Entertainment Industry Research Paper

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Entertainment as an industry—in the United States alone—is responsible each year for $150 billion in expenditures and some 120 billion hours of consumed time (Vogel 1998, p. xvii). Entertainment as an economic sector consists of diverse products and services including motion pictures, television, music, broadcasting, print media, toys, gaming, gambling, sports, and fine arts.

Economic Development and the Demand for Leisure

Leisure time has been a determining factor in the development of recreation and entertainment as an industry. Entertainment has grown as an industry in step with increased income and time available for leisure and recreation. Economic development, often quantified in terms of productivity or output per person-hour, has enabled goods and services to be produced with fewer labor inputs. The growth of the entertainment industries has been directly related to the development of a modern economy and rising economic productivity, though precise estimation of the demand for leisure is a thorny task (Owen 1971). An important issue in the development of entertainment as an industry is the rising productivity of workers, and in particular the ways in which technical progress has increased worker productivity. Progress in technology, in addition to creating the demand for entertainment products and services, has also led to the creation of much of the dominant forms of contemporary entertainment.

Industry Overview

Substantial production in the creative industries takes place within the U.S. economy and creative products are a major U.S. export. Motion pictures, home video and television programming, music and sound recordings, books, video games, and software are collectively one of the largest and fastest-growing economic sectors, responsible for about 6 percent of total U.S. gross domestic product per annum (Motion Picture Association of America 2006a). Multinational entertainment/media conglomerates such as Vivendi, Sony, and AOL/Time Warner are increasingly becoming dominant in this sector, with operations that permit substantial economies across the line of entertainment products. The process often begins with a literary work of fiction, which is then made into a movie exhibited in cinemas and later on syndicated and network television domestically and abroad, and finally released on home video. Characters and other elements from the movie can be developed into a line of toys cross-promoted with fast food, and further developed into a video game or board game, and perhaps even featured in a line of clothing.

In the motion-picture industry, the sector of entertainment with the highest profile, domestic (U.S. and Canadian) box-office receipts accounted for about $9 billion, while worldwide box-office revenue was over $23 billion for 2005 (Motion Picture Association of America 2006b). The international market now yields more revenue than the North American market and it is also the source of revenue growth for the motion-picture industry, though success in the international market is largely conditional on success in the North American market. The dominance of Hollywood films in worldwide box-office revenue gives rise to claims of cultural imperialism, though major Hollywood studios in fact design films for distribution in the worldwide market even though the films are screened in North America first. While international box-office revenues have been rising, the major sources of new revenues for the motion-picture industry have been from home video and digital versatile disc (DVD) sales, and from merchandising arrangements such as toys, video games, clothing lines, and other products that are tied to successful motion pictures.

While Hollywood films dominate worldwide boxoffice revenue, the American film industry does not dominate worldwide production. The Mumbai-based Indian film industry—commonly known as Bollywood because it is the “Hollywood of Bombay” (the former name of present-day Mumbai)—produces more motion pictures each year than any other country. Throughout the 1980s about 250 individual film production companies completed an annual average of about 700 feature films per year with the encouragement of official government policy requiring commercial movie theaters to screen at least one Indian film per show (Gomery 1996). In 2003 the Indian film industry produced 877 feature-length films and 1,177 short films (Central Board of Film Certification 2006); this contrasts with the 459 new films released in the United States during 2003 (Motion Picture Association of America 2006b).

The music industry consists primarily of the sales of prerecorded music—albums distributed on compact disc and audiocassettes, and singles distributed on compact disc. Music videos are also sold as product in traditional formats. Music is also available in alternate digital formats—including MP3, OGG, and WAV—through Internet retailers. The authorized digital distribution of music content has been overshadowed by unauthorized distribution, both free and for profit, though academic research on this issue is much less clear than one would glean from journalistic reports (as is discussed in more detail below).

Gambling in the United States is popularly associated with the cities of Atlantic City, New Jersey, and Las Vegas, Nevada, which are responsible for 9 and 21 percent, respectively, of the 2005 U.S. annual gambling revenues of about $53 billion (PricewaterhouseCoopers 2005). Native American casino-operators account for over 40 percent of gambling revenues. While the United States is a large gambling market, accounting for over 60 percent of worldwide gambling revenues, substantial new growth in gambling revenues is occurring in international markets, especially in the former Portuguese colony of Macao, which began granting licenses to new casinos a few years after being returned to Chinese sovereignty in 1999. While gambling revenues in aggregate make the United States the largest market, the character of North American gambling is quite different from Asian gambling markets. For example, in horse track gambling the average total amount bet on a race day at a North American track is on the order of $100,000, whereas at Hong Kong tracks and Japanese tracks a day’s bets are on the order of $200 million to $300 million, respectively (Busche and Walls 2000).

