Vol. 28, No. 1, January February 2009, pp. 20 35 ssn 0732-2399 essn 1526-548X 09 2801 0020 nforms do 10.1287/mksc.1080.0390 2009 INFORMS Content vs. Advertsng: The Impact of Competton on Meda Frm Strategy Davd Godes, Ele Ofek Harvard Busness School, Solders Feld, Boston, Massachusetts 02163 {dgodes@hbs.edu, eofek@hbs.edu} Mklos Sarvary INSEAD, 77305 Fontanebleau, France, mklos.sarvary@nsead.edu Meda frms compete n two connected markets. They face rvalry for the sale of content to consumers, and at the same tme, they compete for advertsers seekng access to the attenton of these consumers. We explore the mplcatons of such two-sded competton on the actons and source of profts of meda frms. One man concluson we reach s that meda frms may charge hgher content prces n a duopoly than n a monopoly. Ths happens because competton for advertsers can reduce the return per customer mpresson from the ad market, makng each frm less wllng to underprce content to ncrease demand. Greater compettve ntensty may thus ncrease content profts and decrease ad profts. These fndngs are n sharp contrast to those n a regular one-sded product market, n whch competton typcally lowers product prces and profts. We extend the frameworkto examne competton across dfferent meda (e.g., between magaznes and cable TV) and show that frms n a duopolstc medum may beneft from more ntense competton from a monopolst n another medum. We characterze the condtons for each frm n the duopoly medum to bundle more ads and earn greater total profts than the rval frm n the monopoly medum. Key words: meda; advertsng; two-sded markets; compettve strategy; game theory Hstory: Receved March 6, 2003, accepted December 13, 2007; processed by Duncan Smester. Publshed onlne n Artcles n Advance November 21, 2008. 1. Introducton In 1999, Conrad Blacklaunched the Natonal Post n Toronto, brngng the total number of daly newspapers n the market to four. Reports descrbed the resultng context as the most brutal newspaper war n North Amerca n whch losses are mountng and publshers are slashng newsstand prces. Some papers are even dstrbutng specal edtons free (Cherney 2001, p. B1). In the Unted States between 1990 and 2000, the number of move screens ncreased by more than 50% (from 23,814 to 36,280), creatng sgnfcantly more rvalry between theaters. The avalablty of more venues was accompaned by a marked drop n the number of patrons per theater and led theater owners to lower tcket prces slghtly (by 18 cents on average when adjustng for nflaton). Consequently, revenues from tcket sales per theater decreased by 31% (NATO 2005). Satellte rado represents a dfferent example from those above. Operatng as a de facto monopoly n the satellte rado market for ts frst few years of exstence, XM Satellte Rado s ntal strategy was to charge a monthly fee of $9.99 for ts servce. In Aprl 2005, when ts only compettor, Srus, had fnally garnered about 25% share of the market, XM ncreased the monthly subscrpton prce to $12.95 (Murphy 2005, McBrde 2005). Fnally, t s nterestng to observe that most webstes started out n the md-1990s by gvng ther content away for free and relyng solely on advertsng revenues. However, as more provders of onlne content emerged, we have wtnessed the ntroducton of more pay-forcontent models. For example, CNN.com now charges a subscrpton prce of $2.95 a month for ts Ppelne servce, whch offers onlne access to premum vdeo content. The precedng examples suggest very dfferent predctons regardng the mpact of competton on meda frm content prcng. More ntense competton seems to have been assocated wth lower content prces n both the newspaper and the move theater busnesses, but hgher prces n the satellte rado and onlne content busnesses. The former examples seem to conform to standard economc theory, whle the latter, perhaps surprsngly, do not. In ths paper, we nvestgate the mpact of competton on meda frm decsons. It s our prncpal argument that to understand meda frm behavor and explan devatons from standard theory such as those wtnessed n the satellte rado and onlne content markets one needs to take nto account the 20
Marketng Scence 28(1), pp. 20 35, 2009 INFORMS 21 unque structure of meda ndustres. Frms n these ndustres compete n two nterrelated markets. On the one hand, they compete n the content market for consumers, and on the other hand, they face rvalry n the ad market to attract advertsers. Qute dstnct from relatvely smple multproduct competton, ths s a specfc form of two-sded competton n whch the customers n one market represent, n some sense, the product n the other market. That s, a magazne, for example, attracts the attenton of customers n the content market and then sells that attenton to advertsers n the ad market. We demonstrate that ths nteracton between the two markets can yeld outcomes such as those noted above n whch prces may ncrease wth more competton. It has long been suggested or ntutvely beleved that a meda frm sets a lower prce for ts content relatve to what a frm that does not bundle advertsng would set. Ths s because the margnal beneft of one more customer s hgher for a meda frm that can earn more money by sellng that customer s attenton to advertsers. However, the lterature has not addressed the extent to whch ths underprcng effect can be a functon of the degree and source of compettve ntensty the meda frm faces. As we show, wth competton, the returns to underprcng may declne because t becomes more dffcult to capture the advertsng value of addtonal content customers. Thus, competng meda frms may fnd underprcng to be less attractve, yeldng hgher content prces. We also nvestgate a closely related queston: How much advertsng should the frm bundle wth ts content and how does ths change wth competton? Our analyss yelds the nsght that the answer depends crtcally on the source and nature of the competton. In partcular, although ncreased competton n the ad market from another outlet n the same medum has the expected effect of decreasng a meda frm s optmal level of ad bundlng, the same s not necessarly true wth respect to ncreased competton at the content level. Nor do we obtan the standard results n an analyss of across-medum competton. In fact, wth respect to the latter, we fnd that more ntense competton from other meda ndustres may result n more ad bundlng, and n some cases, hgher frm profts. Whle the nteracton between separate meda has always been a relevant topc of nqury, one mght argue that t s becomng more mportant gven the rapd emergence of new meda technologes as marketng communcaton optons. 