The Environment in which Cultural Industries Operate and Some Implications

Colin Hoskins (University of Alberta)

Stuart McFadyen (University of Alberta)

Adam Finn (University of Alberta)

Abstract: In this paper we argue that the performance and actions of companies in the cultural industries can only be understood in the context of the environment in which the industries operate. We examine the microeconomic environment, the regulatory environment, the technological environment, and the global competitive environment of the cultural industries and consider some of the implications for public policy and for the conduct and competitive strategies of companies. The approach adopted is to identify the major issues, provide a state-of-the-art review of the literature, and identify where additional research is needed. The argument is made that economic analysis of the environment is essential to an understanding of the conduct of companies in cultural industries. Such economic analysis permits explanation of, for example, how companies are likely to respond to changes in the external environment, why products of the cultural industries are traded extensively, why the U.S. dominates that trade, and why some particular business strategies are increasingly important. We argue that economic analysis is a prerequisite to sound public policy formulation because companies tend to respond to regulations according to their economic interests.

Résumé: Dans cet article, nous affirmons que les actions et les résultats d'entreprises dans les industries culturelles ne peuvent être comprises qu'en faisant référence au milieu où ces industries fonctionnent. En conséquence, nous examinons les milieux de la micro-économie, de la réglementation, de la technologie et de la concurrence globale des industries culturelles, et considérons quelques-uns de leurs effets sur la politique publique et la conduite et les stratégies compétitives des compagnies. L'approche adoptée consiste à identifier les questions majeures, effectuer un examen très actuel de la documentation sur le sujet, et identifier quelles recherches additionnelles seraient requises. Nous affirmons que l'analyse économique du milieu est essentielle afin de comprendre pourquoi les entreprises dans les industries culturelles agissent comme elles le font. Une telle analyse économique peut nous permettre par exemple d'expliquer comment les entreprises réagiraient face à un changement dans l'environnement externe, pourquoi les produits des industries culturelles font l'objet d'un commerce si intense, pourquoi les États-Unis dominent ce commerce, et pourquoi certaines stratégies commerciales deviennent de plus en plus importantes. Nous affirmons que l'analyse économique est une condition préalable à la formulation d'une politique publique saine, parce que les entreprises tendent à privilégier leurs intérêts économiques quand ils réagissent à de nouvelles réglementations.

This paper examines the microeconomic environment, the regulatory environment, the technological environment, and the global competitive environment of the cultural industries. We also examine some of the implications of various features of the environment for the conduct of companies, including competitive strategies adopted, and for public policy.

Although there are obvious differences between the cultural industries, they have several key characteristics in common. Here, emphasis is given to broadcasting as most of our research has applied to this cultural industry. We set out to identify what the major issues are, identify the relevant literature to see what we already know about these issues, and identify what we do not know and where future research is thus most needed.

Economic and business research provides an understanding of why companies behave the way they do. Such an understanding is a prerequisite to effective public policy formulation since a policy cannot be effective if firms do not respond in the manner anticipated. Economic analysis has a good track record of explaining the behaviour of firms, in cultural and other industries, and of predicting the effect of changes in the environment, including the regulatory environment, on this behaviour. Such analysis typically is based on the assumption that participants act in their own self-interest. For companies this is usually translated into the assumption that the primary motive is profits. Under very competitive conditions mere survival dictates that choices between alternative courses of action be based on which adds most to the discounted value of profits. Shareholders of widely held companies, be they individuals or institutional investors such as pension funds, are typically interested in the profitability of their investment rather than in cultural or other goals. While managers of widely held companies may wish to pursue their own interests at the expense of shareholders, their ability to do so is limited (see Jensen & Meckling, 1976). More leeway is likely possible for a small closely held company such as an owner-manager operation. The owner-manager will wish to maximize his/her utility (satisfaction), but while his/her utility function may well include aesthetic considerations it will also include profits. Even auteurs like to eat. Thus the small film producer may choose a project primarily for artistic reasons; however, choices between, for example, satisfactory shooting locations, are likely to be made on an economic, least-cost basis. Even non-profit organizations such as the CBC and TVOntario will, due to budget limitations, be forced to make many decisions on a benefit-cost basis.

Due to space considerations, this review does not claim to be exhaustive. For example, no review is included of econometric studies.

Microeconomic environment

In this section we examine the cost structure of the cultural industries and the nature of the demand for the products of these industries. To survive and prosper companies have to be able to supply products that are demanded at prices buyers are willing to pay. This has implications for strategies of firms in cultural industries.

Public goods and the cost structure of producers

To a greater or lesser extent, all products of the cultural industries are in economic terminology public goods; that is to say the number of consumers does not affect (or has little effect) on the cost of production. As Owen & Wildman (1992, p. 92) point out, with respect to television programming, "the program is a public good regardless of whether viewers receive it free or must pay for it." This characteristic, although it is not always identified as such, is well documented in the literature on television programming where it exists close to its pure form. In a given market, an additional viewer for a television program has no affect on cost. Consumers are not rivals in consumption since consumption by one consumer does not use up the product; as a consequence it is sometimes described as a joint-consumption good. Many viewers can watch the same program without detracting from each other's enjoyment (see McFadyen, Hoskins, & Gillen, 1980; Hoskins & Mirus, 1988). Even where an extra copy of the program is necessary to reach viewers in other markets, the cost of replication is insignificant compared to the original production cost. This has led some authors (see Collins, Garnham, & Locksley, 1988; Garnham & Locksley, 1991), to use an R&D analogy. The production cost of the first copy of the television program is the R&D; the replication cost is analogous to the cost-per-unit of the production run in an industrial context. This replication cost or marginal cost of an additional copy of the television program is very low.

