably cable TV and other MVPDs, 7 are themselves undergoing rapid technological advancement. We can, however, identify several basic ways in which online video technology may improve upon, or fall short of, offline media. Reduced capacity constraints: The basic architectural advantage of the Internet is the virtual elimination of product carriage constraints, thus enabling the famous long tail of 7 Telcos such as Verizon and AT&T use IPTV delivery, but for our purposes, are grouped with other MVPDs, because they basically offer a linear multichannel service over private networks. The FCC s Annual Reports on Video Competition include excellent commentary and analysis of industry development of MVPDs and online video distributors (OVDs). The 14 th Report, the latest at this writing, was published in July,

9 product variety (See Anderson, 2006). In the video media context, DVD retailers, MVPDs, and other offline media systems face significant marginal costs of adding another DVD or cable channel to their product lines. Online content providers also face marginal costs of capacity to support servers on which videos are stored, but for most suppliers, these are relatively insignificant. The most remarkable illustration of the long tail in Internet video is the billions of usercreated videos hosted by YouTube, few of which could conceivably generate sufficient demand to be supported by offline media. The long tail is less obvious for online video distributors offering professionally produced content, although Netflix, itunes, and others offer large selections of foreign films, for example. YouTube s limited foray into professionally produced content is an apparent milestone in top down creation of long tail programs that are ostensibly narrow in appeal (e.g., Tony Hawk s professional skateboarder channel, machinama, The Onion, Instyle magazine) and also very inexpensively produced. 8 Cost effective video delivery: It is difficult to make cost comparisons among media because they involve fixed capital infrastructures and home premises equipment costs, and thus depend on usage rates. In the case of online video transmission, the Internet network ofnetworks also serves many other uses. Several early authors (e.g., Owen, 1999) and ) argued that as a switched network, the Internet is relatively inefficient for live multicasting of high quality video. The slow development of live television transmission via the Internet seems to bear out that assessment. The Internet is well designed for asynchronous video transmission, however, and it is heavily utilized for that purpose. In 2011, video and music transfer accounted for 60 percent of peak period downstream Internet traffic. (Bazilian, 2011). Netflix alone 8 YouTube s total announced budget for all of the 100 channels together was $ million. YouTube has recently announced that it would invest another $200 million into the programming and add 60 more channels (Efrati, 2012). 9

10 accounted for 33% of peak period North American downstream bandwidth use. (Sandvine, 2H 2012, p.7). Judging from the profusion of video traffic, low prices for video transport, and low consumer prices for broadband access, it is apparent that on demand video transmission is relatively cost efficient. 9 To the consumer s benefit, cost efficient delivery implies low consumer prices for video programming as well as broadband access, and thus competitiveness with offline media. As the Internet s bandwidth capacity has risen, delivery costs have also fallen rapidly. Interactivity and computer functionality: Perhaps the most remarkable advantage of Internet architecture over offline media for video distribution is its sophisticated computer tocomputer communications. Consumers have direct control over program selection and time of viewing. MVPDs have long used limited 2 way interactivity for VOD systems, and these have become progressively more efficient. DVRs have also enabled time shifting control, but computer to computer Internet communication is much more flexible. For example, content providers, rather than the MVPDs alone, can create their own user interfaces and innovative advertising systems. Interactivity and search are also essential to asynchronous management of the long tail of content proliferation on YouTube and other online video services in Table 1. Search engines and video site search functions trump offline media in several ways. They enable viewers to search on a variety of dimensions and tie massive amounts of meta data to their content, including previous consumers ratings and correlations of viewer habits. Through the use of user IDs or cookies, they record a consumer s previous choices and can build suggestion profiles customized to that user For a survey article on the cost efficiency of Internet vs. offline video transfer, see Screen Digest (2012). 10 In 2006, Netflix offered $1 million to the first team that could improve its movie search and recommendation engine by 10%, eventually producing a solution in September, 2009 by a consortium of teams.. The collective knowledge produced by this crowdsourcing contest pushed the boundaries of how machine learning and statistical techniques could handle big data sets, and Netflix immediately created 10

