Thursday, May 22, 2014

The Comcast/TWC Merger Proposal: An Antitrust-Based View

Representatives from Comcast and Time Warner Cable [TWC] testified at the House Judiciary Committee hearing on May 8 defending the proposed merger of the two companies. The proposed transaction occurs at an especially interesting time, with the FCC proposing new net neutrality rules at the May 15 Open Meeting and the recent announcement that AT&T and DIRECTV are proposing to merge.

Consumer groups, some members of the media, and members of Congress on both sides of the aisle have weighed in with differing visions of the future of the Internet and paid television service if their arguments do not win the day. But amidst all the hype and rhetoric, it is important to remember that any analysis of the proposed merger should be grounded in traditional antitrust principles, that the market affected by a transaction or regulation be clearly defined, and that consumer welfare be a top consideration of any proposal.

While the proposed merger between AT&T and DIRECTV may impact the competitive assessment relevant to the Comcast/TWC proposal, and vice versa, in this piece I want to focus primarily on the testimony presented at the May 8 House Judiciary Committee hearing. At that hearing, Professor C. Scott Hemphill explained why, in his view, the merger of Comcast/TWC would not pose anticompetitive concerns. In his written testimony, Professor Hemphill considered the application of antitrust law to Internet service providers (ISPs) and video distributors:

Antitrust law has a critical role to play in preserving competition. Competition benefits the economy through low prices, efficient production, and innovative new products and services. Antitrust law accomplishes this, in relevant part, by prohibiting mergers that may “substantially . . . lessen competition” or “tend to create monopoly.” Some of the concerns raised about this merger are best framed as antitrust objections.

Professor Hemphill found that most objections to the proposed merger were based on analogies in which foreclosure threats were high—threats that he contends are not applicable to the proposed merger due to differences in the nature and structure of video and broadband markets. Mr. Hemphill elaborated in his live testimony that “there is not so much a threat of foreclosure, but an ongoing fight among powerful firms that make possible the dramatic growth of online video” and other innovations.

Allen Grunes, partner at the law firm Gorey and Gorey LLP, also grounded his testimony in antitrust law. He advanced arguments that the merger would enable input foreclosure, customer foreclosure, and harm competition based on bargaining theory. Professor Hemphill addressed each of those arguments by analyzing the effect of a merged Comcast/TWC on individual markets.

First, Professor Hemphill addressed concerns about the merged company dominating content distribution. He explained that most mergers that receive antitrust scrutiny are combinations of rivals. But Comcast and TWC are not rivals because they do not overlap in any geographic territory. As such, output markets – or the markets for products and services sold by the parties – will not be negatively affected. Consumers will still have the same choice of multichannel video programming distribution service post-merger. 

Second, he explained that antitrust concerns are not present regarding the market for video programming. Post-merger, Comcast/TWC will not acquire increased “monopsony” power, which would theoretically incentivize Comcast/TWC to artificially decrease its demand for programming to drive down the costs the company would have to pay for programming. Unlike in certain markets, like the labor market for example, where competitors can drive down wages by reducing hiring, Comcast/TWC would not be able to manipulate demand for programming by purchasing less. This is because sales of video programming do not decrease the amount of programming available for sale; Comcast and TWC do not compete for rights to a scarce resource. Programmers would still have the power to bargain for and demand the same prices for their content post-merger.

Further, in negotiations for video programming, a merged Comcast/TWC likely would not have sufficiently greater bargaining power with programmers or the ability to cause anticompetitive harm due to its enlarged subscriber base. In order to cause such harm, the merged company would have to be so large that a programmer would be unable to effectively function without Comcast/TWC’s business. The post-merger company will lack the requisite scale to pose such harm.

