Program Quality Competition in Broadcasting Markets

• Author: CHANGYING LI,JIANHU ZHANG
• Published date: 01 August 2016
• Date: 01 August 2016
• DOI: http://doi.org/10.1111/jpet.12150

PROGRAM QUALITY COMPETITION IN BROADCASTING MARKETS

CHANGYING LI

School of Economics, Shandong University

JIANHU ZHANG

School of Economics, Shandong University

Abstract

This paper develops a duopoly model where broadcasters first choose

their program quality and then their pricing strategy. Two alternative

financing schemes are considered: pay-TV and free-to-air. We find that,

from a welfare perspective, a pay-TV regime always generates inade-

quate quality and advertising, whereas free-to-air might produce exces-

sive quality and advertising. In the case of asymmetric competition, a

pay-TV broadcaster always has a stronger incentive to conduct research

and development than a free-to-air broadcaster does. Both platforms

could either over- or underinvest. The pay-TV broadcaster always shows

too few advertisements, but the free-to-air media might act in the op-

posite manner.

1. Introduction

In broadcasting markets, a central question is whether or not the market provides ade-

quate quality programs, from a welfare perspective. This question is important and inter-

esting on both theoretical and policy grounds. On one hand, it is frequently observed

that broadcasters spend considerable effort to improve the quality of their programs.

On the other hand, in many—especially European—countries, it is argued that private

stations might have incentives to offer inadequate quality programs, thereby providing a

basis for public intervention in the broadcasting industry (Armstrong and Weeds 2007).

This paper develops a duopoly model of broadcast competition with an emphasis

on quality investment. In particular, we analyze two alternative schemes in which

broadcasters are financed: the pay-TV regime under which broadcasters are financed

both from advertising receipts and customers’ subscriptions, and the free-to-air regime

Changying Li, 27 Shanda South Road, School of Economics, Shandong University, Jinan, Shandong,

250100, P.R. China (changyingli@sdu.edu.cn). Jianhu Zhang, 27 Shanda South Road, School of Eco-

nomics, Shandong University, Jinan, Shandong, 250100, P.R. China.

We thank Myrna Wooders (editor), one associate editor and two anonymous referees for their

valuable comments. We would like to thank Hong Feng, Qiang Gong, Jianpei Li, Jie Li, Ping Lin, Zhiy-

ong Liu, Jie Ma, Lan Zhang, and seminar participants at UIBE, SWUFE, Jinan University, and Yantai

University for their valuable comments. Changying Li gratefully acknowledges the financial support

from the National Social Science Foundation (14AJL008) and the Shandong Science Foundation

(ZR2012GM017). Jianhu Zhang acknowledges the financial support from CPSF (2012T50599) and the

Foundation for Outstanding Young Scientist of Shandong Province (BS2014SF014).

Received November 29, 2014; Accepted December 12, 2014.

C2015 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 18 (4), 2016, pp. 666–689.

666

Program Quality Competition in Broadcasting Markets 667

under which broadcasters are financed from advertising receipts only. The purpose of

this paper is to address the nature of the market failure with respect to the provision

of quality programming. This is particularly important in light of the general trend

towards deregulation in the broadcasting industry around the world (Choi 2006).

Several investigators before us have analyzed some aspects of quality competition

in broadcasting markets. Armstrong and Weeds (2007) compare program qualities un-

der pay-TV and free-to-air. They show that program quality is higher under pay-TV than

under free-to-air. However, by assuming that broadcasters simultaneously choose their

research and development (R&D), advertisements and prices, they consequently ne-

glect the effect of quality investment on the levels of price and advertising. Gonz´

alez-

Maestre and Mart´

ınez-S´

anchez (2015) analyze quality improvement via competing plat-

forms. But they discuss free-to-air only, with an emphasis on comparison between private

and mixed duopoly outcomes. The applicability of that analysis is limited, however, by

the assumption that advertising revenue functions are linear and R&D functions are

quadratic.

The current paper assumes that platforms first choose their R&D efforts and then

their pricing strategies. This assumption allows us to explicitly investigate how quality

improvement affects advertising (and subscription price under pay-TV). The focus of

this paper is the divergence between socially and privately optimal levels of quality and

advertising. We find that, from a welfare perspective, a pay-TV regime always leads to

lower levels of program quality and advertising, whereas free-to-air might produce the

opposite results. Our result implies that program quality might be lower under pay-TV

than under free-to-air, which differs from the finding by Armstrong and Weeds (2007).

The logic underlying our results is as follows. As we show below, a pay-TV regime

generates a full pass-through of advertising revenues into lower prices. An immediate

consequence is that the amount of advertising is undersupplied relative to a social opti-

mum. The pass-through effect also induces broadcasters to offer lower levels of program

quality. By contrast, depending on the strategic response between advertisers and view-

ers, a free-to-air regime might lead to the social under- or overprovision of advertising.

Regarding the determinants of quality investment, there are two opposing forces. On

one hand, an increase in R&D by a platform makes its program more attractive. This

is an encouraging force. On the other hand, an increase in R&D by a platform will force

its competitor to cut the level of advertising, which in turn hurts the investor since its

program becomes less attractive. This is a discouraging force. Therefore, in the free-to-

air market, the levels of R&D could be distorted either upwards or downwards, from a

welfare perspective.

Our analysis obviously falls into the category of studies on a two-sided market. In the

media market literature without quality investment, Anderson and Coate (2005) present

a theory on the market provision of broadcasting, given the level of content differenti-

ation. They show that, from a welfare perspective, the market provision of advertising

may be too large or too small. Some other papers focus on platforms’ endogenous con-

tent and advertising decisions (e.g., Gabszewicz, Laussel, and Sonnac 2001, 2002, 2004;

Gal-Or and Dukes 2003; Peitz and Valletti 2008).1

The rest of the paper is organized as follows. Section 2 outlines the basic model

and derives the socially optimal outcome. Section 3 explores the dependence of quality

1Gabszewicz et al. (2001, 2002) and Gabszewicz et al. (2004), respectively, investigate content differen-

tiation between television channels under pay-TV and free-to-air. Gal-Or and Dukes (2003) emphasize

how negotiation for advertising affects free-to-air stations’ choice of content differentiation. Peitz and

Valletti (2008) focus on the outcome comparison between pay-TV and free-to-air.