1 1 Accordng to a 2006 Forrester report, at least one n four marketng executves were ether usng or expectng to test new meda optons, such as e-mal marketng, search marketng, rch meda, blog marketng, Real Smple Syndcaton (RSS), moble marketng, and Our paper makes four mportant contrbutons. Frst, we derve from frst prncples a comprehensve model of both sdes of the meda busness. Ths model yelds the nsght that the commonly held assumpton that prces declne because of competton may not hold n meda markets. Second, we provde prescrptons wth respect to the amount of advertsng that meda frms should bundle as a functon of meda-level parameters (e.g., ts value for advertsers and the dsutlty consumers experence from ads) as well as compettve ntensty. Notably, we fnd that whle the ad bundlng decson s nsulated from content market factors, ad bundlng declnes n wthn-medum compettve ntensty n the ad market. Thrd, we provde nsghts nto meda frm behavor when rvalry orgnates from a dfferent medum. In partcular, f the platforms of separate meda are substtutable n the eyes of advertsers, there exst cases n whch frms n a more compettve medum (defned as a medum wth more frms n t) bundle more advertsng and earn hgher overall profts than a less compettve medum. Fnally, we show that when separate meda platforms produce complementartes (e.g., when placng ads on two dfferent meda s more effectve than placng them all on a sngle medum), greater complementarty may result n hgher content prces charged n the more compettve medum once agan counter to standard economc theory that would predct lower product prces n more compettve markets. These fndngs shed lght on the strategc decsons made by economcally mportant frms. Meda frms for example, Dsney, Vacom, NBC, Tme Warner, Clear Channel Communcatons represent a szable proporton of the domestc U.S. economy and are of partcular relevance to marketers. They provde the channel through whch most frms marketng messages are delvered to consumers. 2 Understandng how ths partcular form of two-sded competton affects meda frms marketng mx decsons ther prcng of content and the amount of ads to bundle thus represents a doman of nqury that s both theoretcally and practcally mportant. None of these results have been demonstrated n ether the marketng or economcs lteratures. The rest of the paper s organzed as follows. Secton 2 relates our workto the relevant lterature. Secton 3 lays the foundatons of the modelng approach. Secton 4 solves the model, startng wth the monopoly advergames, n addton to the use of tradtonal meda (VanBoskrk et al. 2006). 2 Revenues from advertsng n the Unted States across all meda ndustres were nearly $200 bllon n 2005. Source: Marketng News (2006). Several meda frms, lke Tme Warner, Dsney, Yahoo!, and NBC (owned by General Electrc), are Fortune 500 companes.
22 Marketng Scence 28(1), pp. 20 35, 2009 INFORMS case and followed by analyses of wthn- and acrossmeda competton. Fnally, 5 dscusses the lmtatons of our study, proposes future research drectons, and concludes. To enhance readablty, we have relegated all proofs to the appendx. 2. Related Lterature Our paper s broadly related to the rapdly growng lterature on two-sded markets. A general revew of ths lterature can be found n Rochet and Trole (2004). Among the papers focusng specfcally on meda markets, one can dentfy two dstnct approaches, characterzed by whether or not the meda frm charges a prce for ts content. Wth respect to the latter case of no content prcng, Gal-Or and Dukes (2003) and Dukes and Gal-Or (2003) consder meda frm decsons about dfferentaton of programmng content and the amount of advertsng, respectvely. Ths work shows that lower levels of advertsng (ether because of substtutablty among meda or exclusve contractng wth one advertser) result n less nformed consumers and thus softer prce competton among advertsers. Other papers n ths stream focus on the welfare mplcatons of meda competton or on the dverson effect of advertsng (.e., vewers swtchng channels to avod commercals). For nstance, Anderson and Coate (2005) analyze condtons under whch advertsng s over- or underprovded by competng meda frms relatve to the socal optmum, and Masson et al. (1990) focus on the dsutlty mposed on customers that have to endure ads. In contrast to the papers n ths stream, we allow competng meda frms to charge a prce for ther content. Our nsghts come from the mpact of competton on the meda frm s margnal proft avalable n each market. In some cases, the frm s wllng to earn low profts n the content market to captalze on a hgh margn per customer mpresson n the ad market, and consumers beneft from ths va lower content prces. In other cases, the frm s less wllng to do so and prefers to extract more customer surplus from ts content. Such a comparson cannot, of course, be made n models that do not allow frms to charge a fee for content. Among the relatvely lmted research that explctly consders profts n both the content and advertsng markets, pror work does not tackle the questons we address here. For nstance, Chaudhr (1998) studes output levels for meda monopoles (but does not consder meda frm competton), and Chen and Xe (2007) study the role of asymmetrc customer loyalty on frm profts (where an ncumbent meda frm that has loyal customers faces an entrant). Kaser and Wrght (2006) estmate a model that demonstrates that subsdzaton exsts between content and advertsng n the magazne busness but do not nvestgate the mplcatons of ths subsdzaton for frm behavor. In partcular, Kaser and Wrght (2006) do not study how competton (ts ntensty or source) mpacts the subsdzaton effect, thereby affectng meda frm strategy. Fnally, our paper examnes not only competton among frms wthn a sngle medum but also competton between two dfferent meda. Ths ssue s mportant as the boundares between meda are blurred for many advertsers that can reach relevant consumers through separate meda (e.g., rado, TV, and the Internet). Our paper s the frst to address ths ssue. 3. Model Setup Each meda frm n our model competes n two markets: content 3 and advertsng. For example, Newsweek profts from consumers who purchase or subscrbe to the magazne, as well as from advertsers desre to communcate wth these readers. Frm s total profts are thus the sum of ts content profts co and advertsng profts ad = co + ad. Each frm chooses content prce p 0, yeldng demand x. Wth varable costs of producton c, the frm s margn n the content market s p c. Content profts for frm are co = p c x. Ths leads to a Bertrand game between meda frms n the content market. We allow for the possblty that frm charges a prce n the range p 0 c, whch would mply that the content s sold at a loss. Of course, there are often sgnfcant fxed costs assocated wth the producton of content: studos, prntng facltes, real estate, etc. However, these would have no mpact on the prcng game equlbrum, so they are normalzed to zero. 4 Each frm also chooses how many ads y wll be shown to the x content customers. For nstance, y may capture how many pages wll be devoted to ads n an edton of Newsweek. Ths gves rse to the prce per mpresson q,.e., the nverse demand for advertsng. Normalzng the varable cost of placng ads to zero and aggregatng over all x mpressons for frm yelds advertsng profts ad = x y q. Thus y q s the margn the frm makes n the ad market per customer mpresson. Our specfcaton reflects an mportant nsttutonal characterstc of the ad market: meda frms consder the amount of ads they bundle to be a strategc decson. 5 Ths leads to a Cournot 3 For the rest of the paper, we refer to a meda frm s product as ts content. 4 The qualty of the frm s content s exogenous; thus our normalzaton s wthout loss of generalty. In a rcher model wth endogenous qualty, t would be mportant to specfy costs as a functon of content qualty. 5 For example, Clear Channel Communcatons recently announced plans to reduce the number of ads to affect revenues: Clear
Marketng Scence 28(1), pp. 20 35, 2009 INFORMS 23 game between frms n the ad market, whch has been extensvely used n other theoretcal papers of meda competton (e.g., Dukes 2006, 2004). 3.1. Demand from Consumers: The Content Market To ensure that our model properly reflects the strategc decsons n each market, we buld t from frst prncples based on the workof Vves (2001) and Sngh and Vves (1984). 6 Let the representatve consumer s 7 utlty from buyng x unts of frm s content at prces p be U x x N ( N N = x v dy 1 x 2 2 + 2 ) x x =1 =1 N x p (1) where = 1 N are the meda frms, v s the nherent value of the content to consumers, d s the dsutlty from each ad: hence y ads create negatve value of dy. 8 The specfcaton captures decreasng margnal utlty from consumng more of each frm s offerng va the quadratc term (x 2 ) and the cross-terms (x x ). Notce that captures the extent to whch the content offered by each frm s substtutable wth that of ts compettors. Snce 2 U/ x x =, hgher values of mply a bgger declne n the margnal utlty for x assocated wth purchases of x. The consumer Channel Rado, the largest U.S. rado staton chan, wll sgnfcantly reduce commercal tme sold on ts statons to stem prcng weakness (Gershberg 2004). When consderng ther busness model at launch, XM executves set the number of ad mnutes per broadcast hour at sx (Godes and Ofek2004). 6 A compettve prcng analyss wthout ths utlty bass may yeld an mplausble nterpretaton of results. It s common n marketng and economcs to specfy demand n the form x = v bp + dp j j. However, the parameter d s not a proper measure of substtutablty or compettve ntensty. To see why, note that wth ths specfcaton (assumng zero margnal cost), the duopoly equlbrum soluton s p = v/ 2b d and = v 2 b/ 2b d 2. From ths soluton, a frm s equlbrum prce and profts ncrease wth d. But f d s to capture compettve ntensty, we would expect prces and profts to decrease wth d. Ths ssue dsappears when one derves demand from a consumer utlty maxmzaton standpont and where the parameter, as n (1), measures substtutablty. We thankxaver Vves for hs helpful dscussons on the specfcaton used n ths paper. 7 In realty, meda consumers can exhbt heterogenety. Moreover, meda frms often react to ths heterogenety by targetng content to specfc segments. The magazne ndustry s such an example. One way to nterpret our results, then, s that our analyss covers the compettve dynamcs at the segment level as opposed to the overall market level. We revst ths ssue n the paper s concludng secton. 8 It s concevable that over a certan range, consumers mght derve some postve utlty from advertsng. Ths mght be because of entertanment, for example, or nformatonal value. Ths s not a crtcal assumpton, however. We revst ths ssue n 5, n our dscusson of the model s lmtatons. =1 maxmzes (1) wth respect to each x separately. Ths gves rse to a system of N equatons, whch can be solved to yeld N nverse demand functons of the form p = v dy x x. Drect demands are then found by nvertng these and solvng smultaneously for x ( = 1 N). We wll workwth the followng monopoly and duopoly cases (denoted by the superscrpts M and D, respectvely) throughout the paper. x M = v dy M p M (2) x D = 1 1 v 1 2 dyd + dy D pd + p D = 1 2 (3) As should be clear from the denomnator of (3), we need to mpose the regularty condton 0 < <1, whch ensures that own prce senstvty s greater than cross-prce senstvty. 9 We retan the assumpton made n the lterature (e.g., Vves 2001) that and v are mutually orthogonal. 10 3.2. Demand from Advertsers: The Ad Market We take a smlar approach n the advertsng market. Here, we assume the exstence of a representatve advertser (e.g., a major brand n a gven category). By runnng y ads on meda frms = 1 N, an advertser creates mpressons on customers of the meda content. Let the representatve consumer s utlty from buyng content x unts from each frm at prce p be = A y G y (4) where y s the vector of number of ads an advertser runs on each meda outlet (e.g., Mcrosoft mght advertse ts new Vsta operatng system n Wred Magazne and n PC World), and G N =1 y q s the cost per customer mpresson to the advertser of runnng ts ads on the meda outlets (q s the prce per mpresson defned earler). The functon A s the advertsng response functon,.e., the mpact of advertsng on expected profts per consumer exposed to the ad. Exposure to an ad ncreases the awareness, nterest, or preference of a gven consumer. 11 Ths translates nto a hgher lkelhood 9 Wthout loss of generalty, n (1), we have normalzed to 1 a consumer s decrease n margnal utlty from consumng more of the same meda content. If one allows a senstvty of 1, the only adjustment needed to ensure that the regularty condton s satsfed s 0. 10 See Lu et al. (2004) and Chou and Wu (2006) for a dscusson of a model of content competton wth endogenous qualty. One mght vew our approach as complementary to thers n that they endogenze qualty va a product s locaton on a lne but treat as exogenous prces n both the content and advertsng markets. 11 See Chessa and Murre (2007) for a model of advertsng mpact.
