May 2014 Archives

May 23, 2014 11:24 AM

The Difference between AT&T/DirecTV and Comcast/TWC

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 Antitrust Litigation

The cases are captioned, Garber v. Office of the Commissioner of Baseball, et al.,  and Laumann v. National Hockey League, et al.  I've mentioned these cases before, here and here.

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.

May 8, 2014 2:48 PM

Is Restricting Deployable Spectrum Really the Best Way to Prevent Potential Market Power?

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:

Low Band Spectrum.jpgNote 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.
Low Band Spectrum 3.jpgNote, 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.   

This 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.