11 Online interactivity also enables cheap user participation in content creation and distribution. The closest offline substitutes for YouTube and other video sharing sites are clumsy and little used cable TV local access channels. Portability: Laptops computers have been available since the launch of the first online video providers and have become increasingly light and efficient. Developments in the late 2000s of portable media players, smart phones, and tablet computers have increased the convenience of access to online video entertainment. Together with interactivity, portability has brought to practical fruition the anytime, anywhere mantra for online video entertainment; although to date, tablets and smart phones have not been widely used for video consumption (See Nielsen, 2012). Simultaneously, the development of apps and browser based video systems used by portable devices for video reception has accelerated. More efficient advertising: The ability of Internet content providers to target adsto individuals based on their past browsing, viewing, or purchasing behavior derives from interactivity and has generated a large economic literature that is beyond the scope of this chapter. (For recent surveys, see Evans (2009) and Anderson (2012)). Advertiser supported video providers such as Hulu and YouTube take advantage of targeted advertising, including strategic placement of in program video commercials. DRM controls also make in program commercials harder to evade. Reportedly, however, user tolerance of video commercials has been lower on the Internet, and other forms of Internet advertising, such as display ads, have proven less effective than offline display ads. The difficulties experienced by YouTube in monetizing user generated content with ads have been widely reported and are likely responsible for its segue into offering professionally produced another, more open ended contest, suggesting that the organization believed the competitive advantage offered from search efficiency was worth the investment (Lohr, 2009). 11

12 content. Internet advertising is evolving rapidly, but it remains uncertain whether video entertainment providers have to date experienced a net benefit from Internet ad targeting. More efficient pricing and bundling: Interactivity and secure payment systems have made direct pricing of online entertainment products very efficient to manage. A great variety of alternative bundles are offered, and cookies potentially enable sellers to practice dynamic pricing and product matching to individuals based on browsing and previous purchasing behavior. These features are common to the sale of other products marketed on the Internet, but there are particular advantages for the efficient sale of online video products. First, efficient Internet pricing and bundling help to enable efficient VOD systems with virtually unlimited product variety. Secondly, the essentially zero marginal capacity costs of carrying information products have particular implications for efficient bundling and price discrimination on the Internet. Bakos & Brynjolfsson (1999, 2000) showed that due to the essentially zero marginal costs of carrying information products, large bundles of information products (such as those now offered by Netflix, Hulu Plus, and other subscription services), facilitate efficient price discrimination via large scale value averaging. (See Choi, 2012, for a survey of the economic literature on information product bundling). Meanwhile, cable television and other MVPDs have developed efficient direct pricing of the bundles of programming channels they offer, and they maintain increasingly large VOD systems. However, Internet video providers appear to have an advantage over MVPDs in their ability to bundle large quantities of video products, instantaneously change prices, and price dynamically. More efficient copying and sharing: The basic technology by which a computer file can be downloaded and shared with other users by or via P2P file sharing is obviously far 12

13 cheaper than the alternative of buying a DVD and physically distributing it to friends, or of burning a copy to a blank DVD and sharing it. To the benefit of copyright holders, electronic sharing or DVD burning of legally distributed online videos have been greatly limited by sophisticated DRM controls, which are applied to virtually every product of significant commercial value. 17 USC of the DMCA also makes it a serious crime to defeat DRM encryption. 11 P2P video file sharing, however, has proven far less easy to control, at least in the case of movies; even a single copy of a DVD that is decrypted and illegally posted can end up spreading the movie worldwide. There is some limited statistical evidence that movie file sharing reduces legitimate sales (Waldfogel, 2012). Engineering studies also document high volumes of illegal movie file transfers worldwide (e.g., Mateus and Peha, 2011), and it is a good speculation that this activity has contributed to a steady decline in DVD sales and rentals that began in about Television, on the other hand, does not appear much affected by file sharing. Incentives to pirate most popular TV shows are probably limited because they are already free on broadcast, basic cable, or online video streaming, or they are priced low by itunes and other a la carte program sellers. In summary, Internet technology for video distribution offers some remarkable improvements upon offline media, but also threats to copyright owners and potential bandwidth capacity challenges. The rapid growth of the industry since about 2005 is testimony to its consumer value, but it has a long way to travel to play as significant a role in the market as offline video distribution. 11 The DMCA imposes statutory damages penalties of between $200 and $2,500 per act of circumvention or actual damages, and does not preclude the application of copyright violation remedies. 13