24 Marketng Scence 28(1), pp. 20 35, 2009 INFORMS that the consumer purchases the advertser s offerng, whch s then multpled by the margn the advertser earns per product t sells. We agan use the Vves (2001) frameworkto model the beneft to a representatve advertser from runnng y ads per consumer exposed to ts ads: N A y wy t 1 ( N y 2 2 + 2h ) y y (5) =1 =1 where w represents the medum s advertsng effectveness and h measures the degree of meda substtutablty for advertsng,.e., the smlarty between each meda outlet from the advertser s perspectve. The advertser maxmzes (4) to determne how many ads to run on each meda outlet. Ths gves rse to the followng ndrect demands for placng ads on each of the = 1 N meda outlets: q = w y h y. The monopoly and duopoly ndrect demands are q M = w y M (6) q D 1 = w yd 1 hyd 2 (7) We requre the regularty condton 0 <h<1. 12 Gven that q s the prce per customer mpresson of runnng an ad on meda frm s content, the overall cost of runnng an ad for the advertser, whch conssts of x customer mpressons, s q x. Our characterzaton, n whch the advertsng rate s quoted per customer mpresson and advertsers pay for the total amount of mpressons generated for ther ads, s consstent wth practce (O Gunn et al. 2000). 13 Fnally, we assume that h and w are ndependent of each other. Recall that w s essentally the margnal beneft (n terms of ncreased awareness or nterest, for example) that a sngle ad mght yeld the advertser. On the other hand, h captures the decrease n that margnal beneft that the advertser experences when runnng an addtonal ad on another meda outlet. The orthogonalty assumpton means that meda that are more effectve advertsng vehcles do not necessarly have outlets that are more or less substtutable wth each other. 12 Once agan, wthout loss of generalty, n (5), we have normalzed to 1 the extent to whch more advertsng on the same outlet has decreasng margnal returns for the advertser. If one allows a senstvty of 1, the only adjustment needed to ensure that the regularty condton s satsfed s h 0. 13 In practce, meda frms often quote an advertsng rate per thousand mpressons (CPM), whch would just amount to a rescalng of our unt of analyss. Note that our specfcaton n (5) accounts for decreasng margnal mpact of more consumer exposure to an advertser s ad (through the quadratc terms). Yet the resultng advertsng rate n our model s a lnear functon of the demand (q x ). 4. Model Analyss Our approach s to frst analyze the monopoly case. Ths wll serve as a benchmarkfor comparson and allow us to dentfy several unque features of meda frms actons. We subsequently ntroduce dfferent sources of competton and assess ther mpact. 4.1. Monopoly Case The monopolst solves the followng problem: p M y M = arg max x M p M c + x M y M q M (8) p M y M where the specfcatons of x M and q M are gven n (2) and (6), respectvely. We requre suffcent nherent content value and ad effectveness, such that frms sell nonnegatve amounts of content and advertsng n equlbrum. Hence we assume that w>d 0 and v>c 0. To focus on nteror solutons for content prce, we also assume that 4 v + c > w d w + 3d From (8), the monopolst s frst-order condtons, wth respect to content prce and ad quantty, respectvely, are 14 p M c + y M q M = x M (9) x M y M + p M c + y M q M d = x M q M (10) }{{}}{{} Cost Beneft As shown n (9), the content prce s chosen such that the margnal beneft of a small ncrease n prce (the rght-hand sde (RHS)) s exactly equal to the mpact of the lost demand because of the prce ncrease (the left-hand sde (LHS)). Ths latter quantty s comprsed of losng margn n both the content market p M c and the advertsng market (y M q M ). As for ad bundlng, from (10), we see that a small ncrease n the number of ads ncreases ad revenues (the RHS). Ths beneft must be balanced aganst the cost of bundlng more ads, whch comes n two forms. Frst, the prce of placng an ad declnes. Hence, profts fall by an amount proportonal to the total ad exposure (x M y M ). Second, the more ads that run, the more dsutlty customers of the content experence. Ths causes demand for the content to drop and mposes a cost n proporton to the margn earned per unt of demand from both markets, or p M c +y M q M, scaled by the dsutlty factor d. Solvng the above frst-order condtons yelds the followng. Proposton 1. The monopolst s problem has a unque soluton at p M = v + c /2 w d w + 3d /8 and y M = w d /2. 14 We thankan anonymous revewer for suggestng that we explan the man ntutons by analyzng the frst-order condtons. Note that n (9), x M s a functon of p M and, n (10), x M and q M are each a functon of y M. We have suppressed these arguments for clarty of exposton.
Marketng Scence 28(1), pp. 20 35, 2009 INFORMS 25 The soluton mples x M = v c /2 + w d 2 /8 The standard outcome for a monopolst n a onesded content market would be p = v + c /2 and x = v c /2. Thus, by comparson, the meda frm prces ts content strctly lower by a factor of w d 3d + w /8. Ths captures an mportant and fundamental characterstc of meda frms: they have an ncentve to charge lower content prces to ncrease content demand relatve to a nonmeda frm. Ths s proftable because they can expose customers to ads and earn a margn on them from advertsers. Ths underprcng effect whch Kaser and Wrght (2006) refer to as subsdzaton and factors that affect t, wll prove to be mportant n our subsequent analyss. The way competton mpacts the underprcng effect, and the mplcatons for meda frm strategy, consttute the unque contrbuton of our work. We hghlght the key comparatve statcs for the monopoly model (the complete set appears n the Techncal Appendx, whch can be found at http:// mktsc.pubs.nforms.org). An ncrease n advertsng effectveness (w) results n a hgher margn from the ad market (snce y M q M ncreases n w). Per (9), such an ncrease makes the frm more nclned to generate addtonal demand n the content market to beneft from the hgher ad margn. Therefore, as w ncreases, the frm further underprces ts content and ncreases ad bundlng. In turn, content profts go down and ad profts go up. If advertsng effectveness s hgh enough, the meda frm may lower prces below margnal cost and sell ts content at a loss. An ncrease n the nherent value of the content (v) has the expected effect on the strategc varables of nterest, though wth one caveat. As long as p M >c (.e., a postve margn s earned on each content sale), an ncrease n v leads to an ncrease n p M, x M, co M, and M ad. Intutvely, when the content s of greater nherent value, t appeals more to consumers and a frm can sell more content and stll charge more for t. Havng generated more customer mpressons, ad profts ( M ad ) ncrease as well. However, when 0 < p M <c,.e., content s sold at a loss, co M ntally decreases n v. In ths case, better content (hgher v) leads to more content sales (hgher x M ) but at a negatve margn, whch wdens content losses. The comparatve statcs, wth respect to advertsng dsutlty (d), are more complex and offer the followng nsght nto the mplcatons of the two-sded nature of meda markets. Result 1. As ads create more consumer dsutlty: Content sales (x M ), ad bundlng quanttes (y M ) and ad profts always decrease. However, content prces (p M ) and content profts decrease at low dsutlty levels and ncrease at hgh dsutlty levels. Result 1 reveals that the mpact of greater advertsng dsutlty (d) on the equlbrum content prce (p M ) follows a U-shaped pattern. The ntuton s that