Expansion of casino gambling opportunities in Asia, with new casinos in Macao and proposed casinos in Japan, Thailand, Singapore, and Taiwan, together with recent changes in British gambling taxation and online gambling opportunities, make prospects favorable for the expansion of international gambling markets (Paton et al. 2002).

Important Characteristics of Entertainment Markets

The entertainment industries differ in important ways from traditional manufacturing and service industries. Richard Caves (2000) enumerates seven ways in which the creative industries—including fine arts, music, and motion pictures—differ distinctly from what he terms the humdrum industries:

  1. Neither producers nor consumers know the demandfor product until after it is revealed. Creative products and services are “experience goods” and there is symmetric ignorance of information, not an informational asymmetry.
  2. The creative talents producing the product careabout the creative output explicitly, in addition to their pecuniary compensation in production.
  3. The creators engage in joint multiplicativeproduction with an array of diverse inputs in which all inputs are essential, because there is less substitutability than in other production processes.
  4. Entertainment products are horizontallydifferentiated products. Each product is unique and must be experienced before demand is known.
  5. Products are vertically differentiated by the qualityof the inputs used in production. Furthermore, inputs of different quality levels may be combined—for example, a B-list screenplay and an A-list actor.
  6. Profitability depends on temporal coordination andprompt realization of revenues once assets are sunk. Delays may occur once assets have been committed to production.
  7. Creative products are durable and this leads to issuesregarding rents, collection and monitoring of royalties, warehousing, and retrieval.

The seven features identified by Richard Caves are essential in understanding the markets for entertainment products both qualitatively and quantitatively (Walls 2005). Additionally, the demand for entertainment has two properties that are deserving of our particular attention. The first is that consumption of entertainment requires the time of the consumer. The second is that the demand for entertainment is not fixed in advance of the product being produced; instead, it is discovered by the consumers after the product has been consumed. We will discuss these properties of entertainment demand briefly.

The time-cost element is important in understanding the demand for entertainment, because consumption of entertainment necessarily implies customer-supplied inputs; recognizing this explicitly is essential if we are to understand the functioning of demand and supply in this market. Perhaps the best illustration of this point, in a more general context, is the seminal paper by Arthur De Vany and Thomas Saving (1983). De Vany and Saving demonstrate that when all else is equal, consumption cost is lower for a product that requires less time to consume. Of course, price can be adjusted and this implies a tradeoff between time-cost and the monetary price. In the entertainment industry, this may also involve substitution across alternative media for a similar product. For example, reading an 800-page book may involve a substantial element of time, but a consumer may substitute a videocassette or DVD film version of the book to be viewed on a computer or television monitor, or a compact disc or audiocassette version of the book to be listened to while at home, at work, or while commuting. All of these alternative means of consumption involve tradeoffs in which the time-cost of consumption varies greatly and may be of primary importance in consumption decisions.

The demand for entertainment products is not fixed in advance, but is discovered by consumers as they consume many entertainment products. Understanding this aspect of demand is essential if one is to make sense of many of the entertainment industry’s unique business practices. When movie audiences see a movie they like, they make a discovery and tell their friends about it. This and other information is transmitted to other consumers and demand develops dynamically as the audience sequentially discovers which movies it likes. Supply adapts to revealed demand through flexible exhibition contracts and other business practices that permit the increasing returns in film demand to be realized. For example, early viewers of a motion picture may substantially affect the choices of other potential viewers. This type of behavior is known in the social sciences as, variously, herding, contagion, network effects, bandwagons, path-dependence, momentum, and information cascades (Arthur 1994; Banerjee 1992; Bikhchandani et al. 1992). The particular algebraic models of this behavior differ in the mathematical details, but they are all dynamical processes: Demand depends on revealed demand. As a result of this sequential demand process, initial advantages in movie attendance can lead to extreme differences in outcomes when demand has recursive feedback. De Vany and Walls (1996) showed that box-office revenues have a contagion-like property where the week-to-week change in demand is stochastically dependent on previous demand. A big opening of a bad movie can cause consumption to evaporate. But a big opening of a good movie can lead to an avalanche of attendance. Demand for movies, music, fashion, and other entertainment products and services are characterized by extreme uncertainty due to the nature of dynamical demand.