The public good cost structure also applies to some other cultural goods such as radio programming, feature films, rental video cassettes, and library holdings of books and audio recordings (on tape, compact disc, etc.), as again one copy can be used by many people. In contrast, for pre-recorded videos, audio products, books, newspapers, and magazines sold directly to the consumer, one unit of the product typically reaches only one consumer (or household), although even here unauthorized copying or simply lending may result in one unit being consumed by many (the latter is recognized in the distinction between circulation and readership in the print media). Reaching the market entails a large output, but the incremental cost of each unit is still small relative to the cost of producing the master copy.

This cost structure, with zero or low incremental costs associated with additional consumption, has major implications for the pricing of the products of the cultural industries and for the global competition faced by Canadian producers. We return to these issues later.

Revenue sources and product strategy

Products of the cultural industries are sometimes sold as final consumer goods and sometimes sold as intermediate goods. Products sold directly to the consumer include pay-television, cinema release of feature films, newspapers, magazines, books, pre-recorded VCR cassettes, pre-recorded audio tapes and compact discs. In other cases the cultural product is an intermediate good, bought or produced by a company which is in the business of attracting and selling audiences to advertisers. Free television and radio broadcasting and free neighbourhood newspapers and magazines would come under this category. Some cultural industries (cable television channels, and most newspapers and magazines) obtain revenue from both these markets. Entrepreneurs are continually searching for further opportunities to do this; thus advertising is now sometimes found at the beginning of a pre-recorded video cassette and in the cinema. Gaining revenue from both sources often involves a trade-off. For example, more minutes of advertising on a cable television channel typically detracts from the value of the program to the viewer and hence the subscription price that can be charged. Acheson & Maule (1990) discuss this trade-off and the mix that is suitable for different types of programming. However, Compaine (1980) provides evidence that such a trade-off does not exist for newspapers, as more advertising actually increases newspaper circulation at a given price.

The primary source of revenue, consumer or advertiser, will influence the product strategy. For advertising-supported television, the broadcasters sell advertisers access to audiences. Access is usually sold on the basis of size of audience and time; for example, dollars per thousand viewers per unit of time. This price will vary somewhat depending on the demographics of the audience. Barwise & Ehrenberg (1988) and Carrie & Ehrenberg (1992) produce evidence, in the U.K. case, that the demographic characteristics of television audiences tend to be similar so that revenue maximization tends to be synonymous with audience maximization. As Steiner (1952) demonstrated, it is then in everyone's interest to produce and exhibit common denominator programming of a production quality that maximizes the excess of revenue over costs. Beebe (1977), Spence & Owen (1977), and Wildman & Owen (1985) expanded Steiner's analysis to examine how the profit maximizing program strategy is affected as assumptions are changed with respect to the structure of viewer preferences for different categories of program, the number of television channels, the degree of broadcast competition, the means of financing (subscription, advertiser, government), and the cost of the program. In the Canadian context, Anderson (1992) has suggested that the Canadian content quota has increased program diversity. An excellent review of this literature is provided by Owen & Wildman (1992).

Demand uncertainty and creating brand loyalty

The revenue of producers of cultural products is basically unstable because they are continually introducing new products the success of which is difficult to predict. The continually changing product, for example, as one film is replaced by another, makes it difficult to establish brand loyalty. Brand loyalty may to a greater or lesser extent be attached to the writer (books), artist (sound recording), actor (feature films and television programs), or director (feature films). A new Margaret Atwood book, Denys Arcand film, or Bryan Adams album is virtually assured of success. The Hollywood star system is an attempt to establish brand loyalty and promote high, stable revenues. An interesting literature exists on the economics of stars (see, for example, Rosen, 1981). English-Canadian feature films have failed to establish a star system, perhaps because of a lack of specialized magazines, while French-Canada has been much more successful in this regard. (The French-Canadian star system also encompasses recording artists.) In contrast, in book publishing English-Canadian authors have a high profile.

Another way of promoting brand loyalty is the use of sequels to successful products that continue with the same characters and type of story line as the original. Examples abound in book publishing and feature films. Ian Fleming's James Bond books, and feature films based on the books, were so successful that other authors were commissioned to write sequels after Fleming's death. The television equivalent of the sequel is the series and serial. Sequels build on a successful format, are less demanding on the consumer who already knows the characters, and attempt to build a loyal following. Sequels also have a cost advantage as they already have characters and plots developed (and actors in-place).

Promoting brand loyalty for stand-alone cultural products (such as a single episode television drama or documentary or a book) is harder but can be attempted by packaging them under an anthology heading such as "Masterpiece Theatre" or "Classics" book series.