to contnue to appeal to consumers when each ad causes greater dsutlty, the meda frm can do two thngs: frst, t can lower content prce to compensate consumers for the dspleasure of havng to endure the ads, and, second, t can decrease the number of ads (thus balancng the ncrease n d wth a decrease n y M ). Because bundlng fewer ads results n a lower margn n the advertsng market, ntally as d ncreases, the frm has a greater ncentve to cut content prces than to drastcally reduce ad quanttes. In other words, the frm s wllng to take an even harder ht n the content market to contnue to reap a relatvely healthy margn n the ad market. However, when d s very hgh, the frm must consderably lmt the amount of advertsng to generate content customers. Consequently, the per unt margn from the ad market (y M q M ) s small, and the frm has less ncentve to underprce ts content. The frm starts rasng content prces, brngng them more n lne wth the one-sded market case. As a result, whle ad profts always declne as ad dsutlty ncreases (because the frm s nduced to bundle fewer and fewer ads), content profts exhbt a smlar U-shaped pattern as content prce p M. 4.2. Wthn-MedumDuopoly Competton In a duopoly, each meda frm smultaneously maxmzes the followng proft functon, condtonal on the compettor s optmal behavor: D p D c x D + x D yd qd = 1 2 (11) where x D and q D are gven n (3) and (7), respectvely. Recall that and h represent the substtutablty (or compettve ntensty) between the two frms n the content and ad markets, respectvely. Proposton 2. The duopoly model has a unque nteror equlbrum n whch y D 1 = y D 2 = w d and 2 + h p D 1 = p D 2 = [ v + c 2 + h 2 + d 2 3 + 2h 2dw h + 1 w 2 2 + h ( d 2 + 2 + h v dw ) ( 2 2 + h 2)] 1 Comparng Propostons 1 and 2, one can easly establsh that y D <y M, = 1 2. Facng rvalry n the ad market causes each meda frm to lower the number of ads t runs. On the other hand, overall ad bundlng ncreases (2y D >y M, leadng to a decrease n the advertsng prce per mpresson (q D <q M ). Consequently, the margn per mpresson from the ad market s unequvocally lower n a duopoly than n a
26 Marketng Scence 28(1), pp. 20 35, 2009 INFORMS monopoly (y D q D <y M q M ), and ths nfluences how each meda frm prces ts content. Result 2. () When compettve ntensty n the content market s low, then the equlbrum content prce set by the duopolsts s hgher than that set by a monopolst. () When compettve ntensty n the content market s hgh, then the equlbrum content prce set by the duopolsts may be lower than that set by a monopolst. Thus, content prces wll be hgher n a duopoly than n a monopoly when content substtutablty ( ) s not too hgh. To understand the ntuton, t s useful to lookat the frst-order condton wth respect to p D for frm competng wth frm (12a) and compare t wth the monopolst s correspondng frstorder condton, whch s reproduced n (12b) for convenence. We wrte explct expressons for x M, x D, qm, and q D to see the ntuton more clearly. p D c + y D w yd hyd yd = v dy D p D v dy D pd (12a) p M c + y M w y M = v dy M p M (12b) Comparng the RHS of (12a) wth that of (12b), we see the standard downward pressure on prce because of competton that one would see n a one-sded market model: the margnal beneft of a prce ncrease s lower for a duopolst than for a monopolst by a factor related to v dy D pd, whch reflects the demand-stealng effect of competton f a frm rases ts prce. Comparng the LHSs, we see that havng to compete wth frm n the ad market lowers the margn per mpresson from each ad (by a factor of hy DyD ), whch, n turn, decreases the ncentve to underprce the content. The mpact of competton on content prces s therefore governed by the tradeoff between these two forces: () a downward force arsng from the tradtonal effect of competton that decreases the benefts assocated wth rasng prces, and () an upward force arsng from the fact that competton dmnshes the ncentves to engage n content underprcng because of a lower ad margn per customer mpresson. When content substtutablty ( ) s not too hgh, the mpact of competton on underprcng domnates, and content prces wll be hgher n the duopoly. Conversely, when content substtutablty s hgh, the tradtonal effect of competton on prces can domnate and prces n the duopoly wll be lower. 15 The practcal mplcaton of Result 2 on meda frm strategy s that when confronted wth addtonal competton, a meda frm wll respond by ncreasng prce 15 A frm s desre to charge a hgh prce for content depends on the nherent value t provdes (see Propostons 1 and 2). To sustan p D <p M at hgh levels, we requre a mnmal level for v. Ths s formalzed n the proof. f the two frms content s not hghly substtutable, and vce versa f the frms are very smlar n the eyes of consumers. In the ntroducton, we descrbed several examples (newspapers, satellte rado, move theaters, Internet content stes) regardng the mpact of competton on meda frms prcng patterns. Result 2 offers some nsght nto ths varance. In partcular, prces should rse (fall) because of ncreased competton when the degree to whch the meda content s substtutable s low (hgh). 16 As one would expect, as the compettve ntensty n the market (h) ncreases, the frms bundle less advertsng wth ther content. We also note that y D s not a functon of n ths model (see Proposton 2). That s, as the ntensty of nterduopolst content competton changes, the frms do not alter the amount of advertsng they bundle wth ther content. Nor, n fact, do they do so when v changes. The reason for ths can be seen n an nspecton of the frst-order condton for y D : d 1 p 2 c + x q + y + dq y = 0 (13) 1 2 By rearrangng, and substtutng p from (12a) nto (13), we can express the frst-order condton for y D as beng the soluton to x q + y d = 0. Thus, when content prces are chosen optmally, x acts only as a scalng factor n the advertsng market, and therefore does not affect the optmal choce of ad quantty. Essentally, content prces absorb all exogenous content market shfts, such as a change n the ntensty of content competton ( ) or a change n the nherent value of content (v). As we show n the Techncal Appendx (whch can be found at http://mktsc.pubs.nforms.org), when one mposes p = 0 (as we see n broadcast rado, for example), then y s no longer nsulated from the content market. Instead, n ths case, y s a functon of both v and. 16 For example, n satellte rado, the offerngs of XM and Srus are only moderately substtutable ( low). Each s offered as optonal on dfferent car makes and rentals and they are perceved as sellng dfferentated programmng: Srus offers exclusve coverage of the Natonal Football League, and ts sgnng of Howard Stern and Emnem gve t a partcular postonng n consumers mnds. XM, on the other hand, offers exclusve Major League Baseball, exclusvely features artsts such as Oprah Wnfrey and Ellen DeGeneres, and ars shows produced by famous recordng artsts (e.g., Tom Petty, Snoop Dog, and Bob Dylan). XM s also ptched as havng better sgnal coverage because of robust satellte technology. XM revsted ts strategy and ncreased prces only after Srus garnered 25% market share n 2005 and exerted more compettve pressure (Murphy 2005). By contrast, n the case of newspapers, one mght expect substtutablty ( ) to be relatvely hgh as they each tend to provde smlar content. Competton ntensfes as the number of newspapers n geographc proxmty ncreases. Hence, consstent wth our model, n ths case, more competton should lead to lower newsstand prces.
