With on-line advertising revenues stagnant at best, and print in terminal decline, newspapers are starting to build paywalls.
The economics of on-line media is a little different from the economics of print, and a lot different from the economics of, say, potatoes. The difference is shown in the diagram below.
The diagram shows the amazing revenue potential of on-line distribution. A potato producer can only profit from his potato once. But a newspaper can sell an article a million times over. The question is: how can newspapers tap that potential?
Any business must solve two inter-related problems: how much to produce, and how much to charge for its product. For a potato producer in a competitive market, the problem is, at least in theory, straightforward. The producer charges the going market rate for his potatoes - that's the highest price he can charge and still sell his output. He produces as long as it's worth his while: the price he receives for his potatoes covers the marginal costs of production.
The on-line publisher's problem is a little different. First, she has to figure out how to generate the maximum possible surplus from production. Second, she has to work out how to get as much surplus as possible for herself.
Although publishers don't explicitly talk about marginal costs and willingness to pay, this is the calculation that is implicitly made. I know about this from managing the finances for academic journals. If the editor of Canadian Journal of Economics wants to publish an extra issue, the Canadian Economics Association has to weigh up the costs of each additional article published - copyediting, typesetting, mark-up, hosting - against the benefits. Will we get any new subscriptions? Will we keep more of our current subscribers? Will people pay to read it? Typically the answer to those three questions is "no, no and no", but the Association is a non-profit organization, so weighs other benefits, for example, the opportunity for young academics to publish their research in the journal.
Once an on-line publisher has found approximately the right Q*, the question is: how does it raise revenue from consumers? Charging on a per-article basis is a non-starter. The only way a per-article charge can reach the surplus-maximizing point, Q*, is if consumers are charged their own individual share of the article's marginal cost. For example, suppose freelance, editing, posting and hosting costs amount to $500 per article on the margin, and the marginal article is read by 10,000 people. Then the per-person cost is $500/10,000 or 5 cents per article.
There are two reasons why such a charge is infeasible. First, it's so small that the costs of making the payment, from both the consumer and the firm side, dwarf the revenue the charge would raise. Second, if publishers are charging a marginal cost price, they will never cover their (quite substantial) fixed costs of, say, software, hosting, and so on. Yet a per article charge of, say $1 per article would reduce the quantity demanded - and thus the consumer surplus - far below that available at Q*. The benefits of the entire publishing enterprise would evaporate.
The alternative is to erect a paywall, and charge consumers a fixed monthly fee for unlimited access to the site's content. The maximum amount a consumer would be willing to pay for a subscription is equal to the entire area underneath her demand curve - that's the benefit she receives from subscribing to the on-line service.
In some sense all of this theorizing just re-states the obvious: publishers should produce a good product, and charge the maximum the market will bear for it. Yet it can be used to shed light on real-world publishing dilemmas.
For example, PostMedia has erected paywalls around all of its local papers - the Vancouver Sun, Calgary Herald, Regina Leader, and so on. These papers are substitutes for one another, carrying the same national and international news stories. A person's willingness to pay for each individual newspaper is less than their willingness to pay for all PostMedia newspapers - why should I pay to read a story in the Citizen if I can get it as one of my 10 free monthly articles in the Vancouver Sun? Hence if PostMedia wants to maximize profits, it should institute a PostMedia wide paywall, rather than paper-by-paper paywalls.
The analysis also shows that there is a direct trade-off between people's willingness to pay for subscriptions, and the number of free article allowed each month. If people are allowed, say, 20 free articles each month, the willingness to pay for a monthly subscription decreases by the entire area to the left of the point marked "20" in the diagram above. The amount that can be charged for subscriptions is people's willingness to pay for the articles they could not otherwise obtain for free.
So far I have been discussing pricing strategies - the best way to charge for content - assuming that the entire publishing enterprise is viable. But what if it isn't? What if that yellow "total willingness to pay" area is less than a publishers' fixed costs of doing business?
The internet erases space. A publisher has to convince a potential subscriber that his or her paper provides more valuable content than the next best alternative anywhere else in the world. Thirty years ago the Ottawa Citizen competed with the Ottawa Sun and local television for eyeballs. Now it competes with the New York Times, the Economist, Slate, the Atlantic, the Financial Post, as well as bloggers, tweeters, and so on. For a publisher who captures a global audience, the internet is a golden opportunity, but for others?
Nothing succeeds like success. A newspaper with a strong base can share the cost of creating content across millions of subscribers, giving it huge advantage over its rivals - revenue generates content generates more revenue.
But what about local newspapers? Yes, new technology and the internet allow for some cost savings - managing and copy editors can be dispensed with, for example - but only so many. One view is, if newspapers can't make profits, then they had better fold, and allow resources to be deployed more efficiently.
However alert readers may have spotted that the analysis of newspapers looks a lot like the standard economic analysis of a public good. Even when people value a good, like local news, they have an incentive to free ride, to let others pay the cost of collecting and publishing information. The internet sometimes seems thousands of miles wide and just a few inches deep - all of the blogs, local web pages, and so on rely on the hard news gathered by serious journalists. The marginal cost of opinions is pretty low - everyone has one. The marginal cost of reading through omnibus bills, filing freedom of information requests, making cold phone calls, tracking people down and asking difficult questions is a lot higher. If the fourth estate fails, who will take its place?
Here are some questions on the economics of paywalls. These would be suitable for an undergraduate economics class or graduate public policy class studying public goods: Download Economics_of_paywalls_questions