Strategies for extending market reach

The public good cost structure makes it attractive for suppliers to extend market reach. Networks can efficiently distribute the product to many geographic markets simultaneously, hence increasing revenue at little incremental cost. The television network is the most obvious example, but as Owen & Wildman (1992, p. 157) point out "the oldest electrified media networks are the wire services that distribute news bulletins to subscribing newspapers." In Canada, some examination of the operations of television networks has been undertaken by Babe (1979, pp. 51-56) and Caplan & Sauvageau (1986, pp. 417-420).

Access to more than one market is also possible through "windowing," that is, sequencing sales to different markets through time. Windowing, a form of price discrimination, is an attractive business strategy because the product is not used up by consumption and hence can be re-sold to different markets over time at little addition to cost. As long as the incremental revenue brought in is greater than the small increment to cost, sales to an additional market is worthwhile. The Economist ("Survey," 1989, p. 5) identifies nine release windows for U.S. feature films (North American theatre exhibition, other theatre exhibition, North American home video, other video, U.S. cable television, U.S. network television, non-U.S. television, re-release to U.S. cable, and U.S. television syndication), some of which would also apply to television programming. Books typically have separate hardback and paperback windows. Music recordings can have original, mid-price, and budget issues, which amount to windows, and in future may have television (on a specialty channel such as Much Music in Canada) and video as well as purely audio compact disc and tape windows.

Owen & Wildman (1992, p. 30) identify six factors that a windowing strategy, designed to maximize profits from all distribution channels, must consider. These are:

(1)

differences in the per viewer price earned in the different distribution channels;

(2)

differences in channels' incremental audiences ... ;

(3)

the interest rate as a measure of the opportunity cost of money;

(4)

the extent to which viewers exposed to a program through one channel are eliminated from its potential audience in other channels;

(5)

differences among channels in their vulnerability to unauthorized copying; and

(6)

the rate at which viewer interest in a program declines following its initial release.

All of these factors must be weighed in determining the optimal sequencing and length of the various windows and even whether a potential window should be included or excluded (see Owen & Wildman, 1992, pp. 30-38). Waterman (1987) has estimated the first item listed above, that is, the effec-tive prices received for U.S. feature films in 1984 from different distribution channels.

Owen & Wildman (1992) seem to view the different windows as competing for audience; however, they may also in some cases be complementary. The video window for feature films is now bigger than the cinema release window, and it may well be that a successful cinema release boosts the audience in the video window and perhaps other later windows--in effect, it is advertising or promotion for the later windows. This phenomenon undoubtedly applies to the television/video market for music recordings where the video is an advertising feature for the audio compact disc and tape.

Product bundling and pricing

A decision faced by cable companies is how to package and price channels. The first analysis of the practice of packaging or bundling was undertaken by Stigler (1963) with respect to block booking of feature films, a practice still sometimes followed by U.S. distributors of films and other programming when selling to foreign television channels. Stigler demonstrated that, by offering only a bundle of films, more revenue can be extracted from buyers if buyers value the bundle similarly but differ significantly in their valuation of the individual films that comprise the bundle. In a non-industry-specific analysis, Adams & Yellen (1976) showed that where buyers differ significantly in their valuation of the bundle as well as the individual components, mixed bundling, whereby buyers are offered a choice of the bundle or one or more (but not all) of the individual components, is likely to be more profitable. This analysis was applied to video services by Wildman & Owen (1985). Owen & Wildman (1992, pp. 132-135) provide a brief review of this literature and some illustrative numerical examples. Kenney & Klein (1983) provide an alternative explanation of bundling as a means of avoiding costly search by the buyers. Analysis of the welfare and public policy implications of bundling of cable channels has been undertaken by Hoskins & McFadyen (1983).

The regulatory environment

Producers and distributors/exhibitors in some cultural industries find their activities regulated. Regulation is pervasive in television, radio, and cable. It can constrain the type of product being offered (for example, the radio station format), the origin of the television program exhibited (Canadian content regulations), and the level of competition through control of market entry (television and radio stations require a licence from the CRTC). Our concern here is primarily with how regulation affects the incentive structure of cultural industry participants and the strategies they adopt in consequence. The assumption is that if the regulation impacts negatively on profits, the company will adapt its behaviour to limit this impact. This itself has public policy implications, however, because it can lead to predictions about which policies are likely to have the desired effect and which are not.

Effects of regulations on incentives and behaviour

Perhaps the best documented example of adapting behaviour to limit the impact of regulations on profit is the strategy of private television networks and stations of meeting the prime-time 6:00 p.m. to midnight Canadian content quota by scheduling this programming at the beginning and end of this time period and in the summer months, leaving the real prime-time for U.S. drama (see, for example, Babe, 1979, pp. 77-79). Similarly, commercial radio stations have often been accused of failing to meet their Canadian content quotas of 30% Canadian material during morning and evening drive-time periods of peak listening. Another ploy has been to make extravagant promises of performance in order to obtain a new licence to broadcast and then not fulfill these promises (see, Babe, 1979, pp. 185-194).

