Is the death of the TV business model upon us?

Lynne Kiesling

If you’re a Direct TV subscriber, you know that they are embroiled in a contract dispute with Viacom over subscriber fees, which means you haven’t been able to watch Jon Stewart or Stephen Colbert or SpongeBob SquarePants for the past week or so. But is cable/satellite TV becoming an “if it died would anyone notice?” industry?

Put another way, as Derek Thompson did in The Atlantic late last week, has the technology evolved sufficiently that the cable or satellite TV bundle model is obsolete?

First, Viacom yanked its 19 channels — including Nickelodeon, MTV and Comedy Central — from DirecTV after the two companies failed to agree on subscriber fees. Second a federal judge cleared the way for Aereo, an exciting new startup that could bring local TV (NBC, ABC, CBS, PBS) to any device you wish, from a smart phone to an actual TV.

Big deal, you might say, so DirecTV people can’t watch “South Park” and techies can get a crappy stream of “The View” on their iPad. That’s not a wrong interpretation of the news, but it’s too narrow. The bigger story here is the death of the bundle.

“The bundle” has been a matter of tech policy interest for some time, as some consumers argue that they shouldn’t have to pay to access 500 channels when they really only want 20 of them (disclosure: I, too, have ranted after a couple of glasses of wine about how dearly I wanted “a la carte” pricing). Given the prevailing broadcast, cable, and satellite technologies, the economics of content bundling is more nuanced than that, though — in some ways channel bundling is like risk pooling in insurance. By creating bundles that cross genres and interests, cable/satellite companies can offer a higher “potential eyeball rate” for their channels and charge content providers higher subscriber fees at a lower retail price to each subscriber than if the cable/satellite company offered each channel separately. In that model content providers get the revenue both to do Game of Thrones on HBO and to do deep cable shopping channels.

But Internet streaming technologies have been chipping away at the bundle business model for some time, at least the past year or so, and they are getting efficient enough in their use of bandwidth and are complemented by more efficient devices (from laptops to tablets to phones) that streaming is now a viable competitor to cable/satellite. Those who want a la carte can cancel their subscriptions and do so, for a lot of popular content.

Thus, as Steve Titch noted at Technology Liberation Front, there’s been little policy attention to this latest subscriber fee kerfuffle:

This is the new reality of TV viewing. If you are willing to wait a few days, you can download most of Comedy Central’s latest episodes for free (although John Bergmayer at Public Knowledge reports that, in a move related to the DirecTV dispute, Comedy Central has pulled The Daily Show episodes from its site, although they are still available at Hulu).

What’s more, in a decision that should raise eyebrows all around, AMC said it will allow Dish subscribers to watch the season premiere of its hit series Breaking Bad online this Sunday, simultaneous with the broadcast/cablecast. This decision should be the final coffin nail for the regulatory claim of “cable programming bottleneck.” Obviously, studios have other means of reaching their audience, and are willing to use them when they have to. …

While disputes like this are messy for consumers in the short term, the resolution will be a consumer win because it will force multichannel operators and the studios to adapt to actual changes in consumer behavior, not a policymaker’s construct of competitive supply chain. Washington would be wise to stay out.

It’ll be interesting to see how messy that process is for video content, whether incumbents fight it to their detriment as in music or adapt to it thoughtfully as in book publishing. Personally speaking, we’re just waiting for Fox Soccer to become less technologically incompetent, and then we’re off. I can watch cycling and hockey by subscription and most other stuff by direct purchase. I suspect we’ll end up spending almost as much as we do now for Dish, but with more flexibility and less junk to annoy and distract us.

AT&T/T-Mobile merger is about spectrum, redux

Lynne Kiesling

In case you were in doubt concerning my argument of a couple of weeks ago and back in March that the AT&T/T-Mobile merger is largely driven by our flawed spectrum policy, Gordon Crovitz weighed in with his version of the same argument in the Wall Street Journal earlier this week:

The great threat to competition for wireless data and mobile phones is not mergers—it’s government failure to free enough spectrum to meet demand. Deutsche Telekom agreed to sell T-Mobile, the fourth-largest wireless provider in the U.S., because it couldn’t get enough spectrum to compete and wanted out of the U.S. market. For AT&T, the $39 billion purchase price was the best way to get the spectrum and local cell towers it needs to serve 97% of U.S. consumers with a new 4G LTE network—a technology currently provided only by Verizon. In other words, this merger would mean more competition, not less.

However, as part of the political bargain to take some steam out of the DOJ’s challenge of the merger, AT&T is apparently offering to sell some of its spectrum to smaller wireless companies, according to Ars Technica. Presumably they would do so in markets in which they have substantial network overlap with T-Mobile (such as Chicago), which may reduce the DOJ’s estimate of the potential anti-competitive price effects of the merger.

