13.5 Information Economy

Carl Shapiro, an economics professor at the University of California, Berkeley, and Hal Varian, now chief economist at Google expressed the modern theory of the information economy in the 1998 publication of Information Rules: A Strategic Guide to the Network Economy. They made a simple argument that mirrored a fundamental truth: “Technology changes. Economic laws do not (Shapiro & Varian, 1998).”

While economic laws may not change, the fundamentals of the information business far differ from the fundamentals of most traditional businesses. For example, the cost of producing a single sandwich stays relatively consistent, per sandwich, with the cost of producing multiple sandwiches. As discussed in the first section of this chapter, information works differently. With a newspaper, the costs for the first copy far exceed the marginal costs of producing secondary copies. The high first costs and low marginal costs of the information economy contribute very heavily to the potential for large corporations to gain dominance. The confluence of these two costs creates a potential economy of scale, favoring the larger competitors.

In addition, economists refer to information as an experience good, meaning that consumers must experience the good to judge its value. This poses a problem; how can individuals know, for example, that a movie has high-quality acting and an interesting plot before they’ve watched it? As discussed in the previous chapter , branding solves the problem. Although judging a movie before watching it may seem challenging, knowing that a certain director made it with favorable performers will increase its value. Marketers use movie trailers, press coverage, and other marketing tools to communicate this branding message in the hopes of convincing people to watch the films they currently promote.

Audiences and businesses heavily consider the associated switching costs when debating the value of information technology. When economists consider switching costs, they take into account the difference between the cost of one technology and the cost of another. If this difference costs less than it would take to switch—for information, the cost of moving all of the relevant data to the new technology—then switching technologies makes sense. For example, many people moved their music collection from vinyl LPs to CDs starting in the 1980s (though the vinyl format currently outsells CDS in modern times ). For consumers to switch systems—which includes buying a CD player and stereo—they would also have to rebuild their entire music collection with the new format. Luckily for the CD player, the increase in convenience and quality motivated consumers to switch technologies; however, anyone who frequents thrift stores or garage sales can attest that old technologies persist the media compelled some people to keep them around.

Regulation of the Information Economy

Although Chapter 15 “Media and Government ” will discuss government regulation in greater depth, a basic understanding of the interaction between government and media over time helps provide an essential breakdown of the modern information economy. Public policy and governmental intervention exacerbate an already complicated system of information economics, but for good reason—unlike typical goods and services, the information economy has many significant side effects. The consequences of one hamburger chain outcompeting or buying up all other hamburger chains would surely be fairly drastic for the hamburger-loving world, but not altogether disastrous; having only one type of hamburger harms few people, and the public would still have many other types of fast-food options remaining. On the contrary, the consequences of monopolization by one media company could cause great damage . Because distributed information can influence public policy and public opinion, those in charge of the government have an interest in ensuring fair distribution of that information.

The Federal Communications Commission (FCC) enforces the regulation of media in America. Established by the Communications Act of 1934, the FCC is charged with “regulating interstate and international communications” for nearly every medium except for print (Federal Communications Commission). The FCC also attempts to maintain a nonpartisan, or at least bipartisan, outlook, with a maximum of three of its five commissioners belonging to the same political party. Although the FCC controls many important things—making sure that electronic devices don’t emit radio waves that interfere with other important tools, for example—some of its most important and most contentious responsibilities relate to the media.

As the guardian of the public interest, the FCC has called for more competition among media companies; for example, the ongoing litigation of the merger between Comcast and NBC did not address whether consumers would like streaming Hulu content over the Internet, but rather whether one company should own both the content and the mode of distribution. The public good does not get served if consumers lose their ability to choose when a service provider like Comcast restricts access to only the content that the provider owns, especially if the consumer has no other choice. In other words, actions serving to protect the public good do not show concern with the result of competition, but with its process.  The FCC protects consumers’ ability to choose from a wide variety of media products, and the competition among media producers hopefully results in better products for consumers because it enforces and regulates policies that attempts to provide fair circumstances for all content to succeed.