Regulations designed to constrain behaviour are often accompanied by subsidies to induce behaviour, notably investment in Canadian or various provincial productions. With respect to the cultural industries, Hoskins & McFadyen (1986) argue that inducing desired behaviour through appropriately structured subsidy programs that alter the incentive structure are more likely to be successful than regulations that attempt to force such behaviour. Subsidies to film and television are provided by Telefilm Canada (for an evaluation of Telefilm Canada operations from a public policy perspective see Hoskins & McFadyen 1986, 1989a) and provincial agencies such as the Ontario Film Development Corporation, B.C. Film Fund, and Alberta Motion Picture Development Corporation. As long as the costs (in terms of time and effort dealing with such government agencies) do not exceed the benefits, it makes sense for producers to structure projects in such a way as to access as much of this public funding as possible. Domestic joint ventures provide a means of accessing more than one provincial agency. International joint ventures may provide access to foreign public funding. Another approach is to set up a subsidiary in another province or country. Several Ontario film/television producers have subsidiaries in B.C.

A risk reduction strategy for producers is to try to structure the project so that he/she is producing for fees rather than profits with other investors, such as government agencies, taking the risk. Structuring a project so that it meets Canadian Audiovisual Certification Office (CAVCO) content requirements reduces the tax burden. A co-production under an international treaty automatically qualifies in this regard as well as counting as Canadian content for quota purposes. Acheson & Maule (1991) provide an examination of the incentive effects of capital cost allowance tax provisions for Canadian films.

Capture versus public interest theories of regulation

A prime strategy for firms in regulated industries is to lobby in order to make the regulatory rules, or their application, more industry friendly. The lobbying effort will often be co-ordinated by or channelled through industry associations, such as the Canadian Association of Broadcasters or the Canadian Cable-Television Association. Of course, in some cases the various cultural industries will have different interests and hence be on different sides of an issue, such as the appropriate regulatory response to the U.S. DBS signals; cable companies want permission to carry additional signals whereas broadcasters want a moratorium on new signals.

Caplan & Sauvageau (1986, p. 38) were surprised by private broadcasters' "almost eager acceptance of regulations of some kind." In fact, studies of the effects of cultural regulation by, for example, Caplan & Sauvageau (1986, pp. 38-41), Globerman (1987), Janisch (1987), and Watson (1988) are consistent with the "capture" theory of regulation, first suggested by Stigler (1971). According to this theory, the regulator is captured by the industry, and its regulations protect the interests of the regulated industry rather than the public, the latter being the assumption in the alternative "public interest" theory. Useful research could be done examining the evidence to determine which of these alternative theories best explains regulation of television and radio broadcasting and cable.

It is important to be aware that several justifications for subsidization of cultural industries appear in the economics literature. Without using these terms, the Peacock Committee (1986) in the U.K. advances "merit good," "option demand," and "diversified-choice" arguments for subsidization of television programs concerned with knowledge, culture, criticism, and experimentation. The merit good argument is that some goods are deemed especially important to society and individuals should be required or encouraged to consume them. The option demand argument is that viewers may be willing to provide public funds to produce some types of programming because they wish the option to view such programming to be available. The diversified choice rationale is that "so long as the number of television channels is limited, and there is no direct consumer payment, collective provision and regulation of programmes does provide a better simulation of a market designed to reflect consumer preferences than a policy of laissez-faire" (Peacock, 1986, p. 133). Another rationale is the "infant industry" argument that a new domestic industry with potential economies of scale or learning-by-doing deserves protection and/or subsidy until it has achieved a size and maturity that enables it to compete in the international market.

We find none of these arguments persuasive at the current time. The cultural industries are not infant industries now, while the number of television channels is increasing rapidly and with an ever-growing component of direct consumer payment. There is a rationale we do find persuasive, however, that of "external benefits." For a given cultural good to be adjudged as providing an external benefit, viewers/listeners/readers must become better citizens and bring benefits to others through social interaction. In effect, consumption of a cultural good must be similar in this regard to education, a product that is widely agreed to meet this criterion. We have used this rationale to justify a continued role for the CBC (Hoskins & McFadyen, 1992). However, some conclude that the economic case for subsidization of cultural products is not persuasive on the grounds that any benefits are likely outweighed by the costs (see, for example, Globerman, 1987).

Deregulation abroad and consequent opportunities

The trend to partial deregulation of broadcasting, most notably in Europe, has led to a dramatic increase in the number of commercial channels and accordingly the demand for more commercially oriented programming. This provides export or joint-venture opportunities for Canadian producers. It is also providing opportunities for Canadian broadcasters to establish an ownership interest in foreign channels and, in effect, export the knowledge and expertise gained from operating in the competitive Canadian market. Another goal for such involvement may be to spread the cost of programming over more markets. CanWest Global Communications Corp.'s part-ownership of TV3 in New Zealand and Ten Television Network in Australia is noteworthy in this respect.

The technological environment

In this section we consider the new production and delivery technologies and convergence and the impact on companies and their strategies. Previous Canadian research includes a good, but somewhat dated, treatment of the impact of technological change on Canada's video industry by Lyman (1983). He argues that the new delivery technologies remove many of the remaining obstacles to the free flow of cultural products and services between countries and concludes that Canadian cultural industries must become internationally competitive and more export oriented. Also dated is a collection of eight essays examining policies applicable to the introduction of pay-TV in Canada (see Woodrow & Woodside, 1982). While differing radically on many issues, authors of a number of these essays advocate policies aimed at promoting quality Canadian programming rather than quantity. A useful examination of new technologies in film and television, in the context of the effect on trade policy, is provided by Acheson & Maule (1989).

