Betting on the Wrong Side of the Market

Here’s some bad advice:

You don’t have to shell out hundreds of dollars every year to watch your favorite shows. This year, consider canceling your cable and taking advantage of several free and low-cost entertainment services. The website Hulu, for instance, lets you watch a variety of hit shows for free such as Glee, The Office and Modern Family, plus movies and documentaries. Or for $7.99 a month, you can take advantage of Hulu Plus, which gives you access to all of the selections on regular Hulu, plus more shows and movies.

You can also watch many shows for free on the network’s website, or pay $7.99 for Netflix, which provides access to unlimited movies and TV episodes.

The reason why cable is so expensive is because ad revenue alone is insufficient to cover both production costs and distribution costs. Cable and satellite networks are expensive to build and maintain, and content creation can often be pricey. As such, cable providers have to charge customers in order to be profitable.

The problem internet-based entertainment services face is that they are causing a significant portion of data transfer (i.e. the amount of data transmitted across the various data networks) but aren’t paying for any of the network upkeep and maintenance. Essentially they are paying only for content creation and distribution rights. This, incidentally, is why Hulu+ and Netflix subscriptions are so cheap (that, and Hulu is pretty well-connected to the NBC and Fox family of networks).

More importantly, it is the data service providers who have to pay for the creation and upkeep of data networks, and these networks have data transfer limits known as bandwidth. Essentially, there are limits to how much data can be transferred across a network at any given time. As more and more people begin to use online video content providers, there will be even more at being transferred at any given time, pushing up against physical network limits.

Data service providers will then have two options when this inevitably happens: increase bandwidth or cap data transfers. Most data transfer providers have relatively tight margins, so upgrading a network is not particularly feasible, nor will it be particularly widespread. Thus, the more common choice will be to cap data. Data caps (whether in terms of bandwidth usage or total data downloaded) will significantly curtail entertainment options, and so whatever profitability online video sites may have now will be either significantly reduced or completely eliminated, unless they decide to raise their fees.

Quite simply, the internet is not yet ready to replace cable. The network is not sufficiently built up. More importantly, the producers and aggregators of online content are not paying for the distribution of their content, and those who distribute content (data service providers) don’t have much reason to upgrade their network.

Ultimately, there is a strong chance that the market for online videos will eventually come to resemble the subscription television market. The separation of content providers and content distributors provides a problematic incentive structure that won’t be easily remedies unless content aggregators/producers have a financial stake in distribution, and vice versa.

Note: one thing that complicates this discussion immensely is the role of IP. If there were no IP, there would be many more aggregators of videos, and their subscription costs, if any, would be minimal since it would be considerably easier to find advertisers for pre-existing content, thus leading to an easy method of third-party funding. On the other hand, the amount of original content would diminish, and would probably become more low-brow.

Market Distortion in the News Industry

Newspapers have been unable to monetise the internet as an income stream. This is in part because the BBC website offers so much content for free (i.e licence fee-payer funded) that it heavily distorts the market and mitigates against charging for content. The BBC itself has been forced to recognise this and plans to scale back its website by 20% to allow ‘room’ for competition. Local radio stations also suffer hugely from crowding-out by BBC local radio. Similarly, local paper circulation and revenues have been damaged by the council ‘freesheets’ that Eric Pickles was meant to dispose of.

Government-funded news organizations are problematic not only because they have a strong tendency to kill off the competition, but because they often function as a propaganda arm of the government itself. Americans, of course, have a tendency to complain about how the fourth estate is in the pocket of Big Government, but it is the British for whom this is perhaps literally true. As such, the British run the (very large) risk of having the BBC be nothing more than a propaganda machine, assuming it isn’t already.

