Economies of Scale and Orchestras

As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1

A recent post by Drew McManus at Adaptistration reminded me of a brief argument I had with Greg Sandow at his blog.  In my previous post I talked about one way to increase performance or earned revenue through Price Discrimination for Orchestra Tickets.  Another way to increase performance revenue as well as lower costs is by changing the scale of the operations.

This is commonly referred to as Economies of Scale, and no, this has nothing to do with reducing pay or cutting back a season to lower costs.  The reduced costs comes about as the result of increased production, thus lowering cost per unit.  As the Investopedia defines it:

The increase in efficiency of production as the number of goods being produced increases. Typically, a company that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods.

Increasing Performance Revenue

Over at Sandow’s blog, I brought up Economies of Scale, especially through the adoption of newer technologies such as HD casts to increase production of units (i.e. the performance itself), as a way increase production while reducing costs.  In fact, as I mentioned in the comment linked above, Baumol and Bowen also recognized that Orchestras and other Performing Arts Organizations have benefited from a change in the scale of their operations, simply by increasing the number of concerts:

Some orchestras reached what appeared to be a minimum cost level after as few as 90 concerts per year, while others still went on enjoying economies of scale until they had played nearly 150 concerts per year. (Baumol & Bowen 1966, pg. 203)

A simple way to explain this is to take a series of two concerts (Friday-Saturday) that would cost, say, $90,0001 to produce with the complete rehearsal sequence.  The average cost per concert would be $45,000.  Add another concert to the series (Sunday) and the average cost would fall to $30,000.

Add in 1600 more concerts to the series through an HD cast of the performance in various cities throughout the world and the average cost per “concert” falls to $56.14 (rounded to the nearest cent).  Granted, this is an overly optimistic projection given the number of movie theaters equipped that the Met Opera currently uses for its HD casts and a cost amount that is dwarfed by the Met Opera’s actual cost perproduction.  Given the $11 million in profits it received from the HD casts, however, shows that not only can the new product cover its own costs (Met casts average close to $1 million to produce) but can also turn a profit as well.

After having read about the upcoming merger of the three Dayton, Ohio organizations discussed by Drew McManus in the blogpost linked above, I was reminded of Economies of Scale effects discussed by Robert Flanagan in his book, “The Perilous Life of Symphony Orchestras” (2012).

Lowering Costs

In the section titled, “Reducing the Growth of Expenses” from Chapter 11 “The Economic Future of Symphony Orchestras,” Flanagan discusses forming coalitions of performing arts groups and how this may be a productive and cost-reducing approach.  He states:

There are certainly opportunities for economies of scale. Each arts organization in turn can reduce marketing and fundraising costs, since at least some of the costs currently incurred may be directed at enticing patrons or contributions from other arts or defending against such predation. (Flanagan 2012, pg. 181)

This is interesting, since competition between large arts organizations is, as Flanagan says, “an understudied topic.”  He brings up some of his findings from his controversial (2007/8) report to the Mellon Foundation, “The Economic Environment of American Symphony Orchestras” (aka The Flanagan Report) regarding competition between orchestras and operas within the same geographic region:

An earlier study identified statistically significant evidence of modest competitive effects between orchestras and opera companies for nonperformance income. Private contributions to symphony orchestras were lower in communities with at least one opera company.  After holding the effects of an area’s economic capacity and an orchestra’s development/fundraising expenditures constant, there was evidence that higher development expenditures by an opera company raise support for the opera at the partial expense of the nearby symphony orchestras a year later.  The effect is statistically significant but very small. (Flanagan 2012, pg. 121)

The competitive effects of performing arts organizations is also supported by the RAND study (McCarthy et. al. 2001).  The research brief states that:

The number of nonprofit performing arts organizations increased by over 80 percent between 1982 and 1997, while the number of commercial performing arts organizations increased by over 40 percent (see Figure 1). At the same time, the average real revenues for nonprofit performing groups have declined, suggesting that most of the new nonprofit organizations are small.