14 IV. Content aggregation and market structure We take content aggregation to mean the supply of large amounts of content via a single website or app, typically from multiple creators or copyright owners. Aggregation is important because of its implications for the evolution of market structure in the online video entertainment industry. The firms listed in Table 1 have a range of aggregation levels. At least in economic terms, however, the large scale aggregation from multiple copyright owners appears to be a dominant model in online video entertainment. itunes, the leading VOD supplier, aggregates TV programs and movies from all the major studios and broadcast networks, as well many more minor players. Netflix offers a large menu of movies, TV programs, and other content from many different owners, including films from a number of foreign countries, to its monthly subscribers. Hulu aggregates mainly TV programs from the 3 major broadcast networks which co own the site, and also offers programs from CW, a group of cable networks, and hundreds of other content partners. Viacom s strategy is an intermediate case, offering programming content that has appeared on numerous cable networks through each of their own portals and often Hulu, but most of those programs are owned or licensed by Viacom, a major content provider. Similarly, CBS Interactive offers content from a number of other suppliers in addition to the CBS broadcast network. The major MVPDs TV Everywhere services typically aggregate programming from a number of different basic and premium cable networks, in addition to other suppliers. Whether or not content aggregation is prevalent in the online video entertainment industry is simply an empirical matter. The efficiency of both aggregating and disaggregating media content is enhanced by Internet architecture. Enabled by efficient search, and by the lack of physical economies of scale in IP delivery of more than one program at a time, a provider can 14

15 set up a website to market even a single video program and many do. At the other end of the spectrum, a provider can take advantage of low capacity costs to assemble a virtually unlimited amount of content under the umbrella of one website, and utilize within site search. There are some compelling economic advantages of the aggregation model. Content aggregation in the 1990s by portals that charged flat rates per month, such as America Online, was the basis for the bundling theory of Internet content aggregation developed by Bakos & Brynjolfsson (1999, 2000). The one stop shopping marketing model is probably more relevant than bundling to the current online video market especially to advertiser supported sites such as Hulu, and to VOD sellers such as Amazon and itunes which also offer digital music and other non video products. These sellers apparently attempt to build name identity among consumers, said to be a major consideration in the development of Hulu, for example (HBS, 2008), or to capitalize on established names, as in the case of itunes and Amazon. It is notable, however, that leading online video distributors which rely less upon content aggregation, such as HBO GO, ESPN3, and CBS.com (which among the 4 major broadcast networks, decided to go it alone in 2007), appear to already have well established offline name identities. Another force driving aggregation is that website operators undoubtedly experience certain economies of scale due to fixed costs, like website design, maintenance, and administrative overhead. Other Internet developments also seem to display the economic advantages of content aggregation. Google TV and Apple TV, for example, partially serve as aggregators of program suppliers who are willing to be sold as part of an online package that can be watched on a TV set. The Microsoft Xbox 360, Sony PlayStation 3, a variety of set top boxes, tablets, and the Internet connecting programs of smart TVs essentially function as content aggregators in a similar way. Although the marketing and efficiency advantages of online content aggregation seem to favor larger firms, there are no compelling indications that they will lead online video 15

16 distribution, at least of professionally produced programming, to become a concentrated industry in the long term. The prototype model of online content aggregation s competitive advantages is YouTube, which has obviously benefited from network effects by offering consumers access to the largest possible collection of user generated video and offering users who desired to upload content the largest possible collection of potential viewers. (See comscore, 2012). Presumably, YouTube s recent expansion into a top down commercial programming model will benefit from traffic generated by user created content. However, topdown online video providers of professionally produced programming do not appear to be subject to network effects, and consumer switching costs are evidently minor. Considered more broadly, reasons for the apparently high concentration within the individual industry segments of VOD, subscription, ad supported professional production and user generated content are speculative. In each case, the leaders are the first movers. In the case of Hulu, this consortium of 3 among the four major broadcast networks simply holds the rights to the most popular programming (as does CBS Interactive in the case of the CBS network). In the subscription category, recent exclusive programming contracts, especially by the market leader, Netflix, are a potential concern that could limit competition. Nevertheless, industry participants (e.g., Amazon and Hulu) have been actively seeking to enter each other s business model segments. In any case, they all compete with each other for consumer attention as well as with other online and offline media. A related issue affecting market structure is the disaggregation of existing MVPD packages that Internet architecture makes possible. Individual content suppliers can potentially bypass MVPDs and offer their programming directly to consumers, much as a variety of Internet information providers have disaggregated print newspapers. At least to date, however, few suppliers have attempted to step outside of the TV Everywhere packages requiring MVPD 16

