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Production and Cost2:A - 1(51)
Entertainment and Media: Markets and Economics
Professor William Greene
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Economic Foundations for Entertainment and Media
Production, Cost and Organization of Firms in E&M Industries
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Classical Economics Apply to the Market for Toasters
Costs of production Variable vs. fixed costs
Cost characteristics Economies of scale Economies of scope Technological change
Profit Firms in markets: market power and
brand identity, etc.
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Familiar Market Outcomes in Commodity Markets
Market power Monopoly Competition Branding Market segmentation
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Producing Experiences
Features of Entertainment and Media Firms Conventional economics explains much of
production There are special features of E&M production
Economic Foundations for Production Production functions – the technology Costs of production – an element of competition Economies of scale and scope – produce market
advantages Technological change – markets evolve
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Characteristics of the Creative Industries
What do we mean by “the creative industries?” Not synonymous with experience goods: E.g.,
amusement park vs. art Are there distinguishing features?
Implications for the organization of market activities: Contracts among producers Market organizations for distribution
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Caves on Creative Industries
Characteristics of production in creative industries that are unlike more conventional production
Uncertainty of demand – difficult to resolve using market research
Producers’ emotional connection to the output – art, music Assembly of widely diverse skills for production - movies,
sports) Differentiated products – different consumers have very
different interests in the same proeuct. The role of time in consumption Durable products and durable rent streams
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Features of Production in Entertainment and Media
Multiple stages of production Outputs as downstream inputs
Content creation is often very labor intensive Labor intensive Little substitution Less Technologically Oriented Not always - animation is a major exception
Delivery – Exhibition, distribution Capital intensive Technological advance
Applications: Books, Movies, TV, Newspapers, Radio, Recorded Music
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The Production Function
Output Inputs – The
factors of production
The “process”
Labor
Capital
Materials
The amount producted, Q, depends on “inputs” or factors of production.Conventional inputs: Capital, labor, materials used in making moviesUnconventional inputs: Music used in distribution and production in stores and offices.The crowd used to create big sporting events.
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BB&B Production Function
Output: Distribution of things to consumers
Inputs: Capital: Physical, Financial Labor Energy Materials Music
How do they use music? Why do they use music? How do they pay for it?
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Live Performance Production is Unconventional
Production function – One “stage” Simultaneous production and consumption Feedback between consumers and producers
Concerts Big Sports eBay watchers
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About Production Functions Factors and Factor Intensity
Higher education is very labor intensive, but less so over time. Broadway (legitimate) theater – very labor labor intensive and there is almost no
opportunity to substitute capital for labor Creating Music – labor intensive, but some opportunities to substitute capital for labor. Major League Baseball – only the game on the field is labor intensive. Most of the rest
of the process is very capital intensive. Casino – capital intensive. It takes relatively few people to keep a casino working, and
fewer over time.
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Production Processes Sometimes Allow Substitution
Substitution of Factors Live theater – the “cost disease” results from little opportunity to substitute capital for labor The trend toward animated movies is an example of substituting capital for labor.
The figure shows different combinations of capital and labor that can be used to produce 100,000 units. E.g., the USPS can use people or machines to sort 100,000 pounds of mail.
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Now, after 500 performances, our producers have told us and our union that in order to cut costs they will chop our string section in half, releasing five musicians and “replacing” them with a synthesizer piped in from another room.
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Multiple Output Processes Managing a multiplex – Two outputs
Concessions (the primary source of profits) Movies (the secondary profit center)
Casino: Gambling Food and entertainment
Professional sports performance The sport: Outcome on the field and the signal for broadcasting Concessions including food and merchandise Sky boxes in stadiums
Music Distribution Performances (public) that also distributed recorded versions plus
t shirts and souvenirs Music videos Music for private consumption
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Mathematical Model for a Movie Theater
Tickets= Demand for movie tix: T(Pt,qm,M). Marginal cost = Ct
Food = Demand for food: F(Pf,T,M). Marginal cost = Cf
dF/dT > 0 More movie goers buy more food. Ignoring Food, the theater owner acts like a ticket monopolist:
Profit = T*Pt - T*Ct. Maximize by equating marginal revenue to marginal cost: Pt + T*(dPt/dT) = Ct
Considering food, theater tries to maximize profits from tickets and food: Profit = T*Pt - T*Ct + F*Pf – F*Cf
They must equate MR to MC in both parts. For the tickets part, nowPt + T*(dPt/dT) + Pf*(dF/dT) = Ct
Pt + T*(dPt/dT) = Ct - Pf*(dF/dT)
Marberger, D., “Optimal Pricing for Performance Goods,” Managerial and Decision Economics, 1997, 18, 5, 375-381.
