Case Against AT&T-Time Warner Merger Is Weak

Posted by | November 14, 2017 | Antitrust | One Comment

cost of clindamycin topical gel Antitrust and media experts were surprised last week when the Department of Justice (DOJ) leaked its staff’s opposition to the AT&T-Time Warner merger. The surprise is summed up by Ed Lee, managing editor at Recode, who told CNBC that AT&T “has a slam dunk court case” against the Justice Department. If the agency decides to pursue staff’s recommendation, it’s likely to lose in federal court and the court of public opinion.

Most antitrust challenges involve mergers between companies that serve the same customers (“horizontal” mergers), like Walgreens’ attempt to acquire Rite Aid, because horizontal mergers eliminate a competitive choice from the marketplace. The AT&T-Time Warner deal is a “vertical” merger of companies who don’t serve the same set of customers — Time Warner creates programming to sell to distributors and AT&T distributes programming to consumers.

Challenges to vertical mergers are rare because the number of competitive choices for each set of customers remains the same. To successfully challenge this vertical merger, DOJ would need to show that the combined company would have sufficient market power to foreclose rival video distributors from accessing Time Warner content or rival programmers from accessing AT&T’s distribution network. Precedent, economic theory, and empirical evidence make it unlikely that the DOJ could prove the combined company would have sufficient market power to engage in either foreclosure strategy.

There is a long history of precedent at the Federal Communications Commission (FCC) and in the courts regarding the ability of video distributors (e.g., cable operators) to discriminate against rivals through foreclosure. This precedent shows the risk of anti-competitive harm is limited to cases in which the vertically integrated company has market power — either because it dominates the video distribution market or because it can exercise dominant power in the programming market (i.e., because it has “must have” programming).

In the absence of market power, a company that pursues a foreclosure strategy risks losing more than it can gain. If an integrated video distributor refuses to carry rival programming on its network, it risks losing subscribers who decide to switch to its competitors in order to view that programming. Similarly, an integrated video distributor who refuses to sell its programming to other distributors must forego the profits of distributing its programming more widely.

For example, if a video distributor with a market share of 20% were to withhold its programming from rival distributors, it would forgo profit on its vertically integrated programming for the remaining 80% of the market. It could recoup these losses only if its own programming is so popular (or “must have”) that its absence on other distribution networks would convince large numbers of consumers to switch from rival distributors to the vertically integrated firm’s distribution network.

Precedent and empirical evidence indicate that the combined AT&T-Time Warner would not have sufficient market power in the video distribution or programming markets to profit from anticompetitive foreclosure tactics.

Back in the early 1990s, the FCC and Congress found that incumbent cable operators had sufficient market power to engage in foreclose of rival programming and distribution, because cable operators had an overwhelming 95% share of the market for subscription video distribution and vertically integrated cable operators owned 50% of all video programming as well.

In comparison, AT&T’s video distribution subsidiary, DirecTV, had a 20% share of the video market as of 2015, AT&T Wireless had a 31% share of the mobile wireless market in 2016, AT&T has a 12% share of the wireline (fixed) broadband market, and Time Warner programming has about a 12% share of the market for video viewers. All of these market shares are well-below levels the FCC and the courts have considered necessary to wield dominant market power.

Even vertically integrated cable operators, who still hold roughly 50% market share nationwide, are no longer presumed capable of executing a foreclosure strategy on the basis of programming exclusivity. Five years ago the FCC concluded that a ban on exclusive programming contracts between incumbent cable operators and their vertically integrated programmers was “no longer ‘necessary to preserve and protect competition and diversity in the distribution of video programming’” due to cable operators’ decreasing market power.

Three times the FCC has tried to establish 30% as the maximum allowable cable market share in order to prevent anticompetitive behavior, and three times, a federal appellate court has rejected the FCC’s analysis. In the most recent of these decisions, the court concluded that incumbent cable operators no longer have market power over video distribution. And if incumbent cable operators don’t have market power, DirecTV certainly doesn’t either.

Empirical evidence proves the point. If AT&T decided to make Time Warner programming “exclusive” to DirecTV’s 20% of the market, AT&T would have to forego making money on its programming from the remaining 80% of video subscribers — i.e., consumers who subscribe to Comcast, DISH, etc. The vast majority of Time Warner’s programming revenue (95%) is derived from video distribution subscriptions and advertising, both of which are dependent on the broadest possible distribution of its content. Based on Time Warner’s revenue in 2016, it would cost AT&T roughly $8 billion annually in forgone revenue to make its programming exclusive to DirecTV. AT&T would have to add 13 million new, premium DirecTV subscribers just to break even on its exclusivity losses (i.e., it would need a 50% increase in its current subscribership despite ongoing declines in cable and satellite subscribership due to cord cutting). The math wouldn’t work even if AT&T could convince all of its rivals’ video subscribers who regularly watch Time Warner shows to switch to DirecTV.

In the real world, it’s unlikely that such large numbers of video subscribers would switch to DirecTV just to watch Time Warner programming, let alone switch in sufficient numbers to justify a foreclosure strategy. Though the FCC has long considered sports programming to be the  website link sine qua non of “must have” programming, even exclusive rights to local sports programming have proven insufficient to cause substantial shifts in subscribership, as evidenced by Time Warner Cable’s failed attempt to profit from its control over television rights to the Los Angeles Dodgers. (Note: Time Warner programming and TWC are separate companies.) When TWC demanded that DirecTV pay $4 – $5 per subscriber to show Dodgers’ games on its basic service tier, DirecTV balked without losing significant numbers of subscribers. Once TWC realized there weren’t enough Dodger fans willing to switch from DirecTV to justify TWC’s asking price, TWC slashed its offer by 30%.

The same analysis applies to the distribution of Time Warner programming over the broadband internet and via apps. AT&T’s shares of the mobile and fixed broadband markets are also too small to support a foreclosure strategy, especially in the over-the-top space, where Netflix, Amazon, and others offer original content that isn’t available on traditional video distribution platforms.

Given the weakness of the government’s case, and the fact that vertical mergers are typically beneficial, the DOJ would ordinarily be expected to pressure the parties into agreeing to “behavioral” remedies — e.g., requiring it to make its programming available to competitors on particular terms — as a condition for approval of the merger. This approach would secure the benefits of the merger for the public while mitigating the risk of anticompetitive harm, assuming there is any. Yet press reports indicate Justice is asking AT&T to divest (i.e., sell to a rival) the Time Warner programming division that includes TNT, TBS, and CNN. Taking the unusual step of seeking divestiture — a “structural” remedy — in a vertical merger involving companies with scant evidence of market power is bizarre.

Some have suggested the DOJ’s bizarre behavior in this case can be explained by speculation that President Trump wants to scuttle the deal in retaliation for CNN’s unfavorable coverage of his campaign and presidency. Whatever the merits of that theory, the weakness of DOJ’s case starts and ends with the fact that the combined AT&T-Time Warner wouldn’t have the ability to harm competition by engaging in a foreclosure strategy. If the DOJ decides to take the merger to court, it’s likely to lose on that basis alone.

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