The Real Problem with the Media Business Model

Almost as soon as I finished yesterday’s post on media business models I knew that I had missed an important part of the story. A big part of the problem with the business model for many of the media segments is that they are actually two-sided markets, and the value proposition on one side has collapsed. You may well ask: what in the world does that mean? Good question.

A two-sided market is one where an intermediary acts to bring two distinct groups together. The wikipedia definition is pretty good:

Two-sided markets, also called two-sided networks, are economic networks having two distinct user groups that provide each other with network benefits. Example markets include credit cards, composed of cardholders and merchants; HMOs (patients and doctors); operating systems (end-users and developers), travel reservation services (travelers and airlines); yellow pages (advertisers and consumers); video games (gamers and game developers); and communication networks, such as the Internet. Benefits to each group exhibit demand economies of scale. Consumers, for example, prefer credit cards honored by more merchants, while merchants prefer cards carried by more consumers.

The economics of these markets are explained very well in the book Invisible Engines: How Software Platforms Drive Innovation and Transform Industries by David S. Evans, Andrei Hagiu and Richard Schmalensee (and I just noticed today that the book is available as a free download at that link!). In many of these types of markets, the intermediaries get a pretty good chunk of the money – this has been true in markets like software and the media in particular. In others, like mobile telephony, the money gets spread more widely.

The internet is breaking down some of these two-sided markets in two different ways. One way is that it can make it easier for the two groups to connect up with each other – driving down the profits of the intermediaries or even cutting them out completely. This is what is happening with travel. Online fare finders have driven the marginal cost of comparing flights and prices down near zero, putting pressure on travel agents. On top of that, many airlines now do a substantial amount of their own booking through direct websites, cutting out both online and offline intermediaries.

Bob Garfield explains how the other way these two-sided markets break down in his book The Chaos Scenario. This video summarises the main points of the book pretty well (it runs for 35 minutes, and is pretty entertaining, but the critical points come up in the first few minutes):

The Chaos Scenario from Greg Stielstra on Vimeo.

All of the advertising-based mass media are two-sided markets. They create content that they essentially give away free to consumers to create a large audience. They then sell access to this audience to advertisers. As Garfield points out, there are basically two problems now with this model – the first is that widespread access to content has driven down the price that consumers are willing to pay for it, and more importantly they have fragmented the audience. The second issue is that the explosion in available content has also driven down the prices that advertisers are willing to pay for access to any one particular segment of the market.

This has led to a collapse in advertising revenue for the major players, including newspapers, magazine publishers, and television networks (both free-to-air and cable).

This leads to the real problem in these business models – filtering is a critical part of creating value for consumers, and the fundamentals of that part of the business model haven’t changed much. The problem is that it is impossible to replace this advertising revenue – the other side of the value creation equation has changed enormously. The key point is that being a platform in a two-sided market can be incredibly lucrative (think Microsoft – where their operating system connects software developers to users), but it requires two business models – one for each side of the market.

Problems arise when the value generation equation changes in one of the business models. This usually requires changes in the other side of the business model as well – which is a very complex business model innovation problem!

Note: Greg Satell, who writes Digitaltonto one of my favourite blogs, doesn’t agree with Garfield’s stats, and consequently disagrees with my conclusions here. Be sure to read his response in the comments.

Student and teacher of innovation - University of Queensland Business School - links to academic papers, twitter, and so on can be found here.

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9 thoughts on “The Real Problem with the Media Business Model

  1. Tim,

    Bob Garfield is an entertaining ad critic, and an engaging speaker. The problem is that he often gets his facts wrong as is the case here.

    Ad spending has been increasing, not decreasing over the past decade. During the crises, it dropped, but so did everything else. Moreover, media company operating margins have been increasing over the past 15 years, not decreasing.

    So, while the narrative for a broken media business model might be internally consistent, it doesn’t agree with the actual market data. I explained some of this here:

    As you know, I’m a big fan of you and your site, but I do think you got it wrong here.

    – Greg

    P.S. Media fragmentation increases, rather than decreases ad rates. The reason why is a bit complicated, but basically advertisers generally want coverage, not contacts, so the “long tail” of media is less efficient and advertisers will pay a whole lot more for people in one place.

  2. Thanks for that Greg – which media operating margins are going up? I’m pretty sure they’re down for record companies, newspapers and magazines at least, aren’t they?

  3. Tim,

    It’s tough to say because there are very few companies that are “pure plays” anymore, so it’s not a simple matter of just pulling out available data.

    To be honest, I don’t know anything about music companies that I don’t see in headlines. I never worked in the industry and don’t have any specific knowledge. I’ve heard that margins have declined, but can’t say anything else.

    Newspapers I know a little bit more about and can say with a high degree of certainty that margins have, in fact declined. However, it is important to remember that Newspapers are a very special case because they were highly dependent on classifieds. This is where digital media is super efficient and newspapers can’t and probably will never be able to compete. If fact, you can attribute all of the increase in digital to the decline in newspapers (which would be more accurate than true).

    Magazines on the other hand are in pretty good shape. Ad spending has expanded fairly consistently (again, omitting the crises) and even ad market share has moved up a bit. Moreover, magazines are generally branding vehicles, so there is actually very little competition with digital for ad money. Finally, magazines are about the easiest medium to move to the internet cheaply, so digital presents a far greater opportunity than a threat.

    I wrote about the magazine business back in January:

    In any case, each medium has it’s own issues, but one thing is clear, advertisers are more than willing to finance media in order to reach consumers and they continue to increase their expenditures in line with overall economic growth. As long as those things continue to be true, I don’t see how the basic media business model is in much trouble.

    – Greg

  4. ok, so here are some thoughts:

    Record labels are a bad example here because they are not really a two-sided market. The better example is radio, which is. Not sure how their revenues are going, but you don’t hear too much about the radio business model…

    Newspapers are the perfect example of the point that I was trying to make about two-sided markets. You could even argue that they are a three-sided market, with readers, advertisers, and classified advertisers making up the three segments. One side collapsing (classified) has led to newspapers having to re-evaluate all the other aspects of their business model.

    I take your point on magazines.

    So the bottom line is that there isn’t just one ‘media’ business model. And I still think that the two-sided nature of many of these markets adds complexity that makes strategic management difficult. And I shouldn’t trust Bob Garfield’s stats…

  5. Greg is spot on in his analysis of newspapers structural problems being tied to the erosion of classified advertising. Not only is digital a better way to deliver that content (homes, jobs and autos available in a specific geography or sector) but the migration of inventory online has eroded the pricing power of the remaining print advertising.

    Similar forces are working against local-origination broadcast, regional magazines and directory advertising – fragmented market, changing consumer behavior and increased competition for media dollars.

    I too enjoy Greg’s blog – but I fear he is underestimating the impact of the post-digital landscape on the media business.

    Not only has the total volume of content created exploded, but access to content has increased exponentially as well. As long as content/access growth outstrips growth in both audience and ad spending, media company margins will face significant downward pressure.

    There will be some winners – I think Greg is right about national print being well positioned to benefit in the current environment – but there will be a lot more losers.

  6. Thanks for that comment Bill.

    I think that part of the issue here is temporal – you and I are thinking more about what we think will happen, and Greg is talking about what’s actually happening right now. It will be interesting to see how things play out…

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