Conventional Television Advertising Models in English Canada Market Analysis Report

MBA40 Blue Group 1: Merve Akar, Fabio Cividini, Wataru Fujii, Leonard Liscio, Sheli Miller

Introduction The Market The North American television landscape is witnessing an evolutionary transition. The increasing dominance of cable and specialty channels that cater to specific demographics and the rise of online television are challenging conventional television viewership and disrupting traditional advertising models. Furthermore, television as we know it is no longer only consumed at specific times but rather from mobile devices and on-demand. With this shift comes increased complexity in the industrys advertising models. To better understand this shift, it is important to first understand and analyze traditional advertising models. Since the North American market is large, this market analysis focuses specifically on the English-language market in Canada. The English Canadian television market (hereafter referred to as the market) consists of 13.8 million TV households in 42 television markets, with 99% penetration. Last year 3.6 Billion CAD were spent on television advertising, ($109 per capita) (TVB, 2013). The market consists of four players:

Broadcasters (over-the-air, cable, satellite, internet) Advertisers (agencies and clients) Viewers Content producers Despite the interconnectivity of the market, this analysis focuses more narrowly on the economic relationship between advertisers, viewers and conventional broadcasters. While the main Canadian broadcasters are large media companies that also provide cable and satellite subscriptions in addition to ad-supported online content, these complementary roles will not be directly considered here. We have established boundaries to focus the market definition within the industry (blue shapes in Figure 1).

Figure 1: Simplified Canadian Television Market

The market has one seller- broadcasters, and two buyers - viewers and advertisers: Sellers: The main three broadcasting companies are Bell (CTV), Shaw (Global), and Rogers (City, OMNI). Together they account for 92% of revenues from conventional television broadcasting in Canada (CRTC, 2014). Buyers: Unlike conventional consumer goods industries, the television industry is a two-sided or platform market (Rochet & Tirole, 2002), in which there are two separate types of customers that are not purchasing the same content despite being indirectly connected through the seller. On the one hand viewers are sold the product (television shows) for free in exchange for viewing advertisements. On the other hand, the advertisers generate revenue for the sellers by buying advertising slots, the price of which depends on what the advertisers are willing to pay based on the number of views. Hence, the first type of customer becomes part of the product sold to the second type of customer. Supply and Demand The cost structure of television broadcasting consists of fixed and sunk costs (there are no variable costs, at least in the short run). The costs of broadcasting infrastructure and licenses are sunk; they exist regardless of whether the broadcaster actually broadcasts. These also serve as an entry cost, which can deter new broadcasters. The largest cost for broadcasters (~65%) is programming (CRTC, 2014), which is fixed and does not vary with the number of viewers. (An argument could be made that in the long run the cost of programming is variable, because as the number of viewers changes broadcasters may choose to adjust spending on programming.) It is cheaper to buy foreign programming than to produce original content, but since the amount of Canadian content networks must broadcast is regulated, broadcasters opportunities to lower costs this way are limited. Nevertheless, investment in Canadian productions declined 5.5% in 2013 (to 66%). Other ways to lower costs include showing re-runs, which adversely affects ratings, or producing cheaper content - hence the recent proliferation of Reality TV. The remaining costs to the broadcaster (e.g. maintenance, technological innovation, marketing, G&A) are also fixed. There are economies of scale involved: a larger broadcaster has a lower per-viewer cost. Additionally, a larger broadcaster is able to negotiate a better price for programming purchases. The most important feature of the cost structure is that there is no marginal cost for broadcasting to one additional viewer. This is what facilitates a platform market. Broadcasters provide the programs to viewers for free, in order to maximize audience size. Revenues are derived on the advertisers side of the market. The main demand driver in the market is the number of views. Advertisers buy advertising slots, but the price they are willing to pay depends on the number of views. There are two ways to increase the number of views (Bowman, 1976): (1) Increase the number of advertising slots, and (2) Increase the number of viewers per slot.

In the short run, the total inventory of slots is fixed since advertising minutes per hour of broadcast are regulated. Therefore the supply curve for advertising slots is vertical. However, advertisers purchase slots year-round (short-term and long-term). As the television year (June-May) progresses, the inventory of slots sells out and fewer slots are available, thus shifting the supply curve left (Figure 2). In the long-term, broadcasters could add channels in order to increase the number of available slots but this would require additional expenditures on programming and broadcasting licenses. The largest factor affecting the price of advertising slots in the short-term is audience size. The more views per slot, the more advertisers are willing to pay. The two-sided nature of the market plays a crucial role: broadcasters give up revenue on the viewers side of the market (they do not charge viewers for watching), which shifts the demand curve on the advertisers side of the market to the right (Figure 2).