17 subscription authentication from users. Even in the absence of exclusive contracts, there are strong disincentives for individual program suppliers to take this step on their own. The history of both the MVPD and the online video entertainment industries to date suggests that the competitive battles are likely to be fought among large scale content aggregators. V. Programming content and the multi media windowing model By any account, online content providers have brought forth a tremendous volume of available programming, both Internet original and aftermarket or windowed, by which we mean movies and TV programs that originally appeared in theaters, on standard television, or on other video media. Undoubtedly much of online video entertainment of either type fits into the long tail of programs too narrow in appeal or too low in quality to be profitably supported offline. Economically viable online entertainment content is overwhelmingly dominated by windowed programming. Virtually all the content offered by itunes, Amazon, and other VOD suppliers consists of such programming, as does Hulu.com, CBS.com, Viacom affiliated sites, and other ad supported content providers whose parent companies are major offline content suppliers. Netflix and other online video subscriptions services rely heavily on theatrical movies and broadcast network or cable TV programs that have already appeared on those offline media. There are compelling economic advantages to the multi media windowing model of video media release, because it allows production investments to be spread over more than one medium (Owen and Wildman, 1992; Wildman, 2008). The windowing model of theatrical movie release is by far the most refined and complex. Major Hollywood features are typically offered on Internet VOD for sale or rental about 4 months after theatrical release, at about the same time as they appear on PPV/VOD systems of MVPDs and are released to DVD and Blu ray. Then about 8 months after theatrical 17

18 release, they become available to monthly subscription cable networks and occasionally Netflix. A year or so later, they are licensed to appear on ad supported cable networks, or sometimes broadcast networks or local stations. Many of the movies available on internet VOD or online subscription services are older or niche films not in active cable rotation, or they may have never been licensed to offline TV networks or stations. The movie windowing model has been widely recognized as a method of intertemporal price discrimination by which high and low value consumers are segmented by waiting time and transmission quality of the media (Waterman, 1985, 2005; Owen and Wildman, 1992; Wildman, 2008)). Table 2 shows 2011 pricing and revenues for online VOD and subscription sales. As reflected by their VOD sales and rental prices, movies are relatively high value products. They have online sale and rental prices in the same range as DVDs and the VOD systems of MVPDs with which they share the window thus suggesting that they appeal to consumers within comparable willingness to pay categories. 12 Bundled services such as monthly subscription premium cable networks and Netflix are less efficient for extracting money from high value consumers with intense demand for particular programs, and thus usually have assigned time slots after VOD release. MVPD and online subscription services differ in that the online versions rely heavily on both movies and TV programs. Internet and MVPD consumers of bundled subscription services appear to hold similar valuations for movies, and although the online subscription window remains unsettled, but as Internet subscribers grow in number, it appears to be moving toward simultaneous release with HBO, Showtime and other premium cable networks.a la carte prices for online subscription services such as Netflix and Hulu Plus are generally comparable to those of 12 SNL Kagan Research reported average retail prices of DVD sales and DVD rentals to be $14.23 and $2.71, respectively (Motion Picture Investor, March 30, 2012, p. 3, 5.) 18

19 premium cable TV networks, although the gateway price of broadband Internet access to online video services is far lower than the gateway price of a basic MVPD subscription usually required for purchase of monthly subscription premium service. Table 2: Total online content provider revenues for digital movies and TV programs, 2011 Although still in flux, a similar but less elaborate windowing model has evolved for advertiser supported, prime time television programming (Wildman, 2008). Most of these programs are made available on advertiser supported Internet services such as Hulu and Cbs.com, but only after a delay hence the nickname for Internet television: catch up TV. For subscribers to Hulu Plus, this delay window is generally shorter, and the duration of availability is also much longer, often providing access to previous seasons of some shows. After a significant delay, many of these programs are then made available to Netflix or other online subscription services, often to hype a subsequent season of series programs and enable new fans to catch up on plot developments. The series programming of the four major broadcast networks, which generally still attract the largest TV audiences offline, apparently account for the majority of the direct TV program sales and rentals shown in Table 2.. As suggested by their prices, TV programs are relatively low value products, and the broadcast networks income from online distribution apparently comes mostly from advertising on Hulu and CBS Interactive, estimated to be approximately $.55 billion in It is difficult to tell how the television windowing system may evolve. A plausible general explanation for it is that advertisers pay higher net prices per viewer for standard television audiences, and the networks choose an array of delay times that maximize total revenues from these interdependent online media. Some settling from a period of experimentation is also 13 Estimated by the authors based on Comscore rankings and media reports. The broadcast networks also receive licensing fees from monthly subscription services that exhibit their programming. 19