In their joint written testimony, Comcast CEO David Cohen and Time Warner Cable Chairman and CEO Robert Marcus confirmed that the merged company will only account for 30% percent of cable customers after it divests subscribers to Charter. As Christopher Yoo, a member of the Free State Foundation’s Board of Academic Advisors, explained, critics must overcome one “potentially insuperable obstacle” in order to argue that a company of this scale would create anticompetitive harms to video programmers:

On two occasions, the FCC attempted to institute rules prohibiting cable operators from controlling more than 30% of the nation’s multichannel video subscribers in order to protect the interests of video programmers. On both occasions, the courts invalidated the rules because the FCC’s rationale for imposing the 30% limit was arbitrary and capricious. In both cases, the court indicated that the available evidence suggested that cable operators could control much larger shares of the national market without harming video programmers, driven largely by the advent of competition from direct broadcast satellite (DBS) providers, such as DIRECTV and the Dish Network. Given that the merging parties have committed to reduce their holdings so that the resulting company will control no more than 30% of the national market, these court decisions essentially foreclose arguments that anticompetitive harms to video programmers would justify blocking the merger.

Third, Professor Hemphill found that the transaction is unlikely to lessen competition by enabling foreclosure in the market for programming or in the market for distribution. A company that is able to foreclose competition would aim to inhibit the “competitive prospects of rivals,” which would result in harm to competition, innovation, and ultimately to consumers. A merged Comcast/TWC would not have the incentive or the ability to undermine its rivals’ ability to compete.

Professor Hemphill explained that the merged company would not likely withhold programming from other distributors in order to drive up prices for other MVPDs. Programmers like ESPN will still possess strong bargaining power post-merger. And, new models have emerged in the video marketplace, which enable companies to compete with content producers in new ways. For example, distributors like Netflix that produce their own online-only programming are becoming major content providers and are thriving. Netflix has garnered a larger U.S. base of video customers than Comcast and TWC combined.

Parties that oppose the merger have raised concerns that Comcast/TWC would have the incentive to foreclose the growing online video distribution [OVD] market by taking aim at companies like Netflix. Merger critics fear that the merged company would choke off the broadband Internet access on which Netflix and other OVDs rely. For instance, in a May 7 letter to Chairman Goodlatte and Ranking Congressman Conyers, Consumers Union expressed concerns about the effect approval of the Comcast/Time Warner Cable merger would have on the merged company’s market power, ability to raise prices, and its incentives to act as a “gatekeeper” for video and broadband consumers. 

These concerns are unfounded. First, online video services contribute much value to broadband Internet and harming the OVD business would drive away broadband subscribers who love their Netflix and similar services. As David Cohen and Robert Marcus stated in their joint written testimony: “We have no interest in degrading our broadband services to disadvantage OVDs or providers of other content and services. That would only harm the attractiveness of our fastest-growing business – high-speed data – and simply makes no business sense.”

Next, Comcast’s regulatory commitments made as a condition of its NBC-Universal acquisition prevent it from blocking or discriminating against any content provider. Some witnesses at the May 8 House Judiciary hearing, particularly Dave Schaeffer CEO of Internet backbone provider Cogent Communications, decried the recent Comcast-Netflix interconnection agreement as evidence of Comcast’s intent to disadvantage OVDs and providers of other content and services. However, as Professor Hemphill explains, paid peering is “a new variant of an old business practice” – paying for interconnection – and peering agreements should instead be seen as “a sign that the market is working well. The proposed merger does not change that.” Indeed, paid peering is “a means to put a price on the additional capacity demands resulting from the increased popularity of online video. It is efficient for the distributor and its end-users, considered collectively, to pay for that capacity, rather than spreading the expense among all ISP customers. Doing so better aligns use with cost and incentivizes both investment and economical use.”

The proposed Comcast/TWC merger may create some uncertainty regarding the future form of the broadband marketplace, including the PayTV market segment. But this is not a reason in and of itself for regulators to be concerned; rather the proposed merger is mainly a function of the constantly evolving marketplace.

What is clear is that the broadband marketplace, and the video segment of that market, are both fiercely competitive today. And these markets have grown and developed without unnecessary and burdensome regulatory interference. Businesses are efficiently negotiating to reach agreements that enable companies to roll out innovative distribution platforms and business models to compete for and meet the needs of consumers.

The proposed merger of Comcast/TWC is a transaction that should allow the merged company to react to new consumer behaviors and demands. Based on well-established antitrust principles, the proposed merger of Comcast/TWC likely will not harm these vibrant marketplaces.