After Sunday's announcement that AT&T had entered into an agreement to purchase DirecTV, many parties have rushed to talk about the "media consolidation trend." The usual suspects have expressed their opposition or express their "skepticism." Others have applied an equally superficial analysis to come to the opposite conclusion.
In order to appreciate how the Comcast/TWC merger is different from AT&T/DTV, you have to understand what the two mergers have in common. One, not-so-obvious thing the two transactions have in common is that one party in each transaction--Comcast and DirecTV--is a co-defendant in major consumer antitrust litigation over the foreclosure of sports programming over the Internet to broadband-only consumers.
These cases are significant, because they should have a direct effect on the outcome of the Comcast-TWC merger, but will, most likely, not affect the AT&T/DTV merger. It should be noted that these cases have survived a motion to dismiss (opinion), under the heightened Twombly scrutiny requiring antitrust complaints to demonstrate a "plausible" (vs. merely "possible") claim that would establish an antitrust violation, before allowing antitrust plaintiffs to proceed to discovery. So, we know these cases have some merit.
Equally noteworthy, these cases are being brought by real consumers (not DC interest groups) in reaction to real behavior in the marketplace; behavior that the DoJ and FCC claimed to be fixed by the Comcast-NBCU merger conditions. The D.C. interest groups, on the other hand, supported the feckless merger conditions imposed by DoJ and the FCC.
The plaintiffs are classes of consumers that buy the MLB.TV (or NHL GameCenter Live) online service either by itself or in addition to a subscription TV service. The defendants in the cases (other than the two named sports leagues) are certain individual teams and some regional sports networks owned by Comcast and DirecTV, and the TV providers themselves.
The crux of the complaints is that the sports leagues, and integrated RSN/subscription TV companies, allocate markets through what are, essentially, agreements not to compete with one another. Unlike a typical horizontal territorial allocation scheme, though, these are the result of a series of industry-wide "vertical" distribution agreements with sports leagues and the TV companies' RSNs--the success of the scheme being contingent on identical terms in all agreements.
How the Agreements Work
When the RSN pays all that money for the rights to broadcast all of a team's games, what do they get for their money?
First, the RSN gets the rights to show the games of that team on TV for the home team's "market area". This means the RSN can set the prices that other subscription TV companies in the home market area have to pay in order to give their viewers access to the games. This right is exclusive to the RSN for the market area. Thus, even though when the home team plays away games, the away team also has rights to the game, the contracts are written so that the away team will not sell its broadcasts back into another RSN's "home market."
Second, and most importantly, while the vertically-integrated RSN is technically only buying TV rights, it effectively also gets a promise that the league's online streaming provider (i.e., MLB.TV or NHL GameCenter Live) will refuse to deal--at any price--with broadband-only customers within any teams' home market areas. (If you want to check for yourself, here's the link to the MLB.TV blackout section.) Thus, there is some foreclosure value being offered in exchange for the ridiculously high fees being paid by cable RSNs for regional sports rights.
How Does the Antitrust Litigation Affect Analysis of the Two Mergers?
Knowing this important commonality, we can try to understand how the big media mergers will change things. The Comcast/TWC merger is likely to make things worse for customers and competitors of Time Warner Cable.
According to a study, published last year by Navigant Economics Principals, the "vertical integration premium [the relatively higher fees charged by a vertically-integrated RSN] increases significantly with the local downstream market share of the RSN's affiliated distributor." The paper isn't available for free, but you can access the presentation to the FCC staff here.
So, in all likelihood, Comcast's increased share of certain markets (e.g., New York and L.A.) could be expected to lead to increased prices for TV consumers (of any provider) in those former TWC markets. (Comcast will also increase its L.A. market share through its Charter deal.) Nor would Comcast's accretion of TV market power be likely to change its opposition to the sports leagues making "in market" games available over the Internet.
On the other hand, AT&T's incentives would be expected to change markedly for the better, relative to a standalone DirecTV. DirecTV, only a few weeks ago, questioned why it would even bother creating and promoting an online video package. AT&T, though, just last month, AT&T announced its intentions to get behind over the top content in a big way.
