Transcript Production Costs - New York University

Economic Foundations for
Entertainment and Media
Production, Cost and Organization of
Firms in E&M Industries
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Production and Cost
Technology and Production

Conventional aspects of cost and
production for a commodity

Similarities to and differences from
entertainment and experience goods
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Production and Cost
Classical microeconomics apply
to the production of toasters and books
Brand: Cuisinart
Price: About $80
Behind the price: How much does it cost
to make a Cuisinart toaster?
Costs of production
 Variable vs. fixed costs
 Marginal cost
 Prices, costs and profits
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Production and Cost
Spotify Costs?
4
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Production and Cost
Classical microeconomics apply
to the market structure for toasters
Brand: Cuisinart
Price: About $80
There are many brands
Lots of competition
Probably not unusually
profitable
Behind the market structure
 Economies of scale – can small firms survive?
Examples: Breweries, Car makers
Counterexamples: Paper, Books, Toys, Small appliances
In the middle: Movie studios
 Economies of scope – is there a competitive advantage in producing more
than one product?
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Production and Cost
There are many movie studios
This looks like a competitive market
6
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Production and Cost
Familiar Market
Outcomes in
Commodity Markets
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Market power
Monopoly (Branding)
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Market segmentation
(Low and high end toasters)

Does the idea of “branding” extend to movie studies
or TV networks? To the products they produce?
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Production and Cost
Producing Experiences
 Most of the interesting differences are on the
demand side. (We examined in Part 1.)
 Features of Entertainment and Media Firms
 Conventional economics explains much of
production
 There are a few special features of some E&M
production
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Production and Cost
Producing Experiences
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 as
technology changes
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Production and Cost
Production Function
Making movies has a
well established
production “technology.”
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Production and Cost
Spotify Production Function
Output(s)?
What does Spotify
produce/sell
Inputs?
What resources do they use?
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Production and Cost
Characteristics of the Creative Industries

What do we mean by “the creative industries?”
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Not synonymous with experience goods: E.g.,
amusement park vs. art
There are distinguishing features of creative industries
These features have implications for the
organization of market activities:
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Contracts among producers
Market organizations for distribution
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Production and Cost
Staging in Production

Creating experience goods
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Music: Composition, Creation
Books: Authorship
Delivering experience goods
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Pandora, Spotify, etc.
Prentice Hall Publisher, Amazon Distributor
Different production processes at work
in different stages.
 Contrast this to car manufacturers vs.
dealerships

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Production and Cost
Creative Industries
Some characteristics of production in creative
industries that are unlike more conventional production
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Producers’ emotional connection to the output – e.g., art,
music, … not toasters
Assembly of widely diverse skills for production movies, sports
Durable products and durable rent streams. Contrast to
one-off sale of the toaster.
Production and Cost
Caves on Creative Industries
Some characteristics of demand in creative
industries that are unlike more conventional goods
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Uncertainty of demand – difficult to resolve using
market research
Differentiated products – different consumers have
very different interests in the same product.
The role of time in consumption
Production and Cost
Noteworthy Features of Production in
Entertainment and Media
 Multiple stages of production
 Outputs are often downstream inputs: Think movies
 Creation, Distribution, Exhibition
 Creation stage is often very labor intensive
 Little substitution between labor and capital
 Less technologically oriented
 Not always - animation is a major exception
 Delivery (exhibition) may be very capital intensive
 Capital intensive
 May allow substitution away from labor
 Technological advance
 Applications: Books, Movies, TV, Newspapers, Radio,
Recorded Music, Live Performance (Theater, Concerts)
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Production and Cost
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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Production and Cost
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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The cost disease.
Production and Cost
Production Functions
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Output
Inputs – the
factors of
production
The “process”
The amount producted, Q, depends on “inputs” or
factors of production.
Conventional inputs:
Capital, labor, materials used in making movies
Unconventional inputs:
Music used in distribution and production in stores
and offices.
The crowd used to create big sporting events.
Labor
Capital
Materials
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Production and Cost
Industrial Production Function
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Production and Cost
BB&B Production Function
Output: Distribution of things
to consumers
 Inputs:
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Capital: Physical, Financial
Labor
Energy
Materials
Music
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How do they use music?
Why do they use music?
How do they pay for it?
Production and Cost
Live Performance Production is Unconventional
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Production function – One “stage”
Simultaneous production and consumption
Feedback between consumers and producers
 Concerts
 Big Sports
 eBay watchers
Production and Cost
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 and Cost
Multiple Output Processes
 Managing a multiplex – Two outputs from one
production facility
 Concessions (the primary source of profits)
 Movies (the secondary profit center)
 Casino –