Competitive effects may also be affected by the changing racial demographics and an emerging racial demographic gap.  As the median age of the White population of the U.S. shrinks and ages at a faster rate than the median age of the population as a whole the median age of the non-White demographic is actually getting younger while growing.  With more and more immigrants of non-European heritage begin to populate the U.S. there is a corresponding growth in non-European (i.e. orchestras, opera and ballet companies).

Take the recent labor dispute with the Detroit Symphony that many attribute to the economic decline of the city as a manufacturing center while at the same time, having the largest Arab population outside of the Middle East, has the Michigan Arab Orchestra which just switched to a typical seasonal concert series and is continuing to grow. The Bay Area has also seen explosive growth in traditional Chinese Orchestras which matches the region’s ever growing Chinese-American population. Flanagan also briefly discusses the issue of a changing racial demographic gap2 and its effect on classical music audiences.

While the possibility of reducing marketing and fundraising costs exists for the merger of the Dayton performing arts organizations that McManus discusses, he also mentions the previous financial disaster of one such merger between Utah Opera and the Utah Symphony. I think, however, the more cautious sharing of resources and staff given by Andrew Taylor (a quote by Michael Kaiser), makes more sense and is closer in line to creating Economies of Scale that Flanagan is suggesting for fundraising if not for marketing.

Flanagan also warns that:

The main resistance to such efforts will come from those who are currently employed performing those tasks for specific arts organizations.  Economies of Scale imply fewer personnel in those functions, and personal concerns may receive more weight than the overall effort to raise support for the arts. (2012, pg. 181)

Both the Dayton Arts Organization merger/coalition and the future of HD casts are things to keep an eye on as they will give us some much needed case studies on how Economies of Scale3 may help large Performing Arts Organizations lessen the income gap4.

_____________________

NOTES:

1) For those of you wondering about the specific dollar amount I chose, just google “Kentucky Opera” and you’ll know the reason why.

2) Baumol and Bowen (1966, pg. 75) also noted some anecdotal evidence that ethnic demographic issues seem to affect audiences: “…musical performances are often in trouble in a city without a large German, Italian or Jewish population.  A Jewish holiday can decimate the audience even in a Midwestern city.

3) While William Baumol is much more well known in the Arts for his pioneering the field of Cultural Economics, his most recent research with economist, Ralph Gomory deals specifically with mathematizing scale economies as part of a sustained and rigorous critique of free trade economics and how nations with retainable industries (industries that reach economy of scale first) may not necessarily be the most low-cost producer in absolute terms. It is by being the incumbent producer–usually by achieving an economy of scale first–that will create the lowest producer against which others cannot hope to compete.  See their book, Global Trade and Conflicting National Interests (2000).

4) Sunil Iyengar’s blog post, “Taking Note: An Economic Study of Symphony Orchestras” reviews and summarizes Flanagan’s book and also touches upon Economies of Scale.

REFERENCES

Baumol, W., W. Bowen (1966) Performing Arts — The Economic Dilemma.  The Twentieth Century Fund
Flanagan, R. (2008) “The Economic Environment of American Symphony Orchestras.” Report to Andrew W. Mellon Foundation
Flanagan, R. (2012) The Perilous Life of Symphony Orchestras. Yale University Press.
McCarthy, K., A. Brooks, J. Lowell, L. Zakaras (2001) “The Performing Arts in a New Era.” RAND report supported by the Pew Charitable Trust.

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6 thoughts on “Economies of Scale and Orchestras

  1. [...] In “Global Trade and Conflicting National Interests” (2000) Baumol and his co-author former Princeton Mathematician, Ralph E. Gomory, discuss “Retainable” Industries.  A retainable industry is characterized by High Entry Costs which result in difficulties for small-scale entry.  Such industries, “because of [its] high real start-up costs, offers the current established producers a substantial degree of protection from competitive entry, making it easier for them to retain their positions.”  Often, this characteristic is the result of having taken advantage of creating Economies of Scale which Baumol and Bowen (1966) as well as Flanagan (2012) agree orchestras can do to some extent. [...]

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