– Phill Namara
In this article we would examine the media industry – we will take a deep dive into the economics of the broadcasting business and how they have evolved over time. The revenue function for broadcasters has remained consistent throughout history, coming mostly from a uniform mix of advertising and sponsor revenue. The cost function, however, which includes program rights, production costs as well as general and administrative costs has traditionally been thought of as capital intensive and fixed-cost heavy, however, in this article I will aim to prove otherwise.
Getting into the meat of things, a company’s total costs consist of two categories; fixed and variable costs. Fixed costs are uncorrelated with the level of sales that a company generates i.e. rent, whereas variable costs move in-line with the level of sales i.e. sales commissions at a brokerage firm. Broadcasting companies are fixed-cost heavy businesses – that is they have a high degree of operating leverage. They must invest in acquiring content or program rights as well as some elements of production irrespective of the number of viewers of their programs. Another way of saying this is, hypothetically, if a broadcaster were to make no revenue, perhaps because their product (TV shows) couldn’t attract any advertisers or sponsors, they would incur HUGE losses associated with the costs of acquiring the rights to produce the show. Sports broadcast rights are examples of these large upfront fixed costs – Channel Nine in 2015 spent c.900m for 5 years of NRL broadcasting rights, paying the consideration upfront based on the expected revenue generation from broadcasting the games in future.
When thinking traditionally about broadcasters, many people often fail to acknowledge the variable cost elements of individual production. Let’s use NRL football, everyone’s favourite sport, as an example. The better the production, holding all other factors constant, the greater the expected revenue derived from broadcasting. There is an argument that having more, higher quality cameras, operated by the most skilled users will be able to improve the production of the game and in turn increase the number of viewers contributing to greater revenue. If the incremental income is higher than the additional cost of each camera and employee, it makes financial sense for the broadcaster to invest in quality production. Therefore, in the modern day, whereby data analytics are readily available such that broadcasters know with some degree of certainty which games over the course of the weekend will be watched by how many people – they should be able to deploy the optimal production set up to maximise profits.
This concept can be demonstrated via the following: Let’s say an NRL match has a fixed production cost of $300,000 but revenue of $1,000,000 generating a profit of $700,000. If the broadcaster decided to vary the investment in production costs, the following outcomes could occur.
Source: W. Johnsen, H. (2001). A COST PERSPECTIVE ON TELEVISED SPORT. The Norwegian School of Management – BI
Astute readers will now conclude that by introducing an element of variability into their production costs, broadcasters can optimise profits generated and perhaps withstand the broader industry headwinds they face.