AT&T has different incentives than Comcast with respect to online video, because--according to the Leichtman Research 1st quarter report on broadband additions--AT&T has a much lower share of the market in terms of video-speed broadband than the cable companies. If you massage the information available from Leichtman (which groups T and VZ together), an overly optimistic approximation (which only includes Comcast and TWC in the denominator) gives AT&T and VZ less than a 40% share of video-speed broadband subscribers.
AT&T has already announced plans to dramatically expand its very high speed broadband footprint. AT&T's successful deployment of higher broadband speeds is dependent on consumers having a reason to purchase higher capacity service. This is why AT&T will want to push--more content online--especially linear content that consumers want.
By understanding what has kept linear content--specifically, the sports programming that is so important to consumers--off the Internet, it is easy to see why broadband consumers will be better off with AT&T owning DirecTV than they are now.
On Monday, 16 Republicans on the House Energy and Commerce Committee sent a letter to FCC Chairman Wheeler, complaining that the Chairman's proposal (described in his blog) to restrict bidding on at least 30MHz of the available spectrum in the upcoming incentive auction "is not how a market-based auction should function; it is how a cartel controls price." The House Republicans hit closer to the mark than you might.
Ironically, the purported reason for the restrictions is to prevent "one or two firms from running away with the auction." Such a result would be only be bad if it led to these "one or two firms" controlling enough spectrum to be able, at a later point in time, to exploit consumers through cartel behavior.
We know that cartels restrict output. If bidding restrictions, likewise, reduce output, then whose cartel tactics are likely to cost the consumer more?
The FCC's Theory on the Competitive Significance of Low-Band Spectrum
In his blog, the Chairman states that spectrum below 1Ghz is really important for commercial success in wireless. He believes this, presumably, because AT&T and Verizon (the two wireless companies with the most customers) also have more low-band spectrum than anyone else. However, correlation is not the same as causation.
Presently, here is how much total "low band" spectrum is available for commercial service:
Note that the chart above does not account for the broadcast spectrum to be auctioned in the upcoming incentive auctions. The FCC had originally speculated that the amount of 600MHz broadcast spectrum tendered for auction could be anywhere from 80MHz to 120MHz. The House Republicans speculated that only 60MHz would be tendered, due to the Chairman's decision to limit auction participation, and the value to broadcasters of surrendering spectrum.
If you want to see how the Chairman's plan will affect specific companies, the table below will give you an idea. This information is based on Table 18 from the FCC's 16th Wireless Competition Report (adjusted to reflect mergers), and it assumes that broadcasters will tender 84MHz to be auctioned. We also assume that the FCC wants to limit the amount of spectrum below 1GHz that any carrier can acquire; here, we use 1/3 of the post-auction total (73 MHz) as the limit.
Note, also, that in the above chart, neither AT&T nor Verizon's low-band spectrum comprises a majority of either company's total spectrum.
How Does the Chairman's Plan to Redistribute Low-Band Spectrum Effect Consumers?
The Chairman's plan is not just to limit the amount of
low-band spectrum held by AT&T and Verizon. No, the plan also is
designed to promote a more "equitable" distribution of low-band
spectrum--at the lowest possible price to competitors of AT&T and Verizon.
These distortions are the primary reason no one expects the auction to recruit 120MHz of new low-band. The result of Chairman's bidding restrictions will be a 50% reduction in spectrum capacity available in this
auction, and a total post-auction capacity restriction of almost 20%
less total low-band spectrum available for U.S. consumers.
last point is incredibly important. Restricting output is what
monopolies do when they want to increase prices. Because consumer
demand is fairly steady in the short term, the only way producers can
move prices quickly is to restrict supply, which changes the equilibrium
price to a point higher up the demand curve.
The Chairman of
the FCC is unmistakably urging the Commission to adopt a plan that he
knows will restrict output. The justification for this output
restriction is ostensibly to prevent the top two firms from restricting
output in some future time period.
What's the Worst That Could Happen?
If we assume the auction takes place with no bidding restrictions, reasonable spectrum screens, and we get active (but not maximum) broadcaster participation, then it seems possible that somewhere around 100MHz-110MHz in broadcast spectrum gets tendered. Moreover, let's assume AT&T and Verizon are allowed to buy as much as 60MHz-70MHz of the 100MHz.