 Gambling
 Food and entertainment
One capital intensive output, one labor intensive
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Production and Cost
Multiple Output Processes
 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:
Many products – many distribution channels
 Performances (public) that also distribute recorded versions
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plus t shirts and souvenirs
Music videos
Music for private consumption
Music input to other entertainment
Music blended into advertisements
Production and Cost
A Mathematical Model for a Movie Theater
Marberger, D., “Optimal Pricing for Performance Goods,”
Managerial and Decision Economics, 1997, 18, 5, 375-381.
(1) Movie theaters sell two products:
Tickets, T = the number of movie goers who come to the theater
Food (concessions), F = amount of food sold that night
(2) Mathematical statements for the two products
Tickets= Demand for movie tix:
T(Pt,qm,M). Marginal cost = Ct
Depends on factors like weather, the movie, and ticket
price, Pt
Food = Demand for food:
F(Pf,T,M). Marginal cost = Cf
Depends on the price of food, Pf, the number of movie
goers, T, and other things including the movie.
(3) Central (and intuitively reasonable) result dF/dT > 0
More movie goers buy more food. Selling more tickets will result in
selling more food.
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Production and Cost
Mathematical Model for a Movie Theater
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The manager must decide on the ticket price
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(1) Ignore the relationship between tickets sold and food sold
(2) Figure out both tickets and food at the same time.
Ignoring the connection to food
The theater owner acts like a ticket monopolist:
Profit =
T*Pt - T*Ct - fixed costs

Maximize by equating marginal revenue to marginal cost:
Pt + T*(dPt/dT) = Ct
The resulting price is a monopoly outcome.
Pt = Ct (marginal cost) plus a monopoly effect
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Production and Cost
Mathematical Model for a Movie Theater