New production technologies

With respect to television, the changing technological environment has been well described by Berwanger (1987). Film production is being replaced by video production. New technologies including portable compact video cameras, camera-recorders for electronic news gathering (ENG), electronic field production units (EFP), digital frame memory, digital video processing, and computer video graphics are reducing costs and increasing reliability. The auto-corrective features of the new digital equipment mean that much less training is required and a maintenance and repair infrastructure no longer necessary for successful production. This makes entry into the production industry much easier, and established firms should recognize the likelihood of increased competition. The ease of entry is illustrated by the recent success of shows such as America's Funniest Home Videos in which amateur videos form the basis of content.

Copying of video is easy and cheap and, in 3/4 inch cassette form, light and convenient for transportation. Shipping copies of a video to potential buyers is now almost as easy as the long-established practice of shipping audio tapes (see Rofekamp, 1987). Transcoding from one television standard to another is no longer a problem with the advent of relatively cheap standard converters. Similarly, dubbing costs are down. Thus independent producers should be aware that foreign sales at lower prices than previously can now be economic. New standards are on the horizon with the advent of high-definition television, HDTV. For a recent discussion in the Canadian context see Girard & Peters (1991, pp. 144-147).

Similar trends are apparent in sound recording, where the effect of the spread of digital recording technology, first introduced in 1978, has been to significantly narrow the gap between the quality available in the best professional studio and in a low-cost home studio. In newspaper, magazine, and book publishing, computerized electronic publishing has similarly reduced the barriers to entry. Opportunities are provided for new, small-scale, operations.

In radio, digital audio broadcasting (DAB) with much superior sound and reception qualities is imminent. CBC Radio has already announced DAB on an experimental basis in 1993 with a 1995 target for marketing the new system. The U.S. industry, with its multitude of small, private radio stations, 60% of which lost money in 1991-92, is in poor condition to undertake the investment necessary to introduce DAB and may lag in adopting this new standard. This could provide opportunities for Canadian DAB stations near the border with a footprint that stretches into the U.S. On the other hand, increased competition is also likely; in September 1992, Shaw Cable Systems Ltd. applied to the CRTC to operate a satellite-to-cable digital radio service with 35 stations, 30 originating in the U.S.

New delivery technologies

New delivery technologies include satellite, fibre-optic cable, and VCR. Canada was one of the first countries to be cabled and the first to use satellites for domestic distribution of television signals. The CRTC initially viewed cable as a threat to Canadian broadcasters and imposed restrictions on the U.S. network signals that could be imported (see Babe, 1979, pp. 159-162). While these restrictions were lifted, they have been superseded by restrictions on the import of U.S. specialty and pay channels and cable packaging.

The advent of low-powered satellites, where cost of transmission is unaffected by distance, made country-wide distribution of pay and specialty channels feasible. HBO in the U.S. was the first to realize the opportunity this created for satellite-to-cable distribution. The CRTC did not permit Canadian cable companies to distribute these new pay channels. They also initially outlawed ownership of TVRO satellite dishes to receive these signals, but later this policy was rescinded. However, the cost of these large dishes was such that few were bought in Canada and nearly all these in un-cabled rural areas. In addition, the spread of cable to remote areas was fostered through the licensing of CANCOM to distribute approved signals by satellite, thus providing a reasonable choice without the need to purchase a dish.

High-powered satellite signals which can be received by small, relatively inexpensive dishes now endanger the status quo. DBS signals from the U.S. appear imminent and pose a potential threat to Canadian broadcasters, pay channels, specialty channels, and cable. Their broadcast footprint will cover most of populated Canada near the border. Regulation will be difficult if not impossible. U.S. DBS signals are likely to increase audience fragmentation and reduce cable advertising and subscription revenue while cable penetration may fall if DBS provides a good alternative source of channel choice at a competitive price. Girard & Peters (1991, pp. 145-159) provide a description of the U.S. DBS services being proposed and analysis of their likely affects on broadcasters and cable systems. Their report emphasizes the importance of the new video digital compression technology that seems likely to increase the channel capacity of satellite transponders up to ten times and hence greatly increase the choice that can be offered by DBS. Digital compression is also applicable to cable. Girard & Peters (1991, p. 157) report that the compression technology already exists to double cable capacity, and within three to five years it is likely to be possible to quadruple it. Adoption of the technology would require considerable cable plant investment, however.

Satellite distribution applies not only to video and radio but also to publishing. This technology permitted The Globe and Mail to become a nationally distributed newspaper with copies printed simultaneously across the country as well as in Toronto. The technology introduces additional competition by permitting magazines or newspapers, such as The Economist and USA Today, to be printed simultaneously around the globe.