Now, at some point in the future, the concern is that AT&T and Verizon will realize that demand is strong, every other competitor is capacity-constrained, and their opportunity to restrict output has finally arrived. If this day comes, and AT&T and Verizon decide, notwithstanding antitrust laws, that they want to maximize their opportunity, then they might look to the early 1970's OPEC.
As cartels go, early 1970's OPEC wrote the book on cartel coordination meeting exactly the right opportunity. As the world was already producing at maximum capacity, OPEC's 25% output reduction in November of 1973 changed the world.
So, for a worst case, let's assume that AT&T/Verizon will want to cut output by 25%. A 25% output restriction translates into somewhere between 40.5MHz and 43MHz, depending on whether you assume the two companies bought 60MHz or 70MHz of spectrum in this auction (25% of their combined new low-band total of 162MHz-172MHz).
What Does It Cost to Prevent?
This "worst case" outcome is, obviously, more than a little improbable. For the worst to happen, we have to assume: 1) AT&T/VZ would capture most of the profits from an output restriction, 2) both firms would/could disregard/circumvent the antitrust laws, 3) that such a steep restriction makes sense (25% is a lot), and 4) that the firms could effectively monitor and police their levels of capacity in service. Moreover, output "quotas" do not tend to work for very long (even OPEC members cheat on output quotas).
Nonetheless, the "worst case" does serve a purpose. In this case, it gives us some way of valuing the worst harm the Chairman's proposed bidding restrictions are supposed to protect us from.
If we know the economic costs of the worst case, we can assess the probabilities of that worst case, and get an idea of what preventing it is worth. So, here, the worst case is that consumers will face the higher prices that would result from an output restriction of about 40MHz of premium-grade, low-band spectrum.
But this is only a "risk"--it's not a certainty. But, even if you think there's as high as a 30% chance of the worst case happening, then we can assign a value on the worst case. In rough terms, it would be rational to engage in rules/regulations that "cost" up to 12MHz (in spectrum that will never reach the market) in order to prevent the worst outcome (i.e., a 30% chance of the economy losing the benefit of 40MHz of spectrum capacity).
Worth the Cost?
On the other hand, there seems to be a consensus among observers (both for and against the bidding restrictions) that the Chairman's proposed bidding restrictions will result in broadcasters bringing up to 40MHz less spectrum to the auction. But, even if the Chairman's restrictions "only" cause broadcasters to offer 20MHz less spectrum for auction, the loss is real and it is 100% certain.
Insurance is what the Chairman is selling with his proposed bidding restrictions. But, even at a Vegas blackjack table, insurance pays 2:1. At a guaranteed cost to the public of up to 40MHz, the Chairman owes taxpayers an explanation of why his bidding restrictions aren't the bad bet they look like.
I guess everyone that watched yesterday's Senate Judiciary Committee hearing on the Comcast-Time Warner Cable merger had a different opinion on it. I had prepped myself by reading all of those "Comcast owns Washington" and "David Cohen is The Man" articles, but I really wasn't prepared . . . for the awful truth. See and believe (whole hearing here).
Maybe I'm reading this all wrong, but it looked like the Committee Chairman, Sen. Patrick Leahy (D-VT) pretty much indicated that he's cool with the deal--just, you know, as long as they include some net neutrality commitments, or something. It was almost as if Senator Leahy was listening to Comcast's radio commercial as he spoke. So, yeah, that pretty much set the tone.
The only Senators that represented my consumer interests, i.e., unchaining broadband Internet customers from the pay-TV business model, were Sen.'s Blumenthal (D-CT), Franken (D-MN), and Lee (R-UT). I've already explained that the real problem here is the accretion of power that cable-affiliated RSNs have over pay-TV/broadband competitors. In other words, this merger will harm the ability of consumers to ever use broadband Internet access--from any broadband provider--as a substitute for subscription TV service.
The rest of the Committee members were distracted--like toddlers chasing soap bubbles--by the agenda of net neutrality "concerns" that we've seen hyped and re-hyped by the press for the last 3 months. The reason that these "distractions" consumed the attention they did is, some believe, a sign of Comcast's power to intimidate the "real" witnesses away.
And, according to this report, Comcast's "casting" of the issues covered in the hearing could not have worked out better for them. Unfortunately, if the only people who are going to speak up about this merger can't pass up a public platform for their "net neutrality/broadband is a utility" shtick--then Comcast really is in great shape.
