PDF Newspapers in Times of Low Advertising Revenues

Newspapers in Times of Low Advertising Revenues

Charles Angelucciand Julia Cag?e Columbia University and Sciences Po Paris

February 15, 2016

Abstract

Newspaper subscribers are typically charged a lower per issue price than occasional buyers. This difference in prices has recently increased. This paper posits that this tendency may be interpreted as a response to the continuing drop in advertising revenues. We investigate how the reliance on advertising revenues interacts with the incentives newspapers have to adopt subscriber-based readerships. More precisely, we investigate theoretically and empirically the determinants of second-degree price discrimination in two-sided markets. We build a model in which a newspaper must attract both readers and advertisers. Readers are uncertain as to their future benefit from reading, and heterogeneous in their taste for reading. Advertisers are heterogeneous in their outside option, taste for subscribers, and taste for occasional buyers. To estimate empirically the effect of the advertisers' side of the industry on price discrimination on the readers' side, we use a "quasi-natural experiment". We exploit the introduction of advertisement on French Television in 1968, which we treat as a negative shock on advertising revenues of daily national newspapers (treated group), but not on daily local newspapers (control group). We build a new dataset on French local newspapers between 1960 and 1974 and perform a Differences-in-Differences analysis. We find robust evidence of increased price discrimination as a result of a drop in advertising revenues.

Keywords: price discrimination; two-sided markets; newspaper markets; advertising JEL: C33, L11, M13

We are grateful to Romain de Nijs for his contribution to an earlier draft entitled "Price Discrimination in a Two-Sided Market: Theory and Evidence from the Newspaper Industry." We gratefully acknowledge the many helpful comments and suggestions from Ariel Pakes, Valeria Rueda, Andrei Veiga, Glen Weyl and Alex White. We are also grateful to seminar participants at Harvard University, INSEAD, the London School of Economics, Namur University, the Paris School of Economics, Sciences Po Paris, SHUFE in Shanghai, Stockholm University and Warwick University. Maikol Cerda and Charlotte Coutand provided outstanding research assistance. We gratefully acknowledge financial support from the NET Institute () and the Paris School of Economics. All errors remain our own.

Columbia University, ca2630 [at] columbia [dot] edu. Sciences Po Paris, julia [dot] cage [at] sciencespo [dot] fr.

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1 Introduction

The newspaper industry is a canonical example of a two-sided market: newspapers serve two distinct groups of consumers ? readers and advertisers, where each group cares about the presence and characteristics of the other. The resulting network effects lead to subtle pricing policies that have received much attention recently (see for instance Rochet and Tirole, 2003; Weyl, 2010). One feature of newspapers' pricing policies is the observed price discrimination between subscribers and occasional buyers; subscribers are typically charged a lower per issue price than occasional buyers, and these price differences appear not to be explained by cost differences entirely. Furthermore, this difference in prices has recently increased and newspapers tend now to favor a more subscriber-based readership. This paper posits that this tendency may be interpreted as a response to the industry's state of distress, itself in part attributed to the continuing drop in adverting revenues. In the United States for example, we indeed observe a decline in newspaper advertising revenues (as a share of GDP) since the second half of the 1950's, decline that has been sharper since the beginning of the 2000's (Figure 11). We also observe a decrease in newspapers' reliance on advertising revenues (the share of advertising in newspaper total revenues).

.8

.6

.4

% GDP

.2

0

1950

1960

1970

1980

1990

2000

2010

Notes: This Figure represents the evolution of newspaper advertising revenues as a share of GDP in the United States between 1950 and 2013. Data on newspaper revenues is from the Newspaper Association of America (NAA). GDP data is from the World Development Indicators (WDI).

Figure 1: Newspaper advertising revenues as a share of GDP in the United States, 1950-2103

In this paper we investigate how the reliance on advertising revenues interacts with the incentives newspapers have to adopt subscriber-based readerships. To this end, we first extend recent models of multi-sided industries to incorporate the scope for second-degree price

1Figure B.1 in the online Appendix represents the evolution of newspaper advertising revenues in the United States over the same period in billion dollars.

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discrimination between subscribers and occasional buyers. We then carry out an empirical analysis using a "quasi-natural experiment" and a new dataset on the French local newspaper industry that we build from archives data.