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Movies and FoodTicket Price
Tickets
Food Effect
Demand
Marginal Revenue
Marginal Cost
Marginal Cost minus food effect
Pt|f
Pt
Pt is the monopoly price if the owner ignores the effect of tickets on sales of food.
Pt|f is the ticket price if the owner also considers the effect of tickets sold on sales of food.
Conclusion: To account for the effect of ticket prices on the demand for the main profit center (food), the theater owner drives down the ticket price.
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Multistage Production Is Common
This is not the same as joint production of more than one product
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Multiple Stages in Production
Players
Capital
Equipment
F(x)
Capital
Equipment
Labor F(x)
TV Sports
What’s better for this process, one firm or two?
Disney Pixar, or Disney/Pixar?
The game on the field Team
The TV broadcastNetwork
The viewerCable Operator
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The Costs of Production
Fixed cost: Not a function of output. Capital Sunk cost: One time, nonrecoverable costs
(Often very significant in the movie business) Variable cost: Variable with respect to output
Labor Materials
Marginal cost: Avoidable cost of one more (less) unit Operating Profit = Gross Revenue - Costs
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Movie Cost and Revenue Trends
2002-2004: Revenue growth from $115M to $130M 2002-2004: Cost growth from $111M to $130M
65% due to production and marketing 20% rising home video manufacturing costs 15% due to higher “talent participation”
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Box Office Revenue
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Production Costs
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(2003)Marketing Costs: $ 85MU.S. Box Office: $ 150MWorld incl. US: $ 417M(#113 all time – on a list that does not correct for inflation, currency, or anything else.)Rights: WB 50M Sony 75M
http://www.slideshare.net/MissConnell/film-distribution-costshttp://www.edwardjayepstein.com/x-rar1.htm
2003
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2004
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2000
2001
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Changing Economics for Stars
Before 2010: $10M, $15M, $20M, … Trend since about 2010:
Small or no up front Except for Angelina Jolie – first choice for Gravity but
could not agree on a deal. Sandra Bullock got $20M for signing. Unusual now.
CB 0 contract (Cash-Break zero – percentage after break even)
Far smaller total compensation for start Why?
Economics of film making Falling demand for star power in movies
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Production cost $100MExhibitors At least $300MSandra Bullock $ 77M = $20M + 15% x Studio net (45% ) + Misc TV, DVD, etc.George Clooney ?Net so far $231M - ?Promotion and advertising ? Probably $50M - $100MOther distribution ?
SUCH “FIRST DOLLAR” GUARANTEED BOX OFFICE DEALS FOR ACTORS ARE BECOMING RARE, THE HOLLYWOOD REPORTER SAID, BECAUSE STUDIOS NOW WANT TO RECOUP ALL THE COSTS FOR EXPENSIVE PRODUCTIONS BEFORE SHARING THE PROFITS WITH TALENT.BULLOCK’S CO-STAR GEORGE CLOONEY, GRAVITY DIRECTOR ALFONSO CUARÓN AND PRODUCER DAVID HEYMAN ARE ALSO BELIEVED TO HAVE “BACK END” PAY DEALS.
HTTP://WWW.INDEPENDENT.CO.UK/ARTS-ENTERTAINMENT/FILMS/NEWS/GRAVITY-STAR-SANDRA-BULLOCK-SET-TO-EARN-70M-WINDFALL-FOR-OSCARNOMINATED-FILM-9157448.HTML
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CD Costs and ProfitsCD a
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Mar
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Artist
Dev
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Rec
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Royal
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r and
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Ope
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Labo
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tribu
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Rent (
Shopp
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Mal
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pera
ting
Profit
Record Label $10.80
Retailer $6.20
.75 1.40 2.15 .86 1.08 1.29 .70 1.94 .59 1.36 1.36 2.55 .97
Consumer
Fixed CostsVariable CostsSunk CostsOperating Profit
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Production and Cost Functions?
