Cheap Talk

Students anywhere can watch my old friend Ben Polak teach his famous Yale class.  They can’t get a Yale grade for the class but that possibility is coming ever closer:  A professor at Stanford is teaching a robotics class and everyone can sign up, do the assignments, take the exams and get a certificate of “accomplishment.  Prospective employers do not know whether your friend took the exam for you. This means the certificate has little value.  But surely it is only a matter of time before some verification mechanism is set up and this problem is dealt with.

The implications of this change are multifold but I just want to focus on one: the impact on the research university.  Universities produce research as well as teaching and this other dimension is often forgotten in all the discussion of virtual teaching. Here is one possible sequence of events:

1. Virtual teaching cannibalizes face-to-face teaching.  Tuition goes down and courses become quite cheap.

2. This destroys tuition-based universities which turn into vast teaching factories.  A few universities try an “elite” approach with tiny classes taught by excellent teachers.

3. Endowment based universities continue to survive.  Researchers become concentrated in these universities.  They compete for government funding and do mainly PhD teaching.

4. A “top heavy” university structure emerges with a handful of research universities and a number of vast teaching universities.

This analysis assumes there is weak complementarity between research and teaching.  If there is strong complementarity, the teachers have to be researchers to keep courses up to date, exciting etc. This will make step 2 above more difficult and leave a structure like today’s but with universities having virtual counterparts and huge scale.

I am attending an antitrust conference hosted by the Searle Center at Northwestern University.   In my attempt to Americanize, I am drawn to any paper involving sport.  And if British sport is thrown in for comparison, resistance is impossible.

Haddock, Jacobi and Sag offer an analysis of American NFL football stadiums versus English soccer stadiums.  Their thesis is simple: the NFL controls entry of new teams in the league and teams can move from one city to another. So, if the New Jersey government does not cough up $1 billion for the New Meadowlands, teams can threaten to move and the NFL can refuse to allocate another team to the state.  For example:

When the Houston Oilers threatened to move to Jacksonville, Florida in 1987 Harris County, Texas, responded with $67 million in improvements to the funded by property tax increases, doubling the county’s hotel tax, and underwriting bonds to be paid over the next 30 years.  Within six years the Oilers began lobbying for a new stadium with club seating. Rather than opposing the Oilers rent seeking, NFL Commissioner Paul Tagliabue warned Houston that “If the Oilers’ situation doesn’t work down there, I don’t see any circumstances in which we’re going to guarantee a team, especially when one team’s already found it unsatisfactory.” The message was clear, if Houston lost the Oilers because it refused to accede to the team’s demands, it was unlikely to receive a prompt replacement. At the end of the 1996 season the Oilers left Houston for Nashville where city officials had promised to contribute $144 million toward a new stadium.

In England, entry is easy.  If a team attempts to hold up a city, it can create its own new team.  This reduces the bargaining power of the team.

Jerry Hausman, the discussant, found much to disagree with.  Hausman claimed many British teams were simply no-hopers.  Very few teams are actually competitive. Arsenal is not one of them and hence no-one would fund a stadium for them.  In the NFL, many teams are competitive.  Hence, they can extract rents from the local community.  He thought politics was an the center of problem: Why did Massachusetts fund a new high school in Newton rather than soend money in poorer areas?  He displayed a surprising amount of knowledge about English soccer and claimed to have worked for the Chicago Bulls (I didn’t catch what he did for them).  He speaks fast so I may have missed some details.

David Pogue has also been thinking/fuming about the Netflix price change which effectively increases prices from $10 to $16 for streaming plus one-DVD-at-a-time.   He ends with:

[W]hat makes me unhappiest is how calculated all of this feels. In July, a spokesman told me that Netflix had already taken the subscriber defection into account in its financial forecasts.
And sure enough. When I tweeted that Netflix had lost one million of its 25 million customers, @npe9 nailed it when he wrote:

“It damages their brand and images, but 24 million customers paying $16 is still better than 25 million @ $10. Increases revenue by >50%.”

This issue is perplexing many of us who teach in business schools – are we going to have to change our classes as one of the firms in many of our key examples goes bankrupt?

We are not sure we have a good answer to our question so we will satisfy ourselves with a brain dump.

First, it may very well be true that, as CEO Reed Hastings is saying, Netflix does not want to end up like Borders or AOL in the garbage can of history when the next new technology comes along.  After all, Blockbuster has never really recovered from missteps when Netflix DVDs arrived on the scene.

Therefore, Netflix wants to be ahead of the curve when DVD technology dies and everyone watches streaming movies.   Here is one way to do this:  keep the total price of 1 DVD at a time +streaming at $10 but price streaming alone at $6 and 1 DVD alone at $8.  What they did instead, to maintain margins we assume, is raise prices by 60% so I DVD at a time + streaming is now $16.   Of course this going to cause some serious fall in demand and also create a media frenzy.

There is a broader point: we gave one example of how Netflix might shuffle prices to create switching but we do not have the internal data on revenue and costs so the optimal pricing might be different.  But whatever it is, the optimal pricing requires the DVD and streaming prices to be coordinated. If you split these two services into different (competing?) companies, you might create a price war and not only undermines your whole strategy but destroys your profits….

Even if completely separating the two businesses is the only way Netflix feels it can incentivize its streaming business to move ahead properly, there is absolutely no reason the company should expect consumers to care about its internal strategy issues – the strange angle taken by Hastings’ blog postings and emails to customers. It seems to us that it is the large price hike, far more than any other aspect, which has upset customers.

As a final comment, even if Netflix gets everything right operationally in its streaming business, it is hard to see how they plan to maintain margins and demand given that their suppliers (the content producers and owners) have a great deal of bargaining power and have every incentive to treat Netflix as only one outlet among many competing ones for their product. Other companies in the content delivery business, such as cable & satellite operators, face similar issues, but have the advantage of higher barriers to entry in terms of local franchise rights and physical infrastructure that gives them greater scope to raise prices……Our guess is that we will have more posts as more information arrives.

Sandeep Baliga and Peter Klibanoff