We build a general model of a two-sided market in which a monopolist newspaper repeatedly interacts with a continuum of readers and a continuum of advertisers. Newspapers can be purchased by readers either by subscription or at the newsstand on a day-by-day basis. Independently of the presence of advertisers, the scope for price discrimination stems from (i) the readers' uncertainty regarding their exact willingness to pay in future periods and (ii) the readers' heterogeneity in their average willingness to pay. Readers with a high average willingness to pay subscribe at a low per unit price, while others buy the newspaper at a high price whenever their willingness to pay is high.2

Advertisers are heterogenous in (i) their taste for subscribers, (ii) their taste for occasional readers, and (iii) their outside option (i.e., their payoff when placing ads on alternative platforms). The challenge is to disentangle how the presence of advertisers affects the prices charged to readers. We characterize the optimal pricing formulas of the newspaper, as well as the readers and advertisers' demands. These formulas are intuitive and in the spirit of Weyl (2010). When choosing its prices, aside from taking into account the various marginal costs and demand elasticities, the newspaper must cater to (i) the average taste of marginal readers ? those indifferent between subscribing or buying occasionally on the one hand, and those indifferent between buying occasionally or never on the other ? and (ii) the average taste of marginal advertisers for both subscribers and non subscribers, as well as their outside options.

On the empirical side, the main empirical challenge is to isolate the "advertising revenue" effect on price discrimination. To this end, we follow an empirical strategy in the spirit of an event study. We exploit the introduction of advertisement on French Television in October 1968 by treating it as an exogenous negative shock on the advertising side of newspapers. Television is state-owned in France from 1945 to 1981. The introduction of advertisement on television was decided by law, despite strong resistances by the newspaper industry. This introduction leads to an exogenous shock that shifts exclusively the incentives to price discriminate stemming from advertising revenues. Indeed, reader heterogeneity and the various marginal costs of producing and delivering newspapers were not affected. To the best of our knowledge, we are the first to use this "quasi-natural" experiment.3

Our identifying assumption is that the negative shock on advertising revenues has affected mostly national daily newspapers, and to a lower extent local daily newspapers. Indeed, while

2This rationale for price discrimination was first introduced by Glazer and Hassin (1982), but in a model without advertisers.

3Filistrucchi et al. (2012) considers the "reverse" experiment: they analyze the effects of the advertising ban on French public television in 2009. They find that it did not favour private TV channels at the expense of public ones. They do not investigate how it affects newspapers nor price discrimination, however.

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national newspaper advertisement consists mostly of commercial advertisements that are relatively close substitutes to those broadcasted on television (national brands, etc), a large share of advertisements in local newspapers is instead local in nature (local commercial advertisements and classified advertisements). We document a substitution effect of advertisements from national (but not local) newspapers to television by studying the actual content of the advertisements broadcasted on television and of the advertisements published in newspapers before and after the introduction of advertisement on TV.

National newspapers, for which national ads are likely to provide a significant fraction of revenue, are more likely to respond to the negative shock on national advertising than local newspaper, for which national ad-revenue is likely not their major source of revenue. We thus use national newspapers as our "treated group", and local newspapers as our "control group". Using novel annual data on local and national newspapers between 1960 and 1974, we compare the pre-1968-to-post-1968 change in price discrimination by national daily newspapers to the change in price discrimination by local daily newspapers over the same period (Difference-in-Difference estimation). We show that national newspapers, due to their greater reliance on national-ad revenue, experience a larger drop in advertising rates and advertising revenues than local newspapers after the introduction of advertisement on television. This drop propagates to the reader side of the newspaper market. We find that the decrease in advertising revenues leads to an increase in the extent of price discrimination, i.e., newspapers adopt a more subscriber-based readership as a consequence of the drop in advertising revenues. This increase in price discrimination is driven by a decrease in the price charged to subscribers. As a consequence, we find that the number of subscribers and the share of subscribers in the total circulation increase after the shock. Our results are robust to a range of alternative specifications and controls.

Our proposed interpretation of these empirical findings is that, while newspapers have a preference for subscribers ? having more subscribers allow them to increase their total circulation, and to build consumer loyalty ?, advertisers tend to prefer unit buyers. As a consequence, when advertising revenues play an important role, newspapers tend to distort their pricing strategies in favor of unit buyers. On the contrary, when advertising revenues fall (e.g. after the 1968 French reform), they revert to their own profit-maximizing pricing strategies (independent of the advertising side of the market), i.e. they increase price discrimination in favor of subscribers.

Various explanations may help rationalize advertisers' preference for unit buyers. First, the newsstand helps subscribers increase their reach: whereas a subscription goes to one person or one household, a newsstand copy of a newspaper reaches more people. Next, consumers buying at the newsstand have a real interest in the newspaper ? the newsstand buyer is probably likely to spend more time reading the newspaper than the comparable subscriber.

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While these points have been raised by a number of consultants in the industry, to the extent of our knowledge, we are the first to show empirically that it is indeed the case. Moreover, the theoretical predictions of our model are in line with these preferences.