3 Reasons Why "Net Neutrality" Is Comcast's Best Friend
1. The only "managed service" Comcast needs is the one they already have. I can't say it any simpler than that. When Prof. Susan Crawford went off the handle a couple weeks ago, at the rumor that Apple might have requested a "managed service" from Comcast, she failed to understand that this is precisely what is needed if the Internet is ever going to become a content delivery rival to TV. If Comcast made "TV quality content delivery" available to some third party, then it would be available--and that's the point.
If a "managed" video delivery service is not available for wholesale purchase by Apple, then it's not available to any competitor to Comcast's cable service. The fact is that Comcast will be happy to "swear off" offering managed services, because that's just like telling them to shut the door behind them for all those new markets where they'll be the dominant broadband and subscription TV company.
2. Internet interconnection is not a merger issue (either). Senator's Klobuchar (D-MN) and Franken (D-MN) wasted a fair amount of their time and attention on this little canard. In fact, I'd say this line of questions, more than any other, made David Cohen look like the most reasonable person in the room.
In the media, this issue is hyped a lot by Stacey Higginbotham from GigaOm. She loves this issue--writes about it constantly (see), even when Comcast isn't buying its rivals. Not surprisingly, a few days before the hearing, she writes, "expect more questions about paid peering and the Comcast merger."
The reason this line of inquiry helps Comcast avoid harder issues is that buying transit is a long-established, industry-wide practice, and would exist even if Comcast was a "common carrier." Neither the FCC nor the DoJ, is going to do anything to change this practice in a merger review.
3. Data Caps. The essence of this complaint is that the heaviest users don't like the ISP's pricing structure. This complaint, like the previous issue, is a quixotic attempt to establish price regulation on ISPs.
The "data caps" issue is only an issue for the highest use consumers--who want the lower use consumers to subsidize their consumption. These people share the Reed Hastings view of net neutrality--averaging out the restaurant bill is fair, especially if you're the only guy drinking $100 champagne.
At the hearing, TWC said they deal with this issue in an interesting way: they don't impose caps, but if a customer agrees to not exceed a certain amount of data downloads (and be subject to throttling, if they go over), the consumer gets $5 off their monthly bill. My guess is that Comcast will have no problem offering this one up.
Look, the net neutrality people aren't the "bad guys" here. But, if a significant part of the merger opposition is ceded to the usual suspects--the same folks that seem intent on recycling their same net neutrality arguments, no matter the forum--then that's a shame.
This merger squarely presents the DoJ and the FCC with a very fundamental "crossroads" choice--the future of competition for the broadband Internet versus the cable TV business model. The public interest cannot settle for a bunch of buttercup-and-whipped-cream "commitments" to net neutrality. The consequences are too high.
I wanted to end on a cheerful note, so I'll leave it at this. Remember, kids, while advocacy from 2005 ages poorly, this still-super fly Chamillionaire video never will. Enjoy!
Maybe, I'll send some "Chamillitary" gear over to Prof.'s Crawford/Wu, and Free Press. So, you know, at least the crew can be dressed in the "era-appropriate" pop fashion when they hit the NPR circuit.
In Comcast's public positioning of its proposed acquisition of Time Warner Cable, executives of both companies have chosen to characterize the merger more by what it's not than by what it is. So, we know that the merger is not going to result in any significant efficiencies, because it's not going to reduce consumer prices for cable (even an unconstrained monopoly reduces prices when costs decline).
We also know that the merger is not between two competitors, because--as the companies make it a point to tell us--they don't compete. TWC's CEO says, "[w]hether you're talking about broadband or video, we don't compete with one another." Comcast's CFO goes as far to state, "[w]e don't compete in one single zip code."
Doesn't it kind of seem like they're trying just a little too hard to sell the notion that the combined service territory of Comcast and TWC is not relevant (because, you know, they don't compete)?
Product Market Definition
The last time the DoJ's Antitrust Division ("Government" or "DoJ") looked at a Comcast acquisition, it determined--based on documents from Comcast--that Comcast's "joint venture" (as it was structured at the time) with NBC-Universal would reduce competition in the "video programming distribution" market. See Comp. Impact Stmt. (CES). The Government seemed especially concerned at the ability of post-merger Comcast to destroy nascent competition from online video distributors. CES at C and D.