AT&T’s history in a nutshell

Lynne Kiesling

The DOJ challenge to the AT&T/T-Mobile merger is bringing AT&T to our attention in ways that it hasn’t been in a while, including this great Ars Technica blog post providing a concise guide to the history of AT&T. Matthew Lasar argues that AT&T conquered the 20th century through patents, strategic acquisition, and embracing regulation and using it to its advantage. By so doing it did provide universal telephone access as it consolidated and cemented its monopoly, although some of its ways of using regulation to its advantage proved to be its undoing in the 1982 divestiture.

A highly recommended read, especially if you are not particularly familiar with the history of the telephone industry. That history provides important context for understanding current competition policy issues and events.

Another good response to the Obama administration’s mistaken antitrust policy

Michael Giberson

George Priest, professor of economics and law at Yale, clearly outlines the main errors of the Obama administration’s decision to oppose the AT&T/T-Mobile merger and cites relevant evidence backing the view:

It is very difficult at an abstract level to know what the effects of a merger or acquisition will be on competition within an industry. Firms may merge to create market power and increase prices, though they may also merge to create efficiencies that lower prices.

The Justice Department presumes that the acquisition of T-Mobile (the fourth largest wireless provider) by AT&T (the second largest) will lead to “higher prices . . . and lower quality products” based on the high market share that would result. But market share is a very rough proxy for market power and essentially meaningless in a network industry.

There are strong reasons to predict that AT&T’s acquisition will lower prices and improve product quality. First, there’s lots of competition in the wireless market. Prices have been declining progressively over time. There are many local market competitors with discount and pre-paid plans….

Second, the best evidence of the prospective effect of a proposed acquisition is the response of competitors that will face the combined firms. The chief competitor, Sprint, the third largest wireless company, has been lobbying to stop the merger from its first announcement.

If the acquisition would lead to increased prices and lower quality products as the Justice Department has claimed, Sprint would be better off after the acquisition… Sprint would oppose the acquisition—as it has—only if it thought that the merger would put it in a worse position by increasing the competitive pressures that it already faces.

The market—though not the Obama administration—understands this point. On the day that the Justice Department announced its opposition to the acquisition, Sprint’s share price rose 5.9%, reflecting investors’ belief that Sprint will be in a better competitive position without the acquisition.

The Obama administration also claimed blocking the merger would protect jobs; Priest nails the response:

The Obama administration’s emphasis on job maintenance is even more confused. The administration has argued that the acquisition should be opposed because mergers reduce employment by eliminating redundant jobs. But a sound economy is not built on redundant jobs. An economy becomes stronger as redundant jobs are eliminated, costs and prices reduced, and the effective wealth of the nation enhanced. A major reason that the Obama administration’s efforts to stimulate the economy have failed is that it has consistently poured money into negative-value investments.

[See also the Streetwise Professor on Priest's article.]

Quality, broadband, and spectrum: What the DOJ’s AT&T/T-Mobile lawsuit misses

Lynne Kiesling

Yesterday’s announcement that the US DOJ would challenge the merger of AT&T’s wireless business with T-Mobile’s was surprising, and their approach to the merger seems to be more conventional and rooted in old HHI-market share and price effect metrics. Their analysis suggests that due to the substantial overlap in the existing separate AT&T and T-Mobile networks, the merger would lead to higher HHIs and larger market shares, and most national consumers would experience higher prices; therefore the merger would have anti-competitive effects.

The complaint has more depth than that (separate analysis for business markets and consumer markets, for example), but that seems to be the core of the argument. I think that argument misses a few important points in such a dynamic market.

The first important point is the quality dimension of the wireless service, and the costs associated with providing quality service(s). In this market some of the most important categories of quality are speed, signal strength, lack of latency, and lack of dropped calls. Providing such quality means building bandwidth and more dense network towers. In a lot of locations, building more towers is increasingly costly due to siting, zoning, permitting costs and lags. Building more bandwidth to add to existing capacity is also not cheap. Thus both AT&T and T-Mobile have been suffering in quality comparisons to their largest competitor, Verizon (I don’t know much about Sprint’s quality, or the smaller regional providers), and are looking at substantial investments and time lags to expand and improve their bandwidth capacity and other features that contribute to quality services. I’ve seen a couple of commentators point to the challenges both companies face as stand-alone competitors if they are going to upgrade their networks from 3G to compete with Verizon’s 4G LTE; in fact, Deutsche Telecom has been trying to sell T-Mobile for a while and has balked at the costs of these investments. In this cost environment, the lower-cost way to increase quality is likely to be the merger, which would allow the merged firm to combine their bandwidth and towers to get that capacity without additional siting, permitting, etc. Thus on a cost basis there’s room to argue that prices could fall for higher-quality (LTE) services, and there’s also room to argue that if prices do go up, it’s a reflection of the consumer demand for high-speed LTE service for their smartphones. It’s hard to capture that quality dimension, and how rapidly it can change in such a dynamic technological environment, when your definition of anti-competitive focuses primarily on the effect on prices. This is a very Schumpeterian point.