Indirect Revenue

I’ve been writing quite a bit recently on indirect taxation, and I thought that I would take a minute to look at things from the opposite side of the fence as it were. First, some context for my thoughts:

The state of Connecticut passed a new Internet tax law and contends that Amazon had a physical presence because it had affiliations with websites through its Amazon Associates program. Of course, Amazon dropped the Associates program in Connecticut to avoid having to collect the sales tax or fight that contention. In fact, the same scenario took place in California this year – so Amazon dropped its California Associates program to opt of that government scheme. The headhunting tax thieves from so many states are so focused on getting Amazon, this has come to be known as the “Amazon Tax.” Theft-seeking bureaucrats are fond of supporting their schemes as a logical move to combat an “unfair advantage” that they say online retailers have over brick-and-mortar retailers.

Many people generally only think about the direct taxes they pay when considering alternative tax policies (this being, of course, a form of the broken window fallacy). The same mindset is found in bureaucrats who, contrary to popular belief, are actually human.

Bureaucrats get excited about finding new ways to increase tax revenue, as was seen above with Amazon. They found a new way to charge taxes, or so they thought. There models assumed that Amazon would simply comply because they would not want to forego the extra profits found by selling through their associates in that state. Unfortunately, Amazon’s margins are pretty thin. So thin that, as Karl Denninger has observed, collecting sales tax will kill their competitive advantage. Thus, not having any business sense or, apparently, access to financial reports, Connecticut decided to charge Amazon sales tax because it had associates in the state. Amazon cut ties in order to avoid paying taxes.

As is readily obvious, Connecticut won’t be seeing the increase in tax revenue it’s expecting. But they should also see a drop in revenue from the income tax because associates are now not earning anything from being associates, and will therefore pay less. Some may even move out of state if being an associate was their main job in order to recoup their lost income. There should also be negative repercussions on sales tax revenue, since former associates will likely spend less money. Astute readers will note that this is basically the money multiplier effect being negatively applied to taxes.

What’s astonishing is a) how bureaucrats thought there was not a single chance that Amazon wouldn’t pay the new tax and b) how bureaucrats failed to account for the possibility of Amazon dropping the program. Quite simply, it is amazing how bureaucrats apparently did not even contemplate how their tax policy has indirect effects on other tax revenue. Their stupidity is simply astonishing.

Bloody Pirates

So John Nolte has a post at Big Hollywood that attempts to explain why DVD sales have declined.

Blu-Ray sales have cannibalized some DVD sales, as has the rise of RedBox, Netflix, and Hulu. But Nolte posits that this is not enough to explain the decline. He argues that the reason for the decline in sales is because Hollywood makes crappy product.

This reason seems shallow and highly limited. For one, Hollywood has always made crappy product. It used to be referred to as “b-movies.” Of course, Hollywood has turned pretentious as of late, so b-movies no longer exist, at least nominally.
Additionally, alternative media has had an impact of DVD sales. Google has pushed YouTube as a platform for feature length movies, which undoubtedly reduces the demand for movies in the theater or on DVD. People’s viewing time is limited, so if they watch things on YouTube, they won’t be able to watch other stuff.
Finally, Nolte fails to account for pirating. This isn’t a major oversight on his part, seeing as how there is not much data on the effect of pirating on DVD sales. Still, the popularity of torrent sharing sites would suggest that people are still watching a decent amount of movies, only now they are not paying for them.



Nolte is right in saying that Hollywood faces a revenue problem, but the issue isn’t necessarily a lack of quality films. It may simply be that Hollywood hasn’t figured out an effective business model for the age of the internet.

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Forever Foraging for Fiber

Not much recent local activity in the race to win Google’s Fiber contest, if contest is the right word.  Am I missing anything?

A website fiberforall.org has a daily ranking of how someone out there thinks different communities are faring in their persistent post: Who is Winning the Google Fiber Race? [Updated Daily]

How anyone comes up with that? and whether it means anything at all? Or more importantly does it mean anything to Google?  Who knows?  Let’s hope it means little because we are not doing so well.  The latest ranking of top communities showing community support has us nowhere to be found, which implies were even behind Scranton?? What is up with that?  As I type it says we rank #100!!

from fiberforall.org
Must be something we can do to move up that list..  other communties are way out there in keeping up the effort.
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