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Economies of Scale
Working definition: Declining average cost Market based definition: Competitive advantage of
large size Sources
Supply based: Technical, Demand based: Networks Indivisibilities: Lumpiness
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Economies of Scale in E&M
Cablevision Professional sports Publishing/Movies – Backlists of titles Casinos Movies Television
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Economies of Scope
Cost effect C(Q1,Q2) < C(Q1,0) + C(0,Q2)
Cablevision and Newsday Applications
Cable TV, Internet Mobile phone network Basketball, Hockey
Not the effect behind vertical integration News media owning the sports team?
Sky News motivation for owning Manchester United
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Technological Advance
(Marginal) Cost Reduction
Digital setup in newspapers
Synthesized instruments in Broadway Musical Orchestras
Digital distribution of movies
Less Cost Reduction in Performance Industries: Baumol’s Cost Disease of the service sector
Live theater, Orchestra, Education
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Search Technology - The Long Tail
Reduces the marginal cost of distribution and promotion.
Locate the world market for small or obscure goods – books - information
A result of the Internet and search technology.
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Labor Saving Technological Change in Card Games in Casinos
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Digitizing Entertainment – Technical Advance in Delivery of Existing Forms
Music MP3 - affects distribution, not creation Pop music without musicians.
Literature: E-books – Kindle (Amazon), Nook (B&N) E-zines (Slate.com) Web based news services (NYTimes.com)
Movies: Creation – digital equipment, Pixar animation Distribution – digital transmission without film Distribution – mode Netflix Exhibition – digital projection (expensive)
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“Book” Production Costs
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Music Production and Distribution Costs Studio quality recording with free software and
without studio or graphic design. (XBloome: X Marks the Spot.
Distribution, bypassing the labels. iTunes, SoundCloud
From XBloome's X Marks The Spot website: As maybe the first album ever, 'X marks the spot' was produced exclusively using Free Software (Open Source) and without a professional studio or graphic designers. With this 'proof of concept' album, XBloome have debunked several prejudices about feasibility, professionality and quality of free and self-made productions.“(www.xbloome.com)
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Who should bear the cost?(About $75,000/screen)Film makers? Distributors? Exhibitors? Equipment makers? New York State?The conversion is over 80% complete in the U.S.
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http://www.rollingstone.com/movies/news/how-digital-conversion-is-killing-independent-movie-theaters-20130904
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3D - The Next New Thing
2D Format: Existing projecting systems; 20 new movies in 2008-2010.
3D Format: About 1000 existing projection systems plus 250 IMAX. Requires digital projection.
“It’s not always as good as they say it is…”“I’m not so sure our customers even know we have it…” Theater owner, New Mexico.
Can it be priced?
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PRICING MOVIE TECHNOLOGY
General Seniors ChildrenCabin in the Woods (Georgetown) 12 11 9Cabin in the Woods (7th & H)(Not digital) 12 9.25 9Loews on 84th St. New York 13 9.50 9.50Titanic Imax 18 17 15Titanic Real 3D 16 15 13Wrath of the Titans in Real 3D 16 15 13
Theater owners cannot price digital.
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http://www.marketplace.org/topics/business/movie-theaters-move-beyond-ticket-price
The simple explanation is that fewer people are going to the movies, but they are paying more for their tickets. Mostly we're talking about 3-D movies, which are more expensive. But higher ticket prices aren't necessarily great news for theater owners. Theaters have to share box office revenue with studios, says business professor William Greene of the Stern School of Business at NYU.
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3D Economics
30 3D Movies “Avatar” - $250M Benefit: Net addition to profit $80M (Dreamworks)
Obstacle: Digital Projection Insufficient screens (3000 needed for an opening) Uncertain financing for theater digital projection (financial crisis) Pricing the Upgrade ($25 tickets)
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3D
2D
3D can be priced. “Digital” cannot.
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