Competition Demystified: Chapter 10

The author of the excellent book for beginners, Value Investing: From Graham to Buffett..., is back, this time with a book about how to understand and analyze competitive advantages. Investors interested in better understanding what gives a company a competitive advantage must give this book a read.

This chapter is about how Rupert Murdoch broke through the barriers to entry protecting the three US national tv networks (ABC, CBS and NBC). First it is established that the networks did enjoy barriers to entry. Market shares were stable for these three for decades, and returns on capital were high. This was because viewers were loyal to tv shows (which could be purchased from one of several content providers), and the networks enjoyed economies of scale (distribution costs were fixed no matter how many viewers there were, making it hard for new entrants to compete financially).

Unlike Coke and Pepsi of the previous chapter, however, the networks knew how to maximize their profits by keeping a lid on competing with each other. The networks did not cut advertising prices (they would just fill empty slots with advertising of their own), and ad contracts were done within a relatively short period (so ad buyers could play the networks against each other). Under the mantle of protecting the public, the networks also agreed to limit the minutes of advertising per hour (thus restricting supply and keeping prices high). The networks also did not outbid each other for new shows, again compressing the schedule decisions within a small time window so that the networks could not be played off against each other.

Murdoch wished to join this club, but did not want to destroy its profitable features. His Fox station followed the code of conduct that limited the number of ads, sending a signal to the others that he was not interested in a profit-destroying war. He also pegged his advertising prices 20% below the incumbents'. Without the viewership of the other three, he could not charge the same, but if the incumbents matched him on price, they would lose as well. He would also raise their prices if they did, signalling again that he wasn't looking to undercut. Fox also did not compete with the incumbents for content, opting instead to go with programming selections aimed at younger viewers and with content that were considered too vulgar for network tv. As a result, he stole share from independents (that were more likely to run such content) than from the Big 3. The networks interpreted these signals as peaceful and chose not to fight his entry.

Unfortunately for the industry, things went downhill soon after. Regulations were removed and changes in technology allowed many more channels to be beamed into the homes of Americans. The invention of the remote control and VCR also reduced the power of the national networks, and that trend continues today.