The Challenge of Piracy

The most substantial challenge facing the entertainment industry is intellectual property piracy, largely due to the easily copyable digital format of many entertainment products. Infringement of copyrights and other forms of intellectual property is a large and growing problem around the world and it is of particular importance for the entertainment industry. The Motion Picture Association of America estimates that losses due to piracy exceed $3 billion annually in potential worldwide revenue (Motion Picture Association of America 2005). The intellectual capital of the S&P 500 companies is worth 3.4 trillion U.S. dollars (Bowers 2001), so it follows that even a small percentage infringement on such a large base generates enormous absolute losses to property rights holders. Peggy E. Chaudhry and Michael G. Walsh (1996) provide an overview of trends in counterfeiting in the international marketplace, including a consideration of the legal framework that governs the protection against piracy and a review of different anticounterfeiting strategies.

Piracy of entertainment products can take many forms. These range from illegal copying and distribution of videocassettes and optical media (CD-ROM, VCD, and DVD) to Internet piracy, which can involve commerce and the sharing of digital content. Unauthorized signal transmission and theatrical performances are other types of movie and music piracy. Music and movie piracy are either commercial sale of physical media or the sharing of videocassettes, optical media, and digital content over the Internet.

For most entertainment products the pirate good is identical to the authentic article, except for the packaging and after-sale support. For example, music CDs will be an exact digital copy of the authentic product, but liner notes and lyrics will either be missing or will contain numerous, and often humorous, typographical errors. Many entertainment companies use copy-protection technologies, including the Content Scrambling System for DVDs, dedicated DSL set-top boxes, digital encryption encoding of satellite signals, and Macrovision for videocassettes. The use of antipiracy technologies raises the cost of engaging in piracy, as Sougata Poddar (2003) had modeled analytically. Despite efforts to increase the cost of piracy, however, in practice it is not too difficult even for a computer hobbyist to work around the latest antipiracy technologies (Perry 2005). Even the copy-protection technologies employed in computer software—including online authentication—are quickly rendered obsolete by digital pirates (Harvey and Walls 2006).

Copy-protection technologies, whether effective or not, are aimed primarily at preventing retail products from becoming a source of pirate supply. But the source of pirate movies is often not a retail copy but instead is an insider copy, such as the advance copies used for screening and marketing purposes (Byers et al. 2003). Other copies are made from handheld video camera recordings of motion picture films off of a theater screen. While the quality may be low, the latest movies are also readily available over internet-based file-sharing networks, such as BitTorrent (Kwok 2004). This contrasts with music piracy, in which high-quality copies of songs and entire albums are available either freely through file-sharing networks, such as those available with the Kazaa program, or available for purchase through for-profit retailers such as allofmp3.com.

Many factors are associated with piracy (Limayem et al. 1999), and according to Seung Kyoon Shin et al. (2004) sociological factors may in fact be more important than some economic factors. Most studies suggest that the level of piracy is systematically related to the level of income. Income reflects a person’s average cost of time and the demand for quality. Patrick J. Harvey and W. David Walls (2003) examined the demand for pirate software in a laboratory study and found that the demand for counterfeit goods decreased as the expected penalty for consuming the illicit goods increased. Income may be correlated with other infrastructure that provides alternative means of consuming the product. All of these factors would be expected to decrease the demand for pirate products as income rises. As average income rises, the supply of pirate products would also be expected to decrease due to the availability of more attractive opportunities for employment than pirating. There is, however, no unambiguous prediction of the equilibrium effect of income changes on piracy.

In a forthcoming article, the present author empirically examines the rate of motion-picture piracy across a sample of twenty-six countries and finds that the level of piracy is explained by the level of income, the cost of enforcing property rights, the level of collectivism present in a country’s social institutions, and the level of Internet usage. Conclusions about the behavioral aspects of piracy are more certain than piracy’s actual impact on the entertainment industry revenues, however: Felix OberholzerGee and Koleman Strumpf (2004) found that Internet music piracy had no negative effect on legitimate music sales; on the contrary, their study found that piracy may even boost sales of some types of music, contradicting the music industry’s assertion that the illegal downloading of music online is causing revenues to fall. In contrast, Rafael Rob and Joel Waldfogel (2006) found that the U.S. music industry lost one fifth of a sale for each album downloaded from the Internet. There is no definitive answer to the question of whether or not piracy has a net negative effect on consumer demand in the entertainment industry.

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