A Brief History of Antitrust Legislation

The government employs antitrust legislation to keep healthy competition in the information marketplace. The seminal Sherman Antitrust Act of 1890 helped establish modern U.S. antitrust legislation. Although originally intended to dissolve the monopolistic enterprises of late-19th-century industrialists such as Andrew Carnegie and John D. Rockefeller, the law’s basic principles have applied to media companies as well. The antitrust office has also grown since the original Sherman Act; although the Office of the Attorney General originally brought antitrust lawsuits after the act’s passage, this responsibility shifted to its own Antitrust Division in 1933 under President Franklin D. Roosevelt.

The Sherman Antitrust Act of 1890 outlined many propositions and goals that legislators deemed necessary to foster a competitive marketplace. For example, Chapter 1 “Media and Culture”, Section 13.2 “The Internet’s Effects on Media Economies”,  of the act states that “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States…shall be deemed guilty of a felony (Cornell University Law School, 2009).” This establishment of monopolization as a felony changed the status quo considerably; before, free-market capitalism faced little to no punishment working against the public good, making the Sherman Antitrust Act an early proponent of the welfare of people at large.

Two additional pieces of legislation, the Clayton Antitrust Act of 1911 and the Celler-Kefauver Act of 1950, refined the Sherman Antitrust Act to make the system of antitrust suits work more effectively. For instance, the Clayton Act makes it unlawful for one company to “acquire…the whole or any part of the stock” of another company when the result would encourage the development of a monopoly (Legal Information Institute, 2009). More than just busting trusts, the Clayton Act thus seeks to stop anticompetitive practices before they take hold. The Celler-Kefauver Act made it more difficult for corporations to get around antitrust legislation; while the Clayton Act allowed the government to regulate the purchase of a competitor’s stock, the Celler-Kefauver Act extended this to include the competitor’s assets.

Deregulation and the Telecommunications Act of 1996

Although government in the early part of the 20th century broke up trusts and kept monopolies in check, the media—particularly in the latter part of the century—still progressed steadily toward conglomeration (companies joining together to form a larger, more diversified corporation). Widespread deregulation (the removal of legal regulations on an industry) took place during the 1980s, in large part through the efforts of free-market economists who argued that deregulation would foster more competition in the information marketplace. However, possibly due in large part to the media economy’s focus on economies of scale, this did not occur in practice. Companies became increasingly conglomerated, and corporations such as Comcast and Time Warner  came to dominate the marketplace. The Telecommunications Act of 1996 helped solidify this trend. Although touted as a way to let “any communications business compete in any market against any other” and to foster competition, this act in practice sped up the conglomeration of media (Federal Communications Commission, 2008).

Media Conglomerates and Vertical Integration

The extension of the Telecommunications Act of 1996 of corporate abilities to vertically integrate acted as a primary driving factor behind this increased conglomeration. Vertical integration has proven particularly useful for media companies due to their high first costs and low marginal costs. For example, a television company that both produces and distributes content can run the same program on two different channels for nearly the same cost as only broadcasting it on one. Because of the localized nature of broadcast media, two broadcast television channels will likely reach different geographical areas. This results in cost savings for the company, but also somewhat decreases local diversity in media broadcasting.

The Telecommunications Act made some changes in authority for these local markets. For instance, Section 253 outlines that no state may prohibit “the ability of any entity to provide any interstate or intrastate telecommunications service (Federal Communications Commission, 1996).” Thus, since state and local governments cannot prohibit any company from entering into a marketplace, this imposes checks on the amount of a local market that any one company can reach. In addition, the Telecommunications Act capped the share of U.S. television audience for any one company at 35 percent. However, the passage of additional legislation in 1999 allowing any one company to own two television stations in a single market greatly diluted the effect of this initial ruling. Although CBS, NBC, and ABC may be declining in popularity, they “still offer the only means of reaching a genuinely mass television audience” in the country (Doyle, 2002).

Corporate Advantages of Vertical Integration

Almost all of the major media players in today’s market practice extensive vertical integration through either administrative management or content integration. Administrative management refers to the potential for divisions of a single company to share the same higher-level management structure, which presents opportunities for increased operational efficiency. For example, Disney manages theme parks and movie studios. Although these two industries have no obvious connections through content, both function as large, multinational ventures. Placing both of these divisions under a single corporation allows them to share certain structural similarities, accounting practices, and any other administrative resources that any number of industries may find useful.