That point leads to the second point not to overlook: market definition. Every antitrust challenge of a merger is going to hinge in some way on market definition. If you define the market as national wireless telephony, then the merger would create essentially a duopoly with Sprint as a small third firm. But, as Geoff Manne points out, there are two dimensions on which that’s not the correct market definition — there are regional competitors, and there are other competitors in the broader market, the more relevant market, which is broadband:

Meanwhile, even on a national level, the blithe dismissal of a whole range of competitors is untenable.  MetroPCS, Cell South and many other companies have broad regional coverage (MetroPCS even has next-gen LTE service in something like 17 cities) and roaming agreements with each other and with the larger carriers that give them national coverage.  Why they should be excluded from consideration is baffling.  Moreover, Dish has just announced plans to build a national 4G network (take that, DOJ claim that entry is just impossible here!).  And perhaps most important the real competition here is not for mobile telephone service.  The merger is about broadband.  Mobile is one way of getting broadband.  So is cable and DSL and WiMax, etc.  That market includes such insignificant competitors as Time Warner, Comcast and Cox.  Calling this a 4 to 3 merger strains credulity, particularly under the new merger guidelines.

Yes, particularly the point about how this merger, and the broader evolution of the industry, is about broadband. The distinctions among wireless telephony, satellite, and cable are diminishing as we see convergence across the communications platforms. This is another Schumpeterian point.

Which leads to the final point that cannot be overlooked in analyzing this merger and the DOJ’s challenge of it. It’s about broadband, and thus in large part given the wireless companies involved, that means it’s about spectrum. As I argued in one of the first Knowledge Problem posts back in 2002, federal spectrum policy of the past 75 years has led to distortion, delay, rent-seeking, and political manipulation by incumbent rights holders.

Because of the politics of spectrum rights and the lack of private spectrum ownership, resources might not get to move to higher-valued uses. The FCC is not going to be as impartial a rights arbiter as the combination of well-defined spectrum ownership and a court system using the rule of law. The absence of spectrum privatization may slow or deter potentially beneficial technological change, and leaves in place a political process more prone to financial and other manipulation than one based on markets and law.

If we had alienable spectrum property rights, as Ronald Coase laid out in his spectacular 1959 article on the FCC and spectrum policy, then it’s highly likely that AT&T and T-Mobile would have alternative investment opportunities to gain more spectrum to increase their wireless broadband capacity in their stand-alone networks. Failing that, as a consequence of our turgid spectrum policy, their most attractive feasible alternative for acquiring more spectrum rights is to merge. Do not overlook the effects of poor spectrum policy on the business models of these companies. This is a Coasian point. And, to make a related Doug North point, institutions matter. I made this point initially in March when the merger was first announced.

Being an optimist, let me invoke Jerry Ellig’s point about the DOJ challenge:

For once, the high-profile action everyone pays attention to will occur in an antitrust forum where the decision criterion is the effects of the merger on consumer welfare, period. Regardless of what one thinks about the merger, it’s nice to see that we’ll finally have a knock-down, drag-out fight based on whether a big telecommunications merger harms consumers and competition.  That’s the antitrust standard the Department of Justice has to satisfy in order to prevent the merger.

And to do that it’s going to have to engage these spectrum policy issues, which it has thus far not done.

I am far from expert on all of these issues, so for more I commend to your attention this post from Josh Wright on how the DOJ challenge affected Sprint’s share price yesterday, in addition to Geoff’s post above. Our friends at Truth on the Market and The Technology Liberation Front will be worth reading regularly as this unfolds.

Don’t bet against Netflix, at least not now

Michael Giberson

Jonathan Knee argues that Netflix is succeeding the way big media companies always have succeeded, in a time where such opportunities are less frequent than before. From The Atlantic:

The economic structure of the media business is not fundamentally different from that of business in general. The most-prevalent sources of industrial strength are the mutually reinforcing competitive advantages of scale and customer captivity. Content creation simply does not lend itself to either, while aggregation is amenable to both.

[...]

Netflix’s success in streaming video is therefore hardly paradoxical. The company sits squarely in the tradition of the most-successful media businesses: aggregators with strong economies of scale and customer captivity.

There is a lot more explication at the link.

Some economics of cable content bundling

Lynne Kiesling

Jim Surowiecki has a New Yorker column on cable bundling that does a good job of explaining some of the reasons why bundling benefits all interested parties in the transaction — the cable provider, the content provider, and the consumer. His analysis provides several examples of comparing a policy with the most likely counterfactual, as in this discussion of a la carte pricing:

So consumer advocates have been pushing for a system of so-called “à la carte” programming, expecting that this would drive down prices for consumers.