20 likely. After a sufficient portion of viewers have migrated to online viewing as smart TVs and settop boxes continue to diffuse, the special demographic targeting opportunities of online advertising may steadily increase their relative value, which could change the windowing patterns altogether. The disproportionate share of total online video revenues held by subscription services (Table 2) reflects a rapid growth of this component since these data were first reported in 2008, when it accounted for only 15% of direct payments (SNL Kagan MPI, Nov. 29, 2011). Subscription s growth has been enabled by rapid advance in streaming technology and bandwidth capacity since the late 2000s. Meanwhile, program sales are still limited by lengthy download times, especially for theatrical films. Though still evolving, the emerging pattern of higher revenues from subscription than a la carte transactions parallels a long established historical pattern for cable television. Although PPV service began to be offered by cable in the mid 1980s, available data show that by 2006, when online video revenues were still negligible, cable subscribers spent approximately four times more money in total for monthly subscription channels (primarily movie based services like HBO) than they did for all PPV or VOD (also primarily theatrical movie) purchases. 14 PPV/VOD delivered by cable includes only rentals (since download to own is not practical with cable technology), which handicaps comparison with the online market. However, consumer preference for monthly flat fee rates over a la carte transactions has a long history in other industries (Fishburn, et al, 2000). A well known media example is the monthly DVD rental plans pioneered in 1999 by Netflix, which proved a highly popular alternative to a la carte VHS and DVD rentals at brick and mortar stores. 14 SNL Kagan reported 2006 consumer spending for monthly subscription networks to be $6.5 billion vs. $1.6 billion for spending on PPV movies (SNL Kagan, 2008). Digital video (online) spending was first reported by SNL Kagan in $46 million (Motion Picture Investor, Nov. 29, 2011). 20

21 Online video content suppliers have also brought forth a vast supply of Internet original programming, most of which is very cheaply produced and which surely accounts for much of the long tail. These programs include animation, short subjects and content similar to that introduced in the mid 1990s, and of course the billions of user generated videos on YouTube, Vimeo, and similar sites that rely mostly on user generation. Most of Internet original video entertainment programming could thus not be classified as professionally produced. Wellestablished sites including Netflix and Hulu have, however, more recently begun offering higher quality original series programs such as Netflix s $100 million investment in House of Cards and Hulu s imported Braquo (winner of the International Emmy for Best Drama). Parallels can be made between the developing mix of online video entertainment programming and the early years of cable television. A 1986 content analysis of basic cable networks found 3% of dramatic format programming hours to be cable original, and 97% to acquired broadcast programs or theatrical films (Waterman and Grant, 1991). Because of its architecture and low delivery costs, the Internet has greater potential than cable to reach niche audiences. It is already apparent, however, that online entertainment faces some of the same fundamental demand constraints that niche cable networks have faced. Other things equal, a given video program that is focused toward a potential audience only half as large as that for another program must have double the willingness to pay among those viewers (or among advertisers who want to reach those viewers) in order to support the same production quality. The graveyards of audio visual entertainment are littered with suppliers of original programming who underestimated this constraint. 21

