The Monetization of Digital Content
In a previous piece on Netflix and Amazon, I focused on a specific form of content (video) which was monetized in a specific way (subscriptions). But I think its worth understanding how the economics of monetizing digital content works more broadly which is what I wanted to focus on in this post.
By digital content, I mean any form of content (audio, video, text, virtual goods, etc) which can be made available for ~zero marginal cost.
To understand how the economics of digital content work, we need to understand the incentives of the two key parties involved — content consumers (i.e., people) and content creators.¹
People
With any kind of content, people have a choice of whether or not to consume it. However, this consumption isn’t a binary yes or no choice independent of other factors. Indeed, it is greatly influenced by price, for one thing.
We can assume that each user has some price X which is the most they are willing to pay out-of-pocket for a piece of content. If the content is offered for less than X, they will pay that amount and purchase it. For those familiar with economics, this is the concept of “willingness to pay”.
So what does most content’s willingness to pay graph look like?
For any content there are a lot of users who don’t care at all and so have a willingness to pay of 0. Of the ones that care, most will likely have a willingness to pay also of 0 but will put up with ads. Only a few will be willing to pay “out of pocket”. This tends to be true for most content one finds online — articles, short videos, etc.
However, there is some content which tends to have a set of very passionate people interested in it, who would be willing to pay to access it. The graph for this kind of content might look like below.
There’s still a large set of people who have a willingness to pay of 0, which is expected, but there is also a sizable group that has a non-zero willingness to pay with some people willing to pay quite a bit. In general, content of this form tends to be high quality audio or video content, or content that is niche but people are very passionate about (gaming streams, content from specific creators, etc.)
Note that these are two extremes, with a bunch of content falling in between, but this will help illustrate the economics more clearly.
Creators
Now we’re ready to talk about the other key party in the ecosystem — the content creator. Note that when I use the term creator I mean the party that is looking to monetize the content or commissioned its production (and so NYTimes for example and not the journalist who wrote the content itself).
The creator’s incentive can be thought of as maximizing the revenue from the piece of content they have produced. They may often have other motives as well such as getting their message across, reaching the most number of people they can and so on but for the purposes of this we can assume the primary motive is to maximize their earnings.
The best way to do that theoretically is to charge each user exactly what they’re willing to pay, also known as “perfect price discrimination”. This would involve charging every user with a non-zero willingness to pay their exact willingness to pay, and providing the content for free to users with zero willingness to pay, and monetizing them via ads.
Unfortunately, this is not possible in practice. Therefore, the content creator has two main options:
- Charge nothing, and capture everyone interested in the content, and monetize via ads.
- Charge an amount X and capture everyone who is willing to pay X or more at a value of X
As you might guess, with the two ends of the spectrum we discussed above, for broad content the better approach is to monetize with ads, while with niche it is better to charge users.
This is evident when we consider the curves above. In the case of content like the left, charging X we means we lose a lot of the audience relative to just monetizing via ads, while in the case of the content on the right, charging X still captures most of the audience that would have been captured by showing an ad.
The Monetization Decision
Generalizing the creator’s decision a bit, the creator will choose the monetization strategy that maximizes revenue between ads and charging directly.
This decision is dependent on three variables: the CPM of ads, the percentage of users that would pay if you charged a fee (relative to those that would consume if it was ad-supported), and the price charged.
To illustrate, say we have an audience of 1M people who would consume some content with ads, and say the CPM with ads is $7.5. Based on the percentage of those users that would pay and the price the creator charges, we can calculate the amount they will earn.
This is shown below with the amounts colour coded based on whether they are higher or lower than what the creator would have made by providing the content for free supported by ads ($7500).
Can a creator do even better than just ads or just charging users? The “freemium” approach which falls somewhere in the middle and involves making content available for free (and monetized with ads) with the ability for people to pay in some form allows them to do just that. The exact structure can vary, from either paywalls after consuming X pieces of content (which is common in journalism), to allowing for ad-supported viewing but also allowing for people to leave tips/make purchases or even providing some content for free and up-selling exclusives. This form of monetization has grown in popularity recently since it essentially serves a form of “price discrimination” where the creator can get a best of both worlds in terms of reaching the low-willingness-to-pay people with ads and the high-willingness-to-pay people by charging them.
¹ There are other parties which might be involved (advertisers, content buyers, platforms) but for the purposes of this we can ignore them.
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