Marketng Scence 28(1), pp. 20 35, 2009 INFORMS 27 We are also able to derve a number of results wth respect to equlbrum profts. Result 3. () Advertsng profts are always lower for each duopolst than for a monopolst. () When compettve ntensty n the content market s low, content profts are hgher for each duopolst than for a monopolst. () When compettve ntensty n the content market s hgh, content profts can be lower for each duopolst than for a monopolst. Part () of Result 3 s not necessarly surprsng snce both ad bundlng (y D ) and ad prces (q D ) declne because of duopolstc competton. The same, however, s not true of content profts as shown n part (). When s low, we found n Result 2 that p D >p M, whch overshadows the fact that x D <x M and results n co D > M co. By contrast, when s hgh, as long as the nherent value of the content v s not too low, the duopoly content prce falls below the monopolst s prce and we have co D < M co. Thus far, we have examned how the actons and profts of a meda frm n a duopoly dffer from those of a monopolst meda frm. We now focus on the duopoly case and explore how frm behavor s mpacted by varyng the degree of compettve ntensty ( ). From the equlbrum prces n Proposton 2, t s straghtforward to establsh that a meda frm wll sell ts content at a loss (.e., p D c<0) when the margn per customer n the content market s small relatve to the margn per customer n the ad market. In partcular, when ad dsutlty s neglgble, we have p D c<0ff v c 1 < w 2 / 2 + h 2. Ths also shows that content s more lkely to be sold at a loss the hgher the compettve ntensty n the content market. Ths obvously stems from the fact that ncreased competton for consumers nduces meda frms to lower content prces p D / < 0. At the same tme, as explaned above, ad bundlng s mmune to changes n the compettve ntensty n the content market y D / = 0. These equlbrum propertes have the followng mplcatons on the profts frms earn n each market. Result 4. () Ad profts always ntally decrease and then ncrease n the compettve ntensty of the content market. () If the nherent value of content s small relatve to ad effectveness (v c w d), then content profts ntally ncrease and then decrease n the compettve ntensty of the content market. If the nherent value of content s hgh enough, content profts are everywhere decreasng n the compettve ntensty of the content market. An ncrease n mples that the content offered by the frms s more substtutable. Hence one would generally expect content profts to decrease as ncreases ths would ndeed be the case gven only a content market. Moreover, ths s true n our model when the content market s more mportant than the ad market as captured by the relatve magntudes of v c as compared wth w d. However, the opposte s true when the ad margn per customer mpresson s hgh compared to the content margn, n whch case each frm optmally prces ts content below varable cost and every unt s sold at a loss. The ntuton s as follows. As ntally ncreases, each frm s demand x D declnes. But because each unt of content generates a negatve margn, ths reducton n demand results n a narrowng of losses n the content market (.e., content profts become less negatve). At the same tme, wth fewer customer mpressons, each frm s ad revenue s decreasng. At hgher levels of substtutablty, consstent wth Proposton 2 and Result 3, each frm wll cut prces n the content market to a level where x D starts ncreasng. Content profts then declne (because the drop n prce offsets the ncrease n content demand) whle ad profts wll ncrease. Ths results n an nverted U-shaped pattern for content profts and a U-shaped pattern for ad profts as a functon of (see Fgure 1). We stress that because a frm n a tradtonal one-sded market has only one revenue source, t would never prce ts product below margnal cost. Hence, we would generally not expect ts product profts to ncrease as a functon of greater compettve ntensty n that market. Fgure 1 Content Profts and Ad Profts as a Functon of Compettve Intensty Content profts (π D* co ) Ad profts (πd* ad ) 0.236 0.237 0.238 0.239 0.241 0.242 0.243 0.1 0.2 0.3 γ 0.4 0.635 0.630 0.625 0.620 0.615 0.605 0.1 0.2 0.3 0.4 0.5 0.6 γ Note. In these plots: v = 1, c = 0 8, w = 2 25, h = 0 25, d = 0 5.