Our findings may have important implications for the 21st century newspaper industry. In particular they shed light on the observed current tendency for newspapers to favor subscriberbased readerships through low subscription prices. According to our results, this tendency may be rationalised by the continuous decline in advertising revenues as a result of the competition stemming from Internet.4 Additionally, to the extent that suscribers and unit buyers are different social and political groups (an issue that we do not directly adress in this paper), rising price discimination could contribute to a more polarized access to information and to diverging turnout rates by socio-economic groups.

Literature review This paper builds on the seminal model by Glazer and Hassin (1982) who first study price discrimination by newspapers based on consumers uncertainty.5 We introduce the advertising side in the profit function of newspapers and discuss how the reliance on advertising revenues interacts with price discrimination on the reader side. Moreover, we estimate this interaction empirically. This relates our paper to the growing literature that examines empirically the determinants of price discrimination. A number of papers investigate the role of competition. Seminal contributions include Borenstein (1991) on retail gasoline markets and Borenstein and Rose (1994) on airline tickets. More recent articles include Busse and Rysman (2005) who investigate pricing in Yellow pages advertising, Gerardi and Shapiro (2009) who reexamine air ticket price discrimination, Dai et al. (2012) who study the nonmonotonicity of the effect of competition on price discrimination using data from the U.S. airline, and Seim and Viard (2011) who study nonlinear pricing in cellular telecommunication markets. To the exception of Gil and Riera-Crichton (2011) who empirically tests the relation between price discrimination and competition in the two-sided market setting of the Spanish local television industry, all theses articles study one-sided markets.6 Our paper aims on the contrary at understanding the consequences of network effects on price discrimination.

Carroni (2015) provides a model of behaviour-based price discrimination ? firms offer different prices to consumers according to their past purchase behaviour ? in the context

4While Athey et al. (2013) explore theoretically the extent to which greater consumer switching facilitated by online consumption of news explains the recent collapse in advertising revenue; Gentzkow (2014) investigate how Internet has reduced the return news outlets can earn by selling the attention of their consumers to advertisers.

5On the economics of subscription sales, see also Gabszewicz and Sonnac (1997); Morton and Oster (2003); Resende and Ferioli (2014).

6Marcus Asplund Rickard Eriksson (2008), using evidence from Swedish newspapers, show that more competitive markets have a higher incidence on third-degree price discrimination. But they abstract from the advertising side of the newspaper market.

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of two-sided markets.7 There also exists a very recent vein of research that examines the role of consumers' bounded rationality on price discrimination via subscription (see Grubb, 2012, for an insightful review). Prominent contributions to this literature are DellaVigna and Malmendier (2004) for contracts in health sport centers and Grubb (2009) for cellular phone service plans. Although we recognize that bounded rationality may play a role in consumers' decision as to subscribe or not to a newspaper, the scope for price discrimination in our model instead stems from informational considerations. In addition, our aggregated data do not allow us to investigate this issue.

Our paper also relates to the literature on two-sided markets. Rochet and Tirole (2003) provide a widely applicable model of two-sided markets and discuss markets for advertising, credit cards, software and web portal usage. Weyl (2010) and White and Weyl (2010) further extend two-sided market models.8 Naturally, much work on two-sided markets has focused on the media industry. Argentesi and Filistrucchi (2007) develop an analysis to estimate market power in the Italian newspaper industry, but do not consider price discrimination on the reader side, just like Kaiser and Wright (2006) who estimate a model of competition in the German market for magazine readership and avertising. Seamans and Zhu (2014) look at the impact of the entry of Craig's list on local newspapers' pricing policies and find that this negative shock on the advertisement side of newspapers had led to an increase in subscription prices, a result consistent with previous theoretical studies that show that an increase in competition on one side of a two-sided market can lead to an increase in price on the other side (Godes et al., 2009; Hagiu, 2009).

We contribute to this recent line of research by introducing price discrimination on one side of the market. Seamans and Zhu (2014) find an increase in subscription price as a result of the negative shock on the advertisement side; on the contrary, we obtain that the subscription price decreases. But while they only focus on subscribers, we also take into account unit buyers, which helps rationalize our finding. Our paper makes an important contribution by investigating advertisers' preferences for unit buyers compared to subscribers. Advertisers' preference for unit buyers explains why newspapers react to the negative shock by decreasing the subscription price. Price discrimination matters on the reader side. To the best of our knowledge, Liu and Serfes (2013) is the only paper investigating price discrimination in two-sided markets. However, their modeling approach does not fit well with the newspaper industry as they consider perfect price discrimination on both sides in a Hotelling framework. Our paper is the first theoretical and empirical analysis of second-degree price discrimination

7For a dynamic model of duopolistic competition under behaviour-based price discrimination, but in onesided setting, see Caillaud and Nijs (2014).