Figure 2: Supply and Demand In terms of demand drivers, both types of customers must be considered. Within a simplified model, the number of views is the sole determinant of the value of the advertising slot. In reality, however, advertisers also care about viewer demographics, or demos. Advertisers pay more for desirable demos, such as Adults 18-49, which are thought to have more disposable income to spend on advertised products. The individual demand curve for a particular advertiser may depend on the number of viewers from a niche demo (e.g. Females, 12-17). However, the aggregate demand curve for the market will be swayed by the relative attractiveness of different demos to advertisers as a whole.

Consequently, broadcasters program content that attracts not only more viewers overall, but also more viewers in the desirable demos. Demand on the viewers side may be affected by the quality of the programming, the popularity of the stars, and the time of day in which a show is broadcast. Broadcasters schedule their most popular programs for primetime, in order to maximize audience size. Another factor affecting demand for advertising is the state of the economy; the less consumers spend on their products, the less advertisers are willing and able to spend on advertising. There is high elasticity of demand for this factor, as evidenced by the large drop in advertising revenues in 2009, followed by a recovery in 2010. The demand on both sides of the market is affected by competition. Competition and Future Outlook We distinguish between three levels of competition: Conventional broadcasters: compete among themselves for market share. Other types of television: While conventional television accounts for a larger advertising market-share than the combination of specialty channels, Pay-per-View, VOD and streaming (hereafter referred to as non-conventional television), advertising revenues are declining by 12% for the former and rising by 26% for the latter between 2008 and 2013 (CRTC, 2014). Shifts in consumer preferences for specialty programming and changes in consumption habits (e.g. streaming) seem to be responsible for this trend. Last year, 13% of television content consumption was streamed or downloaded. Conventional broadcasters offset some of the loss of over-the-air viewers by streaming their content after the regular broadcast and charging for advertising. Although Netflix has 4 million Canadian subscribers and accounted for 4% of viewing last year (CRTC, 2014), it is stealing viewers mostly from the non-conventional market (Okalow, 2014). Nevertheless, traditional broadcasters recognize both the threat and opportunity presented by online television (Wong & Ladurantaye, 2014), and are strengthening their online platforms. Adoption rates for new television outlets are high and growing (e.g. Netflix 29%, Internet TV 42%, TV on Tablet 20%). Other types of media: Television is the medium with the highest consumption in Canada (47% of time spent with media is spent watching television), but it faces competition, both for consumers and advertisers, from other media (e.g. radio, movies, Internet). In a way, the Internet can be considered both a substitute and a complement to television: at least 15% of viewers discuss television shows on social media (TV Basics, 2014). Broadcasters are learning to exploit these opportunities through multi-platform extensions. With the continued growth of non-conventional television, conventional broadcasters must reconsider their advertising revenue streams. As viewers shift from televisions to computer and smartphone screens, advertisers are also making the shift (Goodwin, 2014). As the demand curve for conventional advertising slots shifts to the left, the demand curve for non-conventional slots shifts to the right. However, since most major broadcasters control both types of television, the losses from one are partially offset with gains from the other. The challenge for broadcasters is to successfully evolve their advertising models along new market lines. Word count: 1499

Appendix Sources: Bowman, Gary W., Demand and Supply of Network Television Advertising, The Bell Journal of Economics - Vol. 7, No. 1, Spring 1976. URL: . (Accessed Oct 20, 2014). Canadian Radio-Television Telecommunications Commission (CRTC). Communications Monitoring 2014. URL: , 2014. (Accessed, Oct 20, 2014). Canadian Radio-Television Telecommunications Commission (CRTC). Communications Monitoring 2013. URL: , 2013. (Accessed, Oct 20, 2014). Goodwin, Tom. TV Advertising Is About to Change Forever. URL: , Oct 20, 2014. (Accessed Oct 22, 2014). Ladurantaye, Steve. Netflix Canadas growth levels off. URL: , Oct 23, 2012 (Accessed Oct 24, 2014). Okalow, Samson. Why Netflix wont conquer Canada. URL: , Feb 2, 2013. (Accessed Oct 24, 2014). Rochet, Jean Charles and Tirole, Jean. Platform Competition in Two-Sided Markets. URL: , December 2002. (Accessed Oct 20, 2014). Television Bureau of Canada (TBC). The Canadian TV Industry, URL: , 2014. (Accessed Oct 20, 2014) Television Bureau of Canada (TBC). TVBasics - 2013-2014. URL: , 2014. (Accessed Oct 20, 2014). Wong, Tony. Canadian broadcasters beef up their anti-Netflix arsenal URL: , Sep 18 2014. (Accessed Oct 25, 2014).