Based upon the Government's concerns in the previous Comcast acquisition, and DoJ's focus on cross-elasticity of demand in defining a relevant product market, let's focus on some recent information from the Leichtman Research Group to get some valuable insights into how the Government might define a relevant product market.
Consider that, among multi-channel video providers, cable companies lost 1.7 million customers in 2013. But, AT&T and Verizon added 1.5 million MPVD subscribers last year. The Leichtman numbers show that customers are not so much "cutting the cord" (only 105k customers stopped buying from an MPVD in 2013) as they are switching MVPDs--but customers are choosing MVPDs that are also broadband providers. Very high percentages (according to AT&T, well over 90%) of both cable and telco MPVD subscribers are also broadband customers. The Leichtman data confirm this for Comcast and TWC, as well.
Purchasing video service from another broadband provider, allows the customer to purchase services they want from the MPVD, but also purchase services directly from an online vendor, like Netflix. In its earlier analysis of the significant competitive effect of online video distributors, the Government referred to this practice as "cord-shaving." CES, at C.2(b).
Given consumer behavior, it seems likely that the Government will focus on a broadband market--of a sufficient speed to facilitate a competitive MPVD service--as the primary relevant product market. Because it is this market in which the traditional "hypothetical monopolist" test would yield the greatest supply substitution responses. For all practical purposes, we should consider broadband providers offering service at 10-15Mbps as participants in the "MVPD-bandwidth" market.
Geographic Market Definition
If one's primary concern was to look at the area over which the post-merger firm might be able to reduce competition, then that territory would be (at least) the total number of MVPD-bandwidth broadband customers in each geographic market served by Comcast or Time Warner Cable. Within this total subset of homes passed will also include the majority of the customers capable of being served by AT&T and Verizon.
What is difficult to figure out from publicly available data is what percentage of MVPD-bandwidth homes will be served within that area by Comcast, Time Warner Cable, AT&T, and Verizon. For our purposes, just to get a ballpark idea of the type of numbers we would be looking at, we are going to use a datapoint from the Leichtman 1Q 2014 Research Notes that the number of FiOS and U-Verse addressable homes stands at 41 million, giving the companies a video market penetration rate of 26%.
Let's further assume--and this is a generous assumption toward Comcast--that AT&T and Verizon compete with Comcast and TWC in 70% of their combined service territory, but that all of AT&T and Verizon's customers were won in this territory. This would give us a total denominator of about 59 million homes passed (that could receive MVPD quality broadband).
To get useful MPVD-broadband numbers, we are going to work with the Leichtman numbers we used earlier, but, because it is impossible to tell from the telco broadband numbers how many AT&T and Verizon broadband customers are actually U-verse and FiOS customers, we are going to use MPVD customers as a proxy, in order to allow us to get some ballpark market share numbers.
So, we can see that the result of this merger, for anyone that has to depend on getting content, carriage, or online video distribution to these 60 million households will be looking at a market that goes from "moderately concentrated" to "highly concentrated" under the DoJ Horizontal Merger Guidelines at Section 5.3.
The competitive effects on both MPVD rivals like AT&T, RCN, and Verizon, as well as online video distributors like Netflix, are likely to be significant in terms of their ability to get competitive programming. Add to this the fact that Comcast will also control 12 major regional sports networks, and it is easy to see how the post-merger firm could restrict output of the most inelastic, and "linear," of linear programming to broadband and online video competitors.
This last effect is, potentially, disastrous for the future deployment of more MVPD-bandwidth broadband in the area that would be served by the combined Comcast-TWC, because it eliminates what is potentially the biggest source of pent-up consumer demand for MVPD-quality broadband as a substitute for traditional MVPD bundled service--online access to regional sports programming.
How do we know the significance of real-time sports programming to the value of the broadband Internet? Because the first truly linear, all HD, over-the-top channel--the WWE Network--has attracted almost 700,000 customers paying $10/month, in only 6 weeks!
If the DoJ and the FCC value the availability of MVPD-bandwidth broadband throughout the Comcast-TWC territory, then Comcast might have a reason to worry. But, commenters on the political left and right have conceded Comcast's powerful influence over the government; so, Comcast probably does have a decent chance of moving forward with this acquisition. Unfortunately, it just postpones the day when consumers can choose to buy only the video content they want from the vendors they want.
