The Effect of Satellite Entry on Product Quality for Cable Television

Abstract

In vertically differentiated markets, the effects firm entry are contingent upon whether incumbent firms can respond to entry by adjusting product quality addition to simply lowering prices. Using market-level data, I estimate a structural model supply and demand for subscription television that takes into account the endogeneity quality choice. Using counterfactual analysis, I decompose the effect satellite entry on existing cable into two components: the conventional price response and the effect endogenous quality adjustments (measured by changes programming content). Consistent with the empirical observation that cable prices rose during the 1990s and early 2000s in spite of increasing competition, I find that raising both price and quality for the most comprehensive subscription package--i.e., competing head-to-head--is the rational response to entry by cable systems markets with relatively homogeneous consumer types. Elsewhere, incumbents respond less aggressively and relegate themselves to being the low-end provider. When an entrant credibly commits to serving consumers with the highest preferences for quality, competition over both price and quality lowers the welfare gains due to entry, relative to pure price competition. In particular, head-to-head competition results crowding quality choices toward the high end the market and inefficiently low product differentiation. In such cases, consumers with weak quality preferences may actually become worse off following entry. The evidence also suggests that the observed degradation the lowest-quality cable tier many markets during this time period--while commonly seen as an attempt to evade price regulation--may actually have been welfare-enhancing.