Thursday, 19 May 2016

Do we pay for Channel 4? Understanding cost and price

I recently mentioned on Facebook a petition to keep Channel 4 in public ownership (for non-UK readers, Channel 4 is a public service broadcaster, owned by the government and funded by advertising). I noted in my post on Facebook that Channel 4 doesn't cost a penny to the taxpayer. One of my commenters replied that ' It can't be said that it doesn't cost the tax payer, though. Anything that is funded by advertising is of course paid for by us, even if we don't have a TV, as a share of the cost of everything we ever buy goes on an advertising budget.' At first sight this makes sense - we pay for products, some of that money goes to the advertising, so we pay for the advertising. But the reality of costing and pricing is rather different and worth briefly exploring.

I ought to say that I'm not an economist, but I did write the costing models for British Airways for some years, so I have some experience of costing in a large company, and also have a little sideline selling organ music and sing-along hymn CDs and downloads (no, really), for which I have to deal with pricing and costs like advertising directly.

The problem with the 'we do pay, because someone pays for the products' picture is that this only makes sense if prices were directly linked to costs. So it would be true if the company makes the choice to advertise, then they add a bit extra to the cost of the product so I, as the consumer, pick up that cost. But costing and pricing isn't like this. A price is set by the market. You look at what's out there and decide what the market will bear - what is the best price you can get for the product. That price will often be varied in special offers, or once you get a better idea of what sells and what doesn't. It is not in any sense derived from the costs. To say 'Yes, you do pay for advertising' makes no more sense than to say 'Yes, you do pay for the staff canteen.' Both are true at one level, but the fact that you do so makes no difference to the price, and so to say that we pay for an advertising supported service doesn't really make sense. It makes more sense to say that with a service that doesn't have advertising like the BBC or Netflix, you pay not to have adverts.

But why, if this is the case, do companies pay such attention to costs? It's not to set the prices, but rather to see if the price is viable. The costs that go into this fall into two categories, fixed and variable. While accurate, these are rather odd terms, as fixed costs are usually the ones you can vary, while variable costs are fixed as long as you go ahead with the product or service. This is because fixed costs are your overheads. You pay them whether or not you put on a service or put out a product. But variable costs are the costs of actually making and selling the product or service, so they are only received if you do that particular thing. Advertising is generally a fixed cost (though it can be variable if it is tied to a specific product).

To pull it all together, let's look at one of the products from my music site - a track downloaded from Amazon. Here is a non-vocal track, Bach's Air from Suite No. 33, better known as Air on a G string:

The track costs 99p. We spent some money last month on advertising, mostly on Google. So if you buy that track, are you paying for my advertising? I suppose so, technically. But the fact that I took out advertising had no influence whatsoever on the pricing. In fact Amazon sets the price in this case - I have no control over it. So the existence of the advertising has zero impact on what you pay. And that's all that matters to you. Just to rub it in, here is the same track on iTunes, where it only costs 79p:

The fact that you indirectly pay for the advertising (unless I make a loss, in which case I pay for it) has no impact on the price you pay - so to say that you still pay for a service supported by advertising is misleading at best.

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