Tuesday, February 27, 2007

Urge to Merge Part 5: Market Concentration/Barrier to Entry

Once the FCC established the relevant markets and the market participants in the EchoStar/DirecTv merger proposal, it considered the "anticompetitive effects, such as higher prices, lower quality, or reduced incentives for innovation." Following the DOJ/FTC Guidelines, as well as antitrust and Commission precedent, the FCC first examined "the post-merger market concentration and the change in market concentration that is likely to result from the merger." To evaluate the merger, the FCC the used the Herfindahl Hirschman Index (HHI). It is a very simple calculation, being the sum of the squares of the market percentages of all the market participants. For example, if Company A has 10%; Company B, 20%; Company C, 30%; and Company D, 40%, the HHI calculation would yield 10**2 + 20**2 + 30**2 + 40**2 = 3,000. This would be considered to be a highly concentrated market. The increase in the index as a result of a merger would be 2*Company X * Company Y. If Company B and C were to merge, the increase in the index would be 2*20*30 = 1,200, which would set off the alarm bells to the DOJ/FTC/FCC. Under DOJ/FTC Guidelines, any index that exceeds 1,800 is considered highly concentrated (few if any competitors). In the post merger scenario, if the increase in the index exceeds 50, it is presumed that there are likely anti-competitive effects as a result of the merger. Under the EchoStar/DirecTv model, the index was calculated to be below 1,000. The FCC called the calculation "fatally flawed".

Essentially, what they tried to do was to call themselves a national provider and compared themselves to local cable providers attributing a separate national market to each cable provider. It made is appear that there was thousands of competitors. The net effect was, according to the FCC example, equivalent of saying that a Charter customer in Pasandena, California could switch service to Cablevision in New York without moving his household--silly, of course.

As stated in the Relevant Market post, the FCC rejected the idea that EchoStar and DirecTv competed on a national basis with the other market participants. The FCC ruled that they competed locally with the local cable franchises and subsequently divided the relevant geographic market into 3 segments, those with no cable service, those with low capacity cable service, and those with high capacity cable service. It was a total of 4,984 geographic markets. After recalucating the index, the FCC arrive at a mean HHI of 6,043 and a mean post merger increase of a whopping 1,163. This is the reason why the satellite radio providers don't want to go there by establishing terrestrial radio as part of the relevant product market. Once they do this, the geographic market will be ruled local by the FCC. It would be great if the FCC considered terrestrial as a whole. If we assume XM and Sirius have say 5% of the market or listeners (and neglecting the rest), the HHI would be 5**2 + 5**2 + 90**2 = 8,150. This would indicate a highly concentrated market, perhaps super concentrated. The increase to the index due to the merger is 2*5*5= 50, right on the borderline (however, the assumptions might be too high). However, considering that the market is already super concentrate, it is doubtful that the FCC would do anything to increase the concentration.

But this is not what happened in the EchoStar/DirecTv merger proposal. As previously stated, they divided the market into 3 geographic regions. This is precisely what will happen if terrestrial radio is included as part of the relevant market. It is a trap into which they must not fall. Once they start comparing individual markets, those with no terrestrial stations will have a post merger index of 10,000, the theoretical maximum. Those markets underserved by terrestrial radio with have a similar post merger index. In both of these case, the post merger increase would be high. Only in the major markets could there be a low index. Los Angeles, for example, might have a large variety of stations capable of competing with satellite radio (We hear that Country is even coming back on an HD channel). In this case, the index could be low.

If they keep the relevant product market and market participants on a national basis, it has a chance of remaining national. For example, let's say that the market participants and product market is internet (or broadband of some sort) and cell phone providers. In this case, the person in California would have several choices of providers, both broadband and cell phone provided content. It's true that these options would still exist with terrestrial included, but if terrestrial is included, it would be considered the primary competition and this will be the primary comparison. All others will show insignificant market concentration in comparison.

The FCC next considered the "barriers to entry".

If entry is sufficiently easy, new entrants will likely render unprofitable any attempted post-merger price increase. The Guidelines explain thatentry is sufficiently easy to deter post-merger price increases "if entry would be timely, likely, and sufficient in magnitude, character, and scope to deter or counteract the competitive effects of concern." The Guidelines explain that entry will be considered "timely" only if it "can be achieved within
two years from initial planning to significant market impact."

If terrestrial is included, then the barrier is high for a local station to enter the market compared to any return than might be gain relative to a price increase by the satellite radio provider. Satellite radio is next to irrelevant to terrestrial. In reality, terrestrial radio would not react to a price increase by satellite radio. On the other hand, if it is excluded, then the comparison might be to internet (broadband) and the cell phone providers. Here the barrier to entry is low, especially for internet providers. Although a cell phone network is expensive to build out, adding audio services by a third party is not. There are a number of options to cell phone providers. If iPods, MP3 players, and CD players are included in the relevant market, it could act as a price control on satellite radio, but since most consumers find it undesireable to program their on content, it is not a true option. It would be prohibitively expensive for another satellite radio provider to enter the market, even it spectrum were available.

[soapbox]Quite honestly, we have a problem using a broad definition of relevant product market. Internet radio is no substitute for satellite radio. Satellite radio is primarily a mobile service. The internet just can't compete there. It is not ubiquitous. Perhaps it solves the home and office concerns, but it does not address the primary function of satellite radio as a mobile service. Likewise, MP3 players, iPods, and CD are not suitable substitutes. They lack the spontaneity of satellite radio. Cost is a barrier of entry for all of these, plus the cost of the media to provide a similar diversity. In addition, they can't provide weather and traffic, sports, or news programming, at least not without a lot of work by the consumer. All these things we had available as choices, yet we chose satellite radio. There is something about knowing what is coming up next that goes against the gain. The only true substitute for satellite radio is another satellite radio provider--and a merger of the only two providers makes a monopoly.[/soapbox]

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1 comment:

Anonymous said...

Do you work for the NAB? I find it hard to believe that you are unable see any competitive forces at work against satrad, beyond the two rivals. Wifi is spreading, which enables Internet radio. MP3 players with large harddrives essentially allow users to program their own radio stations and are increasingly being installed in automobiles. There is plenty of competition to satrad that did not exist 10 years ago. Two former FCC chairmen can see increased competition.