Content integration—an important practice for media industries—refers to the ability of these companies to use the same content across multiple platforms. Disney’s theme parks would lose much of their charm and meaning without the character Mickey Mouse or Cinderella’s castle; the integration of these two industries—Disney’s theme parks and Disney’s animated characters—proves profitable for both. Behind the scenes, Disney manages to reap some excellent benefits from their consolidation. For example, Disney could release a movie through its studio, and then immediately book the stars on news programs that air on Disney-owned broadcast television network ABC. Beyond just the ABC broadcast network, Disney also has many cable channels that it can use to directly market its movies and products to the targeted demographics. Unlike a competitor that might not want to promote Disney’s films, Disney’s ownership of many different media outlets allows it to single-handedly reach a large audience .

Ethical Issues of Vertical Integration

However, this high level of vertical integration raises several ethical concerns. In the above situation, for example, Disney could entice reviewers on its television outlets to give positive reviews to a Disney studio movie. Therefore, this potential for misused trust and erroneous information could harm audiences.

In many ways, the conglomeration of media companies takes place behind the scenes, with only a minority of consumers aware of vertically integrated holdings. Media companies often try to foster a sense of independence from a larger corporation. Of course, this rule has some exceptions; the NBC sitcom 30 Rock often delved into the troubles of running a satirical sketch-comedy show (a parody of NBC’s Saturday Night Live) under the ownership of GE, NBC’s real-life owner at the time.

The Issues of the Internet

Although media companies have steadily turned into larger businesses than ever before, many of them have nevertheless fallen on hard times. The instant, free content of the Internet deserves most of the blame for this decline. From the shift of classified advertising from newspapers to free online services to the decline in physical music sales in favor of digital downloads, the Internet has transformed the economics of legacy media  outlets.

Media companies fear an unregulated Internet because it allows other parties to replicate digital files and send them anywhere else in the world. Large music companies, which traditionally made almost all of their money from selling physical music formats such as vinyl records or compact discs, find themselves at a disadvantage. They incur all the expenses to secure musicians to create and record music they will sell, while modern consumers, who pay as little as nothing and at most the cost of the song or album for the music, can share and distribute the files to anyone. In addition, the DMCA exempts Internet service providers from liability.  With providers freed of liability and media consumption a driving factor in the rise of high-speed Internet services, ISPs have no incentive to deter illegal sharing along with legal downloads.

Digital Downloads and DRM

Although music companies have had some success selling music through digital outlets, they have not been pioneered online music sales. Rather, technology companies such as Apple and Amazon sensed a large market for digital downloads coupled with a sleek delivery system and created platforms that executed these services.  Already accustomed to downloading MP3s, consumers readily adopted the model. However, record companies believed that the lack of digital rights management (DRM) protection offered by MP3s represented a major downside.

Apple provided a way to strike a compromise between accessibility and rights control. Having already captured much of the personal digital audio player market with the iPod, which uses other Apple products, Apple has also long prided itself on creating highly integrated systems of both software and hardware. Because so many people already used the iPod, Apple had a huge potential market for a music store even if it offered DRM-locked tracks that would only play on Apple devices. This inflexibility even offered a small benefit for consumers; Apple succeeded in convincing companies to price their digital downloads lower than CDs.

This compromise may have sold a lot of iPods and MP3s, but it did not satisfy the record companies. When consumers started to download one hit single for 99 cents—rather than buying the whole album for $15 on CD—the music industry felt the pain. Still, huge monetary advances in digital music have taken place. Between 2004 and 2008, digital music sales increased from $187 million to $1.8 billion.

Piracy

The music industry has wasted no amount of firepower to blame piracy for the decline in album sales: “There’s no minimizing the impact of illegal file-sharing. It robs songwriters and recording artists of their livelihoods, and it ultimately undermines the future of music itself,” said Cary Sherman, president of the Recording Industry Association of America (Sherman, 2003). However, economists see the truth of the matter as significantly more ambiguous. Analyzing over 10,000 weeks of data distributed over many albums, a pair of economists at the Harvard Business School and University of North Carolina found that “Downloads have an effect on sales which is statistically indistinguishable from zero (Oberholzer-Gee & Strumpf, 2007).” Either way, two things become clear: Consumers will pay for digital music, and digital downloads are on the market to stay for the foreseeable future.