Strategic Differentiation by Business Models: Free-To-Air and Pay-TV

Why do `Free' and `Pay' content cohabit in practically all media markets? We develop a model in which two identical broadcasters compete for viewers and advertisers that leads to endogenous differentiation. We show that differentiation does not require heterogeneous agents. Instead, we relate it to the `two-sided' nature of these markets. The asymmetric outcome is driven by the property that business models form strategic substitutes: if one station goes towards the ‘pay’ business model the rival has stronger incentives to choose the ‘free’ business model and viceversa. We propose a simple and natural property of the advertising technology that enhances strategic substitutability guaranteeing differentiation. In regime of competition there is a misallocation of advertising messages and therefore a waste of viewer attention. We show that a multi-station monopolist does not necessarily maintain differentiation and never offers content for free.