28 Marketng Scence 28(1), pp. 20 35, 2009 INFORMS Gven these patterns, the dfference between duopoly content profts and ad profts ( co D D ad ) wll tend to exhbt an nverse U-shaped relatonshp wth. Thus the ntensty of content market competton has the effect of alterng the relatve promnence of each proft source. 17 Fnally, although content and ad profts can ncrease wth greater compettve ntensty over certan nonoverlappng ranges (Result 4), frms are worse off when they have to compete more ntensely as total profts declne wth (ths also mples that D < M. 4.3. Across-Meda Competton Thus far, we have looked at a sngle meda ndustry and analyzed the mpact of wthn-medum competton. In realty, though, we often observe frms from separate meda competng as well, partcularly n the ad market. Ths occurs because advertsers typcally allocate ther budgets across multple meda (O Gunn et al. 2000, Dolan 2000). For example, when Intel ntroduces a new chp, t mght run TV ads n prme tme featurng the Blue Man Group, place prnt ads n PC World, ar advertsements on local rado shows, and dsplay banners on CNN.com. Although televson, magazne, rado, and the Web do not necessarly compete heavly n ther respectve content markets (e.g., a consumer can only lsten to rado when drvng, wll prmarly consder TV vewershp n the evenng, wll read a magazne whle lyng on the beach, and may browse the Web at work), they all compete n the ad busness for a share of Intel s budget. In ths secton, we examne the mpact of such across-meda advertsng competton. We analyze the case of two frms that compete wthn a medum (a duopoly, as n 4.2) that also face competton n the ad market from a sngle frm n a separate meda ndustry. Denote the two meda ndustres j A B, where A s the duopoly medum, and B s the monopoly medum. The degree of compettve ntensty (or substtutablty) across meda s measured by 0 1. In the context of our dervaton from frst prncples as n (4), a greater means that the advertser perceves an ad bundled wth the content of a frm from medum A to have a more smlar effect to an ad bundled wth the content of a frm from medum B. We assume that the content assocated wth these two meda are perfectly dfferentated n the eyes of the consumer. 18 Referrng to the examples above, the utlty that a consumer derves from 17 We formalze ths n the Techncal Appendx, whch can be found at http://mktsc.pubs.nforms.org. We also show that an ncrease n the substtutablty n the ad market (h) wll unambguously ncrease the margn earned n the content market versus the ad market. 18 Techncally, ths means that n (1) there are no cross-terms related to x A xb. Ths smplfyng assumpton captures the dea watchng a TV show s lkely to be consdered very dfferently from, say, readng a magazne, gong to the moves, or lstenng to the rado (e.g., because each s consumed durng dstnct occasons). Furthermore, the level of nherent value of content can vary across the two meda. The same s true wth respect to ad effectveness and dsutlty. We thus allow v j, w j, c j, and d j to dffer by medum. We also assume that s ndependent of all these parameters. Each frm seeks to maxmze ts total profts, condtonal on the other two frms actons: A = A ad + A co =xa pa c A +x A ya qa =1 2 (14) B = B ad + B co =xb p B c B +x B y B q B Smlar to our dervatons from frst prncples n 3, the expressons for demand n the content market are as (2) and (3) for medums B and A, respectvely. The nverse demand n the ad market s gven by q A = w A y A hy A yb 1 2 q B = w B y B y A 1 + ya 2 (15) We can now solve for the equlbrum. Proposton 3. The olgopoly model 14 has a unque nteror equlbrum soluton n whch p A y A = y A = 2 wa d A w B d B 2 2 + h 2 y B = 2 + h wb d B 2 w A d A 2 2 + h 2 = p A = va 1 +c A + 1+h y A 2 y A w A + 1 d A y B 2 p B = vb + c B + y B 2 y B w B + d B 2 y A 2 (16) To focus on the compettve effects, we assume that there s not too bg of a dsparty n the net ad effectveness or content value between the two meda, specfcally w j d j 3 + h /4 w j d j and v j + c j v j + c j <. We later dscuss these assumptons and the mplcatons of relaxng them. From the soluton gven n Proposton 3, we can establsh the followng mplcatons of across-medum competton on frms decsons n each medum. Result 5. As across-medum competton becomes more ntense ( ncreases): () medum A frms decrease (ncrease) the number of ads bundled and that across-medum content substtutablty s lower than wthnmedum substtuton. Nonetheless, there are cases n whch ths substtuton may be nonneglgble (for example, a recent study found that young men have decreased TV vewershp n favor of Web usage; see Schwartz 2004).
Marketng Scence 28(1), pp. 20 35, 2009 INFORMS 29 Fgure 2 The Impact of Across-Medum Competton: Duopoly Medum vs. Monopoly Medum Ads bundled per frm (y j* ) Total profts per frm (Π j* ) 0.45 0.40 0.35 0.30 0.25 A* y y B * θ 0.2 0.4 0.6 0.8 1.0 Note. In these plots: v j = 1, c A = 0 2, c B = 0 25, = 0 25, w j = 1, h = 0 2, d j = 0 1. 0.19 0.18 0.17 0.16 Π B * A* Π θ 0.2 0.4 0.6 0.8 1.0 ncrease (decrease) the content prce charged at low (hgh) levels of across-medum compettve ntensty. The medum B frm always decreases the number of ads bundled and ncreases content prce: () consequently, for low values, each frm n medum A bundles less advertsng than the frm n medum B (y A <y B ), but for hgh enough values, the reverse s true (y A >y B ). Moreover, for close to 1, the frm n medum B drops out of the ad market altogether. Result 5 reveals that when the across-medum compettve ntensty s hgh enough, the frms n medum A wll bundle more advertsng than the sngle frm n medum B. Ths surprsng result holds even when frms n medum A have the same or lower net ad effectveness than the frm n medum B (specfcally, n the range w B d B w A d A 3+h w B d B /4. The ntuton s that as the meda become more substtutable n the eyes of an advertser (lettng ncrease), frms n ndustry A face an ncreased threat from only one frm, whle the frm n ndustry B faces an ncreased threat from two frms. The drect mplcaton of ths s that the margn per customer mpresson from the ad market (y j q j ) decreases n proporton to y1 A + ya 2 for the monopoly medum, but only n proporton to y B for each frm n the duopoly medum. 