Within the last decade, ownership of VCRs has increased from close to zero to around 70% of Canadian homes. This technology has permitted viewers to by-pass the regulated broadcasting sector and oligopolistic cinema exhibition of feature films and has added to audience fragmentation. Besides providing, as discussed earlier, a further window for producers and distributors of feature films and, to a lesser extent, television programs, it provides an opportunity for network and channel packagers. In April 1989 the British Broadcasting Corporation began BBC Video World, a three-hour compilation of domestic programs shown in the U.K. during the previous two weeks. Subscribers receive by express delivery (to most parts of the world) 26 videos and 6 colour magazines per year for £295. Hoskins & McFadyen (1991b, p. 48) note that video tape sales are a good way to access ethnic markets. VCRs also provide the viewer with the opportunity to record television programs and play them back later, fast-forwarding through the commercials and thus reducing their effectiveness.

Convergence

Advances in technology have facilitated a potential convergence of the cable television, telecommunications, and computer industries. Both digital compression and fibre optics make it easier for cable companies to provide telephone and data services in addition to television services and for telecommunications companies to deliver television services. Although the CRTC does not at present permit cable television systems to offer telecom services or vice versa, it is sound strategy for Canadian cable companies to position themselves for a possible change in this regulatory environment. Several Canadian cable companies have done this by investing in British cable franchises where no such restriction is in place. For example, Videotron is involved in several U.K. cable franchises where its partner is BCE Inc. A discussion on convergence, from a Canadian perspective, is provided by Ellis (1992).

Implications of technological change for business strategies

What business strategies are available to cultural industry participants faced by technological change? One strategy, discussed earlier, is to lobby for regulatory protection against the new competitors that technological change permits. Broadcasters have claimed that the decline in profitability 1989-91 is due to structural changes in the industry rather than the recession. Their strategy has been to paint a doom-and-gloom scenario with respect to the effect of expected U.S. DBS services, dubbing the satellites "death stars." It was industry pressure that led the government to set up the Girard & Peters Task Force, the co-chairmen being ex-broadcasters themselves.

In the new era of abundance of choice, networks, stations, and channels have to consider strategies that promote viewer loyalty. The need is accentuated by development of television set and VCR remote controls which facilitate channel switching. One approach is to serve a market niche with distinctive programming.

The new technologies provide industry participants with opportunities as well as threats. The rapid expansion of channels means, in the words of Patrick Whitten (CIT Research, London), that "it is programming, not channel capacity, which is the new scarce resource" (Wasco, 1985). This provides new markets for producers who can provide internationally competitive programming. However, as argued by Coase (1972) in non-industry specific terms, as film and video tape is durable the new programs must always compete with the old which can be brought out of the library and re-run. As the new product cannot compete in price with the old, this suggests the strategy should be to provide high quality, contemporary programming that can justify a greater price. Also, there is no reason why DBS signals should flow only from the U.S. to Canada. The opportunity exists for Canadian DBS services targeted at the U.S. The CBC in fact proposed such a service in its submission to the Caplan-Sauvageau Task Force (Canadian Broadcasting Corporation, 1985). In August 1992, CBC announced that a modified version of its 1985 proposal has been approved by Cabinet. A joint-venture with Power Corporation of Montreal plans satellite-to-U.S. cable delivery of the Northstar service with possible later export of the service to Europe. It is ironic to note that Northstar is to be part of the U.S. DirecTv satellite package, the same satellite package labelled as a "death star" service by Canadian cable and broadcasting interests.

Software and hardware producers in the cultural industries have strategic decisions to make regarding their positioning when there are rival hardware standards. Owen & Wildman (1992) provide a good discussion of the relevance of what economists call network externalities. Consumers make their choice of standard on the basis not only of the attributes of the standard but also on how many people already use the standard, the reasonable assumption being that more software will be available for the most popular standard. Because of an earlier start or some other advantage, inferior technology or standards can dominate. The classic example is the dominance of the QWERTY typewriter keyboard layout. In video, the VHS standard triumphed over Beta, whilst in sound recording the audio cassette triumphed over the 8-track tape. One strategy firms have adopted as a consequence is vertical integration. If a hardware company such as Sony owns a music recording producer, such as CBS Records, and a Hollywood producer, such as Columbia Pictures, it can ensure an adequate supply of software for its hardware product innovations.

The global competitive environment

The U.S. dominates trade in the products of the cultural industries. For example, it is estimated that the U.S. is responsible for about 75% of television program exports, while the broader U.S. entertainment industry had net exports of $5.5 billion in 1988, second only to aerospace (see Hoskins and McFadyen, 1991c, p. 207). Although official government statistics are unreliable or non-existent, considerable research energies have been expended tracking trade flows (see, for example, Varis, 1974, 1984; Larsen, 1990).

International trade is particularly attractive because of the public good cost structure and very low incremental cost of an additional copy. Any price above this very low incremental cost makes export attractive. This is confirmed by a study by Hoskins, Mirus, & Rozeboom (1989) who developed a public good model for explaining the (low) price of U.S. television programs on the international market. The predictions of the model were tested using regression analysis. They found that "variations in export prices for U.S. programming are the result of differences in the location of the demand curves and differences in the extent of buyer competition" (p. 70).