This morning, FCC Chairman Wheeler and Commissioner Pai spoke to the House Appropriations Subcommittee on Financial Services and General Government to make a formal request for the agency's FY 2015 budget allocation. View hearing here. Today's hearing was a more formal re-run of the briefing that the Chairman and Commissioner Pai gave the Subcommittee on Tuesday, when the FCC provided information on the agency's request for a $36 million increase in the FCC's allocation in the FY 2015 budget. The Commission's total budget request for 2015 was $375 million.
First among the FCC's budget priorities was securing an additional $10.8 million for USF improvement, directed mostly at policing the Lifeline program (which is intended to provide discounted telephone service for low income Americans). As this Bloomberg BNA article reports on the Tuesday briefing, the Chairman told the Subcommittee,
"We need more muscular enforcement about what is going on in universal service," Wheeler said. "The Lifeline program has been abused. My line from day one is, 'I want heads on pikes' and we need enforcement capability we don't have."
The Chairman's statement that he "want[s] heads on pikes" is a nice, political thing to say, given that the program has been under scrutiny, after ballooning in the wake of the Commission's decision to allow program participation by wireless carriers in 2008. The Commission took major steps to reform the Lifeline program rules in 2012, which led to a decline in total (non-Tribal) Lifeline subsidies from a peak of $2.13 billion in 2012 to $1.77 billion last year. See app. LI07 here.
The Commission, however, has yet to complete the most basic part of its Lifeline reform NPRM initiated in 2011--determining the correct subsidy for wireless carriers. Given that the growth in the Fund has come entirely from wireless services, one would think that getting the wireless carrier subsidy correct would be job #1.
The FCC Is Required to Establish Prudent Carrier Reimbursement Costs
The Lifeline program subsidizes consumer discounts through reimbursement payments to the consumers' service providers. The relevant statutory provision that deals with Lifeline provider reimbursement is 47 U.S.C. Section 214(e), which says,
A carrier that receives such support shall use that support only for the provision, maintenance, and upgrading of facilities and services for which the support is intended. Any such support should be explicit and sufficient to achieve the purposes of this section.
(emphasis added). The plain language of the statute indicates that Congress didn't want the FCC to be deliberately spending more than was necessary for the provision of the relevant facilities/services.
This only makes sense. After all, if the subsidy is in excess of wireless carrier costs, then the Commission is not only failing to implement the law, but is (effectively) subsidizing wireless carrier profits rather than merely reimbursing service costs. The distorted incentives that excessive subsidies create also contribute to an even greater need for the enforcement resources the Commission is currently seeking.
Wireless Reimbursement Costs Should Be Lower than Current (Wireline) Subsidies
In this post from several months ago, I explained--with numbers--how the wireless lifeline business is able to make money off "free" service. The 2012 Lifeline Reform Order retained, but simplified, pre-existing average "per customer" reimbursement rates of $9.25--which were originally established to offset costs to serve wireline customers.
As I explained in more detail in the earlier post, the average wireless Lifeline customer will have a direct wholesale cost of $4.875/month to serve. In return, the carrier receives $9.25 from the USAC. If we estimate indirect costs at around $2.00/line (say $1.875/line), we can see that it is not out of the question for a fairly typical wireless Lifeline provider to earn around $2.50 per line served per month ($9.25-$6.75).
How Much Could the FCC Save Consumers by Fixing Wireless Cost Subsidies?
Last year there were about 14 million non-Tribal Lifeline subscribers. See LI08 appendix. About 80% of Lifeline consumers use prepaid wireless service, which amounts to about 11.2 million wireless Lifeline subscribers. If the FCC should be reimbursing these subscribers' carriers $6.75/month instead of $9.25/month, then the USF and its contributors would save $22.4 million/month--or $268 million/year.
In other words, if the FCC simply finished the part of the Lifeline Reform Order that the FCC should have addressed first, the Commission could annually save consumers about 70% of the projected costs to run the entire agency. It goes without saying that the Chairman's next budget briefing would be an easier "ask" if he could assure lawmakers that the Commission is putting most of that number right back into consumers' pockets--while still supporting the vitally important benefits provided by the Lifeline program.