19 Because of ths asymmetrc senstvty, the frm n medum B lowers ts ad quantty more precptously, and ths has a strategc mplcaton. Specfcally, gven Cournot competton n the ad market, frms ad bundlng quanttes are strategc substtutes (.e., 2 j ad / yj y j < 0). At some pont, the fact that the frm n medum B s bundlng very few ads makes the strategc effect domnant for the frms n medum A and they begn ncreasng the amount of ads they bundle as ncreases. When s hgh, the frm n medum B may 19 In analogy to (12a), f we wrte the frst-order condtons for (14) wth respect to rasng content prce: for the frm n the monopoly medum, the LHS cost would have a term related to y A 1 + ya 2, whle for each frm n the duopoly medum, we would have a term related to y B. actually drop out of the ad market to concentrate on ts content market where t s a monopolst, and we may see only the duopolsts bundlng advertsng. Ths can be seen on the left panel of Fgure 2. In practce then, one may fnd that n meda that are more compettve, each frm bundles a greater number of ads relatve to other meda that are less compettve; we would expect ths to happen when there s consderable substtutablty between them n the eyes of advertsers. Regardng the content prcng decson, as explaned above, ntally, frms n both meda bundle less advertsng as across-meda competton ncreases. Hence the ncentve to underprce decreases, and content prces go up n both meda as ncreases. However, as competton across meda further ncreases, the frm n medum B bundles very lttle advertsng, whle the per unt ad margn for frms n medum A becomes more attractve. Ths results n a greater desre to underprce and, hence a decrease n content prces for the frms n medum A. Note that there can exst a scenaro n whch p A >p B for low and p A <p B for hgh enough. Ths would depend on the wthn-medum content substtutablty ( ) beng low enough. The followng result characterzes how the profts n each medum depend on. Result 6. () As across-medum competton becomes more ntense: for each frm n medum A, total profts and advertsng profts ntally decrease and then ncrease, whle content profts ntally ncrease and then decrease. For the frm n medum B, total profts and advertsng profts both decrease, whle content profts ncrease. () If content market compettve ntensty ( ) s low enough n medum A, then total profts for each duopolst are lower (hgher) than total profts for the monopolst n medum B when across-medum compettve ntensty s low (hgh). Result 6 reveals the surprsng fndng that total profts per frm n the medum A duopoly can
30 Marketng Scence 28(1), pp. 20 35, 2009 INFORMS ncrease wth more ntense competton from the medum B monopoly. Ths result agan stems from the mpact of competton on the underprcng effect for meda frms. When the two meda are hghly substtutable (large ), the frm n the medum B monopoly fnds the margn that can be earned n the ad market to be very low and foregoes the ad market to focus on the content market (less ad bundlng and hgher content prce), whle the frms n the medum A duopoly return to the ad levels and prces they could set when they faced no competton from the rval medum. In some sense, the frms n medum A crowd out the frm n medum B from the ad market. Because the ablty to leverage the ad market offers frms an addtonal source of revenue, t allows medum A frms to secure hgher total profts as ncreases. Note that wth no across-medum competton ( = 0), the frm n the monopoly medum has a strong underprcng effect and tends to make sgnfcant profts n the ad market compared to each frm n the duopoly medum. However, ad profts for the monopoly medum frm always declne sharply n, whle those for each duopoly medum frm at some pont ncrease. Hence, f B ad =0 > A ad =0, an nterestng mplcaton of Result 6 s that ntally as competton across meda ntensfes, the two meda converge n terms of the profts they make from the ad market relatve to the content market. But as across-medum competton becomes more ntense, the frms prmary source of profts wll at some pont begn to dverge. Sad dfferently, as contnues to rse, the frms n medum A wll ncreasngly be ad drven (.e., make the bulk of ther profts from the ad market), whle the frm n medum B wll be more content drven (.e., make the bulk of ts profts from the content market). Reflectng on Results 5 and 6, we note that n a regular one-sded market, a frm reacts to more competton by ncreasng producton or lowerng prces whle makng less profts. Ths s not the case for meda frms that face two-sded competton. As shown on the rght panel of Fgure 2, profts can ncrease wth greater compettve ntensty, and mportantly, there can be a crossover of total profts between the meda. Specfcally, at hgh levels of substtutablty, each frm n the duopoly medum can earn hgher profts than the sngle frm n the monopoly medum. At a practcal level, our fndngs suggest that f across-medum substtutablty s already relatvely hgh, frms n a more compettve medum have an ncentve to portray ther medum as even more substtutable to other meda as an advertsng platform. Consder the case of onlne advertsng. Increasngly, webste owners are downplayng the unqueness of onlne advertsng relatve to tradtonal meda by, for example, de-emphaszng clckthrough. Instead, they are adoptng formats that allow them to clam an mpact smlar to televson advertsng. For nstance, many webste owners have ntroduced new onlne formats, such as the VdeoClp Module for onlne vdeo sequencng, 20 that use the same metrcs to track effectveness as those used for televson commercals (brand awareness and ad recall). Webste owners emphasze these smlartes n the ptches made to ad agences for allocatng meda buys to the Web. Gven the myrad number of webstes and smaller number of TV statons, and the fact that the two meda were already competng at some level for ad dollars, ths s consstent wth Result 6. 21 Fnally, we dscuss the condton mposed on ad effectveness across the meda, w j d j 3 + h /4 w j d j. Ths condton ensures that frms n medum j do not have too bg of a dsadvantage n advertsng effectveness relatve to frms n medum j.if the condton s not met, then frms n medum j have a much lower ncentve to partcpate n the ad market to begn wth. For example, f w B d B w A d A, then from the equlbrum soluton n Proposton 3: y B y1 A + y2 A, and ths would domnate the acrossmedum compettve effects studed here. 22 Smlarly, some of the fndngs above would be qualfed f (v A + c A ) and (v B + c B ) are very dssmlar. Although all the comparatve statcs n Results 5 and 6 hold, the crossover n total profts (or n prces) would not occur f one medum offered vastly superor content. 4.3.1. Advertsng Complementarty Across Meda. Up to now, we have assumed that frms across meda drectly compete n the sense that, from the advertser s perspectve, placng an ad on the platform of a frm from one medum decreased the beneft of placng an ad on the platform of a frm from the other medum. Sad dfferently, the meda exhbted demand substtutablty and ths was captured by restrctng the parameter to be nonnegatve. Although ths s a reasonable assumpton n many contexts, there s evdence that reachng the same consumer through multple meda formats can have a renforcng effect (see, for example, Chang and Thorson 2004, for evdence of synerges between advertsng on TV and 20 See Eyeblaster (2004). 21 Even though at ths pont advertsng spendng s stll markedly lower onlne than on televson, from 2006 to 2007 onlne advertsng grew by 19% compared to networktv advertsng, whch decreased by 1.5% (Nelsen Company 2008). 22 In the Techncal Appendx, whch can be found at http:// mktsc.pubs.nforms.org, we examne the mplcatons of asymmetres n ad effectveness for across-medum competton. We are able to show that as ncreases, the medum wth greater net ad effectveness (w j d j ) wll have a pattern of decreasng and then ncreasng ad bundlng, whle the other medum monotoncally decreases ts ad bundlng. The reverse pattern holds for content prces.