The global competitive environment for television programming has been examined by Renaud & Litman (1985), Waterman (1988), Wildman & Siwek (1987, 1988), Hoskins & Mirus (1988, 1990), and Hoskins & McFadyen (1991c). Although the emphasis of the papers varies considerably, all are concerned with providing an economic analysis of the global environment, the reasons for U.S. dominance, and the sustainability of that dominance in the light of technical progress and a worldwide trend to deregulation. The economic explanations for U.S. dominance contrast sharply with the "media imperialism" thesis promoted by Schiller (1969, 1981) and others. In this section we first look at the "cultural discount" and examine the implications of this concept in explaining the crucial significance of market size. We then use Porter's framework to examine national competitive advantage.

Cultural discount and the importance of market size

In most countries television viewers prefer to watch domestic programs when given the choice (see Berwanger, 1987). As Hoskins & Mirus (1988) explain: "A particular program rooted in one culture and thus attractive in that environment, will have diminished appeal elsewhere as viewers find it difficult to identify with the styles, values, beliefs, institutions, and behavioural patterns of the material in question." They denoted the consequent reduction in the value of a foreign program to a broadcaster, which will be reflected in the price the broadcaster is willing to pay, as the "cultural discount." Hoskins & McFadyen (1991a) identified a similar regulatory discount faced by foreign programming in markets where a domestic content quota is in place. Faced by such a quota, broadcasters will be willing to pay less for foreign programs.

The cultural discount, in some cases reinforced by the "regulatory discount," explains why the size of the domestic market is of crucial importance to revenue and profit opportunities. Hoskins & Mirus (1988) use a numerical example to help explain the interaction of cultural discount and market size assuming a two-country world comprised of the U.S., much the largest TV market, and a smaller Country B market. They assume a cultural discount of 40% applies to trade in both directions and compare the revenue that can be recovered from a domestic television program costing $1 million if such a program produced in the U.S. would earn revenue of $1 million in the U.S. market while a similar program produced in small Country B would earn only $100,000 from its national market. The total revenue of the U.S. program, with an export sale to B, would be:
$1,000,000 + (1 - 0.4) 100,000 = $1,060,000

whereas that for Country B with an export sale to the U.S. would be:
$100,000 + (1 - 0.4) 1,000,000 = $700,000.

Assuming the cost of reproduction for export to be insignificant, the U.S. production would make a profit of $60,000 while the Country B production would make a loss of $300,000. Country B here could represent Canada, a country with a market approximately one tenth the size of that of the U.S.

While Hoskins & Mirus (1988) stress the importance of market size in explaining trade flows and U.S. dominance, Collins (1989) puts more stress on language. To some extent the differences may be more apparent than real, as Hoskins & Mirus include language as a factor determining the size of the discount rate.

Porter's competitive advantage framework

Hoskins & McFadyen (1991c) examine the global competitive environment for television program production employing Porter's competitive advantage/strategy framework (Porter, 1980, 1985, 1986, 1990), the best developed for identifying the fundamental determinants of national competitive advantage in an industry.

Besides the market size and language advantage, the U.S. has enjoyed first-mover advantages in television production largely as a result of economies of scope (synergies) with the Hollywood movie industry. The movie industry provided an infrastructure of skilled technicians, actors, a worldwide distribution system, and the Hollywood star system. The U.S. was the first country to switch from live television drama to film (an innovation that made export possible in a pre-satellite era) and the first to move from "an artisanal mode of production where products are strongly marked by an authorial signature, whether that of director or scriptwriter, to series production in which it hardly makes sense to ask who is the author of Dallas" (Collins, Garnham, & Locksley, 1988, p. 56).

The U.S. has a comparative advantage because the attributes of its operating and demand environment provide a desirable global platform. "Competitive production companies vie to supply the commercial networks, sophisticated buyers finely attuned to the tastes of viewers and advertisers" (Hoskins & McFadyen, 1991c, p. 216). It should not be surprising that many programs that are successful in the competitive U.S. domestic market have also been successful in the world market where, until recently, much of the competition has been from in-house production by public broadcast monopolies.

These advantages have led to the U.S. dominating international trade in television programming. However, technological advances and the trend to deregulation in broadcasting may be undermining the U.S. advantage. With the rise of cable channels, independents, and the Fox Network, the U.S. economies-of-scale advantage is threatened by audience fragmentation of its domestic market. First-mover advantages in television film production are being adversely affected by the new video production technology discussed earlier. Deregulation in many broadcast markets, notably in Europe, is increasing competition and may result in global platforms that rival that of the U.S.

It is this fluid global environment that Canadian television program producers must take into account when determining their competitive strategies, strategies to create and sustain a competitive advantage. One increasingly used strategy for competing in this environment is the use of international joint ventures including co-productions under the auspices of one of 24 treaties negotiated with other countries. This strategy may be undermining the U.S. market size advantage as joint ventures pool finance and aid access to foreign markets. Hoskins & McFadyen (1993) have examined Canadian participation in international co-productions for television programming. Hoskins, McFadyen, Finn, & Jackel (1994) are studying Canada-Europe co-productions in television and film to evaluate the benefits and drawbacks associated with a co-production strategy and the partners' assessment of success.