8Anderson and Coate (2000) study broadcast markets in which retailers pay for advertising to reach consumers, and where consumers dislike advertising. Rysman (2004) provides an empirical analysis of the market for yellow pages. Jin and Rysman (2013) study US sports card conventions pricing though the lens of the two-sided market theory.

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in a two-sided market. Finally, this research project is a contribution to the empirical literature on media using

historical data to understand the evolution of the newspaper industry and its impact on society. In a paper investigating the effect of newspapers entry and exit, Gentzkow et al. (2011) find that newspaper entry has a robust positive effect on political participation in the United States. Cag?e (2014) finds in the French context that competition has a negative effect. In their recent work on competition and ideological diversity Gentzkow et al. (2014) estimate a model of newspaper demand, entry, and political affiliation choice, in which newspapers compete for both readers and advertisers. In this paper, we use historical data and a quasinatural experiment to estimate empirically the effect of the advertisers' side of the industry on price discrimination on the readers' side.

The remainder of the paper is organized as follows. Section 2 develops a model of seconddegree price discrimination by a platform. Section 3 introduces the new dataset we built for this study and provides descriptive statistics. In Section 4, we discuss the historical context of the introduction of advertisement on French Television in 1968, and document a substitution effect from national newspapers advertisements to advertisements broadcasted on television. In Section 5 we estimate the effect of the advertising side of newspapers on price discrimination on the reader side using a Differences-in-Differences analysis based on the introduction of advertisement on French Television. Section 6 concludes.

2 Two-sided markets and second-degree price discrimination

We build a simple model of a two-sided market in which the platform (i.e., the newspaper) engages in second-degree price discrimination on one side of the market.

2.1 Set-up

Consider the interaction between a monopoly newspaper, a continuum of readers of mass one (side R of the industry), and a continuum of advertisers of mass one (side A). The newspaper produces n distinct issues during the period of interest. Let t denote a given date/issue, where t = 1, ..., n. Readers can either subscribe to the newspaper to receive all n issues, or buy some issues on occasions. We refer to S as the subset of readers who choose to subscribe, and O as the subset of readers who choose to be occasional readers.

Newspaper The profit-maximizing monopoly newspaper chooses price pi to charge group i = O, S, A. We denote by ci the per-issue newspaper's (constant) marginal cost of serving group i. We do not model the actual production of news, and thus implicitly assume that the newspaper produces content that is of interest to at least some readers.

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Readers The payoff to reader i from reading the newspaper at date t is given by:

UiR,t = i - iN A + t - pi,

(1)

where i denotes reader i's taste for reading, iN A denotes reader i's taste/distaste for the quantity N A of ads in the newspaper, and where t captures a shock common to all readers at date t (e.g., the holding of elections). We assume the pair (i, i) is drawn according to joint pdf f R (, ), where each parameter has support going from minus to plus infinity. Furthermore, t is drawn according to U [ , ] and is i.i.d. across dates/issues. At each date t = 1, ..., n, reader i, if she has not subscribed, observes the realization of t before deciding whether to purchase the newspaper. Not subscribing therefore allows readers to make informed purchasing decisions. By contrast, readers who choose to subscribe make their decision prior to observing all n future realizations of . We assume readers have an outside option equal to 0.

Let UiS denote reader i's expected payoff when subscribing. For a given per-unit subscription price pS, it is equal to:9

n

UiS = Pr i - iN A + t 0 E i - iN A + t | i - iN A + t 0 - npS,

t=1

n max =

i +

- iN A, 0 2 - npS.

2

(-)

A subscriber does not necessarily read all n issues of the newspaper. Instead, Pr i - iN A + t 0 measures the probability that a given subscriber i reads the newspaper on a given t. The price pS plays no role in this decision because it is already sunk by the time the decision to

read an issue comes. Naturally, though, a necessary condition for reader i to subscribe in the

first place is that (2.1) is nonnegative.

The expected payoff of a reader who chooses to be an occasional reader is equal to:

n

UiO = Pr i - iN A + t - pO 0 E i - iN A + t - pO | i - iN A + t - pO 0 ,

t=1

(2)

= n max i +

- iN A

- pO, 0

2

.

2

(-)

Not surprisingly, the decision to purchase an issue of the newspaper depends on the price pO. We refer to occasional readers who make a purchase with positive probability as "active" occasional readers.

Anticipating on the computation of the demand functions, note that for some readers to

9We assume readers do not discount future payoffs to simplify expressions.

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