Wednesday, February 28, 2007

Urge to Merge Part 6: Public Interest Benefit

XM and Sirius will have to prove that the public will benefit by this merger. This is the overriding concern of the FCC. The opponents to the merger will press their arguments as public interest concerns. In the end, the FCC did not find the EchoStar/DirecTv merger in the best interest of the public:

The Applicants have failed to meet their burden of proof to show that, on balance, the proposed merger is in the public interest. In this case, the record indicates that substantial potential public interest harms may result from the transaction, which in turn creates the need for Applicants to demonstrate that substantial and cognizable merger-specific public interest benefit will flow from the combination. The record before us irrefutably demonstrates that the proposed transaction would eliminate a current viable competitor from every market in the country, whether those markets are currently served by cable systems or are markets in which no cable systems exist, at best resulting in a merger to duopoly, and at worst a merger to monopoly. It would combine two DBS competitors who are currently fairly evenly balanced in terms of the assets necessary for effective competition in the MVPD market. Each has, over a number of years, at great expense, acquired the necessary spectrum licenses, developed and deployed the necessary equipment (satellites, earth stations, and consumer premises equipment), developed the necessary resources for marketing and consumer support, and acquired a substantial base of customers. Perhaps most significantly, each holds licenses for approximately half the total available orbital slots that allow broadcast to the entire continental United States - licenses they seek in this proceeding to transfer to a single new entity. Accordingly, the barrier to entry for any entity seeking to compete in the market for satellite provision of MVPD service would be enormous. Sufficient widespread entry into MVPD markets via terrestrial wireless and wireline platforms, at least within the next two years, is not substantially easier in [that?] respect.

It will be incumbent on XM and Sirius to explain the public benefit. The FCC evaluated the proposed EchoStar/DirecTv merger according to the following points:

1) Claimed benefits must be merger-specific; i.e., the claimed benefits must be likely to be accomplished as a result of the merger but unlikely to be realized by other means that entail fewer anticompetitive effects.

2) Claimed benefits must be verifiable.

3) Benefits are generally counted only to the extent that they can mitigate any anticompetitive effects of the merger.

4) The Commission applies a sliding scale approach to evaluating potential benefits, under which it will require applicants to demonstrate that claimed benefits are more likely and more substantial, the greater the likelihood and magnitude of potential harms.

The proposed benefits of the merger, taken from several documents, are:

a) Vigorous longterm competition in the audio entertainment market

b) More choice for the consumer - A la carte programming

c) Intentions to provide more commercial free music channels, sports, talk radio, etc., and the most advance traffic and weather available

d) The combined company will ultimately be able to eliminate duplicative programming and could use the extra bandwidth to offer enhanced public interest programming, particularly more diverse programming that targets under-served communities.

e) Satellite radio has enormous fixed costs, as demonstrated by the $6 billion in accumulated combined losses of the two companies. Improved efficiencies will allow the new company to reduce costs and deliver a better product to current and future satellite radio subscribers.

f) Strong platform for future innovation

Lets see how these stack up against how the FCC will likely evaluate them.

Claim a. Vigorous longterm competition in the audio entertainment market: Satellite already vigously competes in the audio entertainment market, regardless of the merger. The mere fact that terrestrial is now pushing HD radio is a result of competition from satellite radio. It is not
merger specific, so it fails point 1. They will have to show how the combined companies competes more vigorously in the audio entertainment market and how this is a public benefit. This is very tricky. The FCC found that if the EchoStar/DirecTv merger were more competitive with cable and simply meant that they were able to take customers away from cable, then it wasn't a public good. In other words, if they profited at the expense of cable, then it wasn't a public good. Likewise, if the combined company is able to steal listeners from terrestrial because they are better able to compete, it isn't a net gain for the public. It would also seem to fail point 4. If the market becomes more concentrated as a result of the merger, it is a hard argument to make that it offsets any anticompetitive effect. Consequently, it will be difficult to verify that
this will be true; therefore, it fails point 2.

Claim b. More choice for the consumer - A la carte programming: This could be a public good. If, for example, subscribers are able to receive MLB and the NFL, Stern and O&A, Martha and Oprah, all for the same price, then, yes, the public could benefit from this. We are extremely skeptical of a la carte programming. It means to us that they will extract more money out of subscribers. If it costs subscribers more without delivery more content than the combined services offer today, then it is not a public good. Logically, we should pay no more for the combined services. A subscription fee of $12.95 should cover the combined services. Any a la carte selection should be less expensive. If that is the case, then we might agree. We would love to be able to select only the music channels and pay less money. The big question is, how will they give the public more choices with the old receivers. We have a combined total of six receivers with one on a five year plan. It would seem to us that the vast majority of subscribers, in fact no currents subscribers- would benefit without paying out a lot more money. It only passes point 1 if they can get around the hardware limitation. It has the potential to be a public good. We need to hear more.

Claim c. Intentions to provide more commercial free music channels, sports, talk radio, etc., and the most advance traffic and weather available: The road to hell was paved with good intentions. Fails point 2. Would likely fail point 4.

Claim d. The combined company will ultimately be able to eliminate duplicative programming and could use the extra bandwidth to offer enhanced public interest programming, particularly more diverse programming that targets under-served communities: This was and is the great promise of satellite radio. Both services are bandwidth constrained. However, these benefits are in the future. The FCC will not consider it if it is more that 12 months off, if we are not mistaken. Although it is certainly true, it will likely fail point 2 and point 4 because it is so far off. The
bandwidth is also likely to be a problem with the FCC. As stated, both are bandwidth constrained. Both are developing hierarchical modulation (HM) techniques that will allow them to pack more in their allotted bandwidth. With the combination of bandwidth and the elimination of duplicative programming, they will have extra bandwidth for additional programming; however, they will be less likely to implement HM. They may decide that rather than going to the expense of implementing HM, they will just use the bandwidth that was freed up. EchoStar/DirecTv lost this argument. To not use the bandwidth as efficiently as possible is a public detriment. The FCC will count this against them if they are convinced that the combined companies are less likely to use their bandwidth less efficiently. One remedy would be to remove one of the licenses. It has the potential to be a public good, but it also has the potential to be a public harm. The following the text from the EchoStar/DirecTv merger proposal:

An additional problem with the Applicants' efficiency claims is that they ignore the
possibility that, because the merged entity will possess more spectrum, it will use it less efficiently than would EchoStar and DirecTV individually absent the merger. In particular. the merger may affect the incentive of the merged entity to adopt new, more productive technology, which in turn could affect how efficiently the spectrum will be used. The reason that the merged entity may be less willing to invest in productivity-enhancing technology is that the marginal value of a firm's spectrum will decline as the total amount of spectrum it controls increases. This suggests that, if as a result of the merger, New EchoStar doubles the amount of spectrum it controls, it will have a reduced incentive to invest in productivity enhancing technology. We note, in this regard, that the Applicants themselves have acknowledged the diminishing marginal value of the recovered spectrum. Thus, from a social welfare point of view, the merged entity may select a technology that is less efficient than it would select if each separate DBS competitor controlled less spectrum resulting in a public interest harm rather than a benefit.


XM and Sirius will have to address this issue. What seems like a public good can easily be turned into a public harm. They will also be asked to consider if the elimination of duplicative program could be done in other ways. The opponent of the merger brought up the following:

196. Opponents, while conceding that the merger could eliminate duplicative programming,
respond that consolidating channel delivery and eliminate duplicative programming could he achieved through less anticompetitive means. For example, some Opponents suggest that DirecTV and EchoStar could form a joint venture to share channel uplinks and downlinks and use compatible set-top boxes that could receive programming from either company's satellites and that the spectrum efficiencies are therefore not merger specific.


It could very well fail point 1. XM and Sirius could indeed form a joint venture and have interoperable radios. They should have had interoperable radios long ago. Look for their opponents to gig them on that. It will be one of many examples that will be given where their
opponents will say that they have flaunted their licenses.

Claim e. Satellite radio has enormous fixed costs, as demonstrated by the $6 billion in accumulated combined losses of the two companies. Improved efficiencies will allow the new company to reduce costs and deliver a better product to current and future satellite radio subscribers. It is perhaps worthwhile to cite the entire section of the FCC analysis on the Cost benefits. The FCC did not accept this argument by EchoStar/DirecTv:

2. Cost Savings

206. The Applicants claim that the merger will generate significant cost savings of
REDACTED per year or REDACTED. First, they assert that the merger will result in a reduction of REDACTED in subscriber acquisition costs (SAC). which represents a reduction in the cost of adding an additional customer of REDACTED. The Applicants break down the reduction in SAC into the following categories: reduced piracy costs of REDACTED (resulting from increased signal security made possible by the shift to a single DBS service platform), increased efficiency of installation for a savings of REDACTED, incremental volume discounts from hardware manufacturers and suppliers amounting to REDACTED, and savings in marketing. advertising and distribution of REDACTED.

Second, the Applicants also claim that the availability of local programming, plus other enhancements will reduce customer churn and save a total of REDACTED. Third, they claim that by merging, the parties will be able to realize a REDACTED reduction in programming costs which amount to a total savings of REDACTED. Fourth, the Applicants claim savings of REDACTED resulting from reductions in general and administrative expense. Finally. they assert that the merger will permit them to reduce capital expenditures by REDACTED. Opponents dispute these projected cost savings and the claim that they will be passed on to consumers. NAB suggests that the high post-merger concentration makes it unlikely that the merged entity will pass any cost savings on to consumers. NRTC and Pegasus further claim that the additional costs associated with the merger make it unlikely that the merged entity will pass along any cost savings to consumers. NRTC and Pegasus also argue that reduced customer churn should not be considered an efficiency, because it is the result of the elimination of competition. NAB claims that the Applicants failed to include any empirical data to support their claims and that the efficiency gains would be in fixed costs, which are less likely to off-set the competitive harms resulting from the merger. In response to the Applicants' July 5. 2OO2 Ex Parte presentation, NRTC questions the Applicants' claimed reduction in programming costs. NRTC claims this is not a true economic efficiency and even if realized might nor even represent volume discounting REDACTED.'"

207. Discussion: We find a number of issues and problems with the Applicants' efficiencies
showing. These issues and problems cause us to conclude that the Applicants have failed to adequately support their claims that the merger will result in significant cost savings. We discuss each of these issues in turn.

208. First, the Applicants have claimed several efficiencies that do not appear to be merger-specific and therefore are not cognizable. For example, the Applicants claim that the merged firm will require over 30 million new set-top boxes and that the cost per box will decline significantly REDACTED due to economies of scalc in production. They then claiim that the reductions in the costs of the set-top boxes represent an efficiency of the merger. To demonstrate that claimed volume-based cost savings are merger-specific, however, the Applicants must demonstrate that the cost savings result from the