Considering the connection of movie tickets and food

The theater owner tries to maximize profits from tickets and food at
the same time. Recognizes the ticket price will affect the amount of
food they sell.
Total Profit = Tickets profit + food profit
= (T*Pt - T*Ct ) + (F*Pf – F*Cf)
They must equate MR to MC in both parts. For the tickets part, now
Pt + T*(dPt/dT) + Pf*(dF/dT) = Ct
The ticket price is lower than if the food is ignored
Pt = Ct - T*(dPt/dT) - Pf*(dF/dT)
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Production and Cost
Movies and Food
Ticket Price
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.
Pt
Pt|f
Marginal Cost
Marginal
Cost minus
food effect
Food
Effect
Demand
Tickets
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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Marginal Revenue
Production and Cost
Two Product Monopolist
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Production and Cost
Multistage Production Is Common
This is not the same as joint production
of more than one product. Early stages
are inputs to later ones.
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Production and Cost
Multiple Stages in Production
 The TV broadcast
Network
The game on the field
Team
Capital
Players
Capital
Equipment
 The viewer
Cable Operator
F(x)
Equipment
Labor
F(x)
TV
Sports
What’s better for this process,
one firm or two?
Disney  Pixar, or Disney/Pixar?
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Production and Cost
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)
$Multimillion model of Titanic
 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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Production and Cost
Box Office Revenue 1997-2013
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Production and Cost
Production Costs
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Production and Cost
Movie Cost and Revenue Trend
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2002-2004: Revenue growth from $115M to $130M
2002-2004: Cost growth from
$111M to $130M
 65% due to costs of production and marketing
 20% rising home video manufacturing costs
 15% due to higher “talent participation”
Costs grew a bit faster than revenue
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Production and Cost
2003
(2003)
Marketing Costs: $ 85M
U.S. Box Office: $ 150M
World 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-costs
http://www.edwardjayepstein.com/x-rar1.htm
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Production and Cost
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Production and Cost
Changing Economics for Stars
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Before 2010: $10M, $15M, $20M, …
Trend since about 2010:
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Why?
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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
Economics of film making
Falling demand for star power in movies
Production and Cost
Production cost
Exhibitors
Sandra Bullock
$100M
At least $300M
$ 77M = $20M + 15% x Studio net (45% )
+ Misc TV, DVD, etc.
George Clooney
?
Net so far
$231M - ?
Promotion and advertising ? Probably $50M - $100M
Other 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-TOEARN-70M-WINDFALL-FOR-OSCARNOMINATED-FILM-9157448.HTML
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Production and Cost
Budgets and Box Office Revenues
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Production and Cost
Breaking Down Music Costs
CD Costs and Profits
.75 1.40
2.15
.86 1.08 1.29 .70
Consumer
Retailer
$6.20
Record Label
$10.80
1.94
.59
1.36
1.36
2.55
.97
Fixed Costs
Variable Costs
Sunk Costs
Operating Profit
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Production and Cost
Production and Cost Functions?
Most of the marginal cost of something sold for download from iTunes is the royalty.
E.g., the 99 cent single track triggers about 70 cents in royalties.
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Production and Cost
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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Production and Cost
Economies of Scale in E&M
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Cablevision
Professional sports
Publishing/Movies – Backlists of titles
Casinos
Movies
Television
Production and Cost
Economies of Scope
 Cost effect
 Cost(Q1,Q2) < Cost(Q1,0) + Cost(0,Q2)
 Cablevision and Newsday
 Applications
 Cable TV, Internet
 Mobile phone network
 Basketball, Hockey teams
 Not the effect behind vertical integration
 News media owning the sports team?
Sky News motivation for owning Manchester United
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Production and Cost
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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Production and Cost
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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Production and Cost
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Production and Cost
Labor Saving Technological
Change in Card Games in Casinos
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Production and Cost
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:
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Creation – digital equipment, Pixar animation
Distribution – digital transmission without film
Distribution – mode Netflix
Exhibition – digital projection (expensive)
Production and Cost
“Book” Production Costs
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Production and Cost
Music Production and Distribution Costs
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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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Production and Cost
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Production and Cost
SoundCloud’s Conventional Entry into the Music Streaming Market
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Production and Cost
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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Production and Cost
http://www.rollingstone.com/movies/news/how
-digital-conversion-is-killing-independentmovie-theaters-20130904
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Production and Cost
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Production and Cost
Theater owners
cannot price digital.
PRICING MOVIE TECHNOLOGY
General
Seniors
Children
Cabin in the Woods (Georgetown)
12
11
9
th
Cabin in the Woods (7 & H)
(Not digital)
12
9.25
9
th
Loews on 84 St. New York
13
9.50
9.50
Titanic Imax
18
17
15
Titanic Real 3D
16
15
13
Wrath of the Titans in Real 3D
16
15
13
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Production and Cost
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Production and Cost
3D
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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Production and Cost
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Production and Cost
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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Production and Cost
3D Economics
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30 3D Movies
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“Avatar” - $250M
Benefit: Net addition to profit $80M (Dreamworks)
Obstacle: Digital Projection
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Insufficient screens (3000 needed for an opening)
Uncertain financing for theater digital projection (financial crisis)
Pricing the Upgrade ($25 tickets)
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Production and Cost
3D can be priced. “Digital” cannot.
3D
2D
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Production and Cost
4D can be priced.
A subsidiary of a distribution and exhibition company, CJ 4DPlex provides the technology for
112 4D theaters in more than 20 countries throughout Asia, Europe and the Americas.
Tickets Stateside cost $22 on average, but for that premium price, moviegoers get to kick
back in motion-based seating in a theater that spays water, emits odors and jerks visitors
around, all synchronized to the on-screen action.
Moviegoers seem interested in taking this particular ride. Over its 13-day 4D engagement,
for example, “Transformers: Age of Extinction” generated $105,016 in ticket sales compared
to a U.S. average of $44,054 during the same period. That’s an 138% improvement.
Likewise, “Dawn of the Planet of the Apes” capitalized on its action-heavy plot to deliver
$94,247 in ticket sales in one 4DX location over its first 13 days compared to an industry
average of $38,404. That’s 145% better.
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Production and Cost