In fact, it probably wouldn’t. The simple argument for unbundling is: “If I pay sixty dollars for a hundred channels, I’d pay a fraction of that for sixteen channels.” But that’s not how à-la-carte pricing would work. Instead, the prices for individual channels would soar, and the providers, who wouldn’t be facing any more competition than before, would tweak prices, perhaps on a customer-by-customer basis, to maintain their revenue.

He then points out two consumer-focused reasons why the demand for a la carte options has never been sufficient to bring them to market. First, it’s very common for people to prefer bundles because they reduce transactions costs and search costs; second, bundles create option value for consumers (I don’t care about watching that channel right now, but I might in the future, so there’s a value to having it).

The appeal of bundling is partly that it reduces transaction costs: instead of having to figure out how much each part of a package is worth to you, you can make a blanket judgment. Bundling eliminates the problem of fretting about small expenditures, which may be one reason that flat-rate pricing is very common in the vacation industry (cruise ships, all-inclusive travel packages, and so on). It also offers what economists call option value: you may never watch those sixty other channels, but the fact that you could if you wanted to is worth something. Many consumers also perceive bundles as bargains; getting a bunch of things for one price feels like a deal, even when it’s not.

But in this era of disintermediation and ease of streaming TV and video, isn’t that likely to push consumers to want more a la carte options? Sure, and that’s why he argues that it is in the interest of cable providers and content providers to avoid the short-term profit-motivated bickering over fees (such as that between Scripps/HGTV-Feed Network and Cablevision) so they can maintain the long-term benefit of consumers who are interested in bundled goods.

Is Florida agency price gouging or just charging what the market will bear?

Michael Giberson

Last year thousands of Florida consumers called the state to complain about price gouging on gasoline after Hurricane Ike.  This year, hoteliers, gas stations, and other business owners are saying they are being price gouged by the Florida Department of Transportation.  The issue: the fee the state charges business owners who wish to appear on the blue gas, food, and lodging signs near interstate highway exits.  The state plans to increase the charges from $1,000 to a maximum of $2,500 in rural areas and $5,000 in urban areas.

“When you increase 300 and 400 percent, that’s a form of price gouging. We consider this economy to be a hurricane, truly the worst disaster that we’ve seen in the economy since our lifetime,” said Hemant Patel, Treasurer with the Asian American Hotel Association. “We understand a level of fair playing, we understand a 10 percent increase, 15 percent increase, which is fair to business and we understand the economy, but to have it 300 and 400 percent, that’s no different than me charging my hotel rates by 300 percent when we have a disaster in our area.”

According to the story:

Officials from Florida’s Department of Transportation said state lawmakers adjusted the program earlier this year so they could generate more revenue for the state’s Transportation Trust Fund. Moving forward, DOT officials will review each interchange, each year, and adjust the prices accordingly based on traffic, population, market conditions, demand, and the cost of the program.

The director of “Right of Way” for the Transportation department said, “If you think of these as advertising value, these are still the best advertising value.”

Some policy activists argue that government should be run “more like a business.” With the focus on boosting revenue, this policy change appears to be an example of what that slogan entails. But revenue maximization probably ought not be the sole goal of state policy.

  • Note, for example, the government is a business that has the capability to regulate the competition.  The more restricted the ability to install private billboards (or present other forms of information for travelers), the higher the value of appearing on the state’s blue roadside signs.  We wouldn’t want the state to maximize its revenue by excessive clamping down on other advertising.
  • More generally, policy changes by the state acting as a vendor should consider more than just private costs and benefits to the state and business owners.  The factors to be considered in adjusting rates mentions the “cost of the program,”  which probably just refers to the state’s program expenses.  But, in the ideal, the state should encompass consideration of the net costs (or benefits) to travelers and other “third parties” from constraining advertising in the way the blue highway signs do.
  • And, realizing that it is fallible in its assessments, the state may want to err on the side of permissiveness in its restrictions on alternative sources of roadside information.

With the rise of location-aware smart phones and internet-aware navigation systems, the state’s little blue signs will slowly diminish in value — useful to consumers lacking smart phones (a smaller and smaller group), consumers in cell phone “dead zones,” and to all consumers during emergencies which disrupt communications services.

Perhaps the state is just trying to grab some extra revenue from the program while it can, before technology renders it mostly meaningless.

Shane Greenstein on remote connectivity

Lynne Kiesling

My colleague Shane Greenstein does very interesting work on industrial organization and networks in Internet-related industries. These insights also bubble up when he is reflecting on his personal experience in his recent family holiday travels, as related on his blog. Here he relates what they found on their recent travels to northern Wyoming, one of my favorite places on the planet; part economics, part sociology, part travel essay, this is an excellent read.