22 VI The future of online entertainment As the speed and quality of IP video transmission continues to rise, as broadband diffusion grows, as more efficient and portable media players continue to proliferate, and as the interaction between consumers and video content providers becomes more seamless, the economic viability of the online video entertainment industry seems bound to improve. At some time in the future, the online and offline television and video industries are likely to become indistinguishable as television sets become more seamlessly integrated with computer controlled user devices. Even as technological constraints fall away, however, the online video entertainment industry faces significant uncertainties and constraints in the reasonably near future. Among the uncertainties are technological advances in competing media, the viability of illegal file sharing (especially for movies), and the continuing viability of Internet business models (especially for advertising). Another complex issue is how video delivery costs, content provider prices, and ISP pricing structures will evolve as consumer bandwidth demands for online video accelerate. For example, more widespread adoption by ISPs of bandwidth usage sensitive pricing may result in heavy video entertainment users paying effectively higher prices per movie or TV program, reducing demand for online video. Perhaps the greatest economic constraint on the online video entertainment industry in the reasonably near future may be limits on the availability of recent movies and television programming from content providers. As we have seen the owners of these programs maximize their profits by releasing their products to a variety of different media over time. In the near future, MVPDs and ISPs are unlikely to unbundle their TV Everywhere portals from their offline services and distribute them beyond geographic connection service constraints. The Internet is adopting an increasingly important role in intertemporal content release strategies, but as long 22

23 as higher returns per viewer can be realized by earlier release of movies to theaters, and earlier release of television programs on broadcast and cable networks distributed by MVPDs, the ultimate Virtual Video Store, in which any program is available at any time online, will itself have a delay. VII. A note on research needs One the central questions about video over the Internet is how much benefit, if any, that it will eventually have to media consumers. Will it substantially increase the quality and variety of video entertainment products, and reduce prices to consumers? The evidence so far suggests so, but online video entertainment is a very new industry. In music and in news, for example, the weakening of intellectual property protection and the trading of established media business models for apparently much less lucrative online models has raised questions about whether the transitions to digital music and online news are positive or negative sum games overall. 15 While it is challenging to study new and unsettled industries productively, progress can be made to inform these questions. For example, can the sharp decline in DVD sales and rentals since 2005 be attributed to movie piracy, or to consumer substitution for cheaper online video alternatives? Does the more efficient targeting of online video ads actually result in higher cost per thousand ad prices? How valuable to consumers is the long tail of online content? More generally, one could attempt to measure the consumers surplus generated by online video. Or focusing on segments of the audience, how successful is online video in serving the needs of racial and ethnic minorities? It will also be important to inform policy decisions, such as proposed mergers, or whether MVPDs or ISPs should be constrained by regulation or antitrust from attempting to 15 For discussion of the news case, see Pew (2011). An empirical study byt Waldfogel (2012) finds that the precipitous decline in recorded music revenues since Napster has not significantly reduced the supply of music. 23

24 monopolize online video distribution. For this purpose, establishing a strong economic foundation to explain market structure of the industry, or to explain the motives behind business practices, can often be the best support for good policy. Are levels of concentration in online video distribution, for example, reasonably attributable to the natural forces of economies of scale, network effects, or similar economic factors? Are the prices that online content aggregators pay for programming plausibly attributable to monopsony bargaining power? Can the offline to online program windowing practices of the major television networks be explained by the standard intertemporal price discrimination model? Or, can the offline/online video bundling practices of MVPDs be explained by straightforward marketing objectives? Finally, we mention the value of developing historical analogies by studying policy or market outcomes in other media industries. For example, what have been the results of competitive battles between premium cable television networks that have attempted to gain competitive advantage through exclusive programming contracts? Or, what has resulted from historical attempts by established media industry players to slow the development of new media industries that threaten competition? How have policy initiatives in these situations affected the outcomes? Such studies can often give us better insight into the likely path of a new industry like online video entertainment, than study of the new industry itself. 24

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26 Bakos, Y., and Brynjolfsson, E. (1999) Bundling and Competition on the Internet, Marketing Science, 19 (1), Choi, J.P. (2012) Bundling information goods, In The Oxford Handbook of the Digital Economy, Martin Peitz, M. and Waldfogel, J. (eds). New York, NY: Oxford University Press. comscore (Mar. 28, 2012) comscore Study Finds Professionally-Produced Video Content and User-Generated Product Videos Exhibit Strong Synergy in Driving Sales Effectiveness, comscore Press Release. comscore (January 14, 2013) comscore Releases December 2012 U.S. Online Video Rankings, comscore Press Release. Convergence Consulting Group (2012) The Battle for the American Couch Potato: Online & Traditional TV and Movie Distribution, Company White Paper. emarketer, A Sample of emarketer s Topic Coverage, accessed Jan. 31, Federal Communications Commission ( ). Annual Assessment of the Status of Competition in the Market for the Delivery of Video Programming. (Various annual reports, including the 2012 ed., released, July, 2012, FCC 12-81, MB Docket No ). 26