Summary and recommendations

In this paper we have examined, from an economic and business perspective, the microeconomic, regulatory, technological, and global competitive environments that firms in cultural industries face. We have attempted to demonstrate that economic analysis is essential to an understanding of the conduct of companies in cultural industries. It enables us to explain, for example, how companies are likely to respond to changes in the external environment, why products of the cultural industries are traded extensively and why the U.S. dominates that trade, and why some business strategies are increasing in importance (for example, use of international co-productions and co-ventures in television and film). Economic analysis is a prerequisite to sound public policy formulation as such policies can only be effective if companies respond in the anticipated manner.

Our review of the literature suggests that further research would prove particularly fruitful in the areas of regulation and public policy, microeconomics and industrial organization, technology, and global competition. Specific topics are identified below for each of these areas. Our ordering of research areas and topics does not imply a ranking of priorities.

1. Regulation and public policy

   (a)

   Compare economic and cultural development rationales for subsidy. Examine the extent to which the external benefits rationale of economists is consistent with the cultural development rationale. Are economic and cultural development approaches irreconcilable, or do differing terminology and emphasis hide basic similarities?

   (b)

   What form should any subsidy take? The traditional approach has been to subsidize production, but a case can be made that in some instances subsidization of consumption is preferable as it is more consistent with a market allocation of resources. Examination of the merits of different forms of subsidy, and alternative methods of delivering them, warrant further study.

   (c)

   Examine the incremental national effect of subsidies provided by provincial government film and television funding agencies. Questions that could be considered are the extent to which these agencies result in additional activity as opposed to cancelling each other out or resulting in activity taking place in one province instead of another.

   (d)

   Examine lobbying activities and their consistency with the capture theory of regulation. Study the lobbying activities of the Canadian cultural industries and the relationship between the regulator, government, and industry participants, including the flow of personnel between them. Examine attempts of the less regulated cultural industries, such as music recording and book publishing, to become more regulated.

   (e)

   Examine CRTC regulatory policy that continues to separate cable television and telecommunications in an era in which advances in digital technology are facilitating convergence of these and computers.

2. Microeconomic and industrial organization

   (a)

   Examine network arrangements. Given the recent turmoil at CTV, further examination of network arrangements including the ownership structure and relationship between the network and the affiliates is called for. In an era of very low profitability for radio stations, economies associated with radio networks and syndication should be examined. Syndication of features, comics, and photographs to newspapers is also worthy of study.

   (b)

   Examine sequential exhibition strategies for different cultural goods. An examination of windowing should consider the extent to which some windows are complements rather than substitutes and analyze the business strategy implications.

   (c)

   Examine bundling strategies. An examination of the bundling practices of Canadian cable companies would be a useful extension of the literature, although it must be recognized these practices are constrained by CRTC regulations. It would also be interesting to look at pay channels (as distinct from pay-per-view) and recorded music in this context. In the case of a pay channel there is pure bundling as the package of programs that make up the product are only sold as a bundle. With respect to recorded music there has been a long history of mixed bundling with songs available as single records or packaged with others on long-playing records (this practice has been continued as compact discs have replaced records).

3. Technology

   (a)

   Examine the effect of new technologies on the effectiveness of advertising as a source of revenue. As mentioned earlier, VCRs reduce the effectiveness of commercials on television. This phenomenon should be studied. Other influences on the effectiveness of television advertising aimed at the mass market, such as audience fragmentation and pay-per-view, should also be analyzed together with the apparent trend away from advertising aimed at the mass market and toward sales promotion and direct marketing.

   (b)

   Examine business strategies in an era of convergence. A comprehensive study is worthwhile of horizontal integration and strategic alliances between companies in different cultural industries and between companies in a cultural industry and companies in other related industries. Of particular interest would be an investigation of whether the Canadian cultural industries practise more or less cross-industry ownership or alliances than is typical, and the impact of any difference for global competitiveness. Motives for vertical integration should be studied.

4. Global competition

   (a)

   Study of trade flows. More research and better statistical recording is warranted if we are to have a reasonably clear view of what the trade flows actually are and can answer questions such as how great is U.S. dominance and what are Canadian levels of exports and imports for various cultural goods?

   (b)

   Attempt to quantify the cultural discount. It would be interesting to attempt to quantify the cultural discount for television programs and examine whether a similar cultural discount applies to other products of the cultural industries. Casual observation suggests a larger cultural discount may apply to popular books and perhaps a lower one in popular pop music. An attempt could also be made to measure the regulatory discount.

   (c)

   Examine the importance of language in the cultural discount. Collins (1989) stresses the importance of language, whereas Hoskins & McFadyen (1991c) include language as one of a number of components. Is the cultural discount primarily a language discount?

   (d)

   Examine the global competitive environment of the various cultural industries. Most of the recent work on the global competitive environment has been addressed to television, presumably because this environment is in a state of flux. However, much of the analysis of television would also seem to apply to feature films (Wildman & Sivek, 1988, specifically include feature films in their study), recorded music, and magazine and book publishing. A Porter-type examination of the global competitive environment of these other cultural industries could profitably be undertaken. The recorded music industry might make a particularly interesting study.

   (e)

   Examine international co-productions/co-ventures. This is an increasingly important competitive strategy that may undermine U.S. domination. What are the benefits and drawbacks of this strategy, and how successful has Canadian participation in international co-productions been in both financial and cultural terms? Does Canada's policy of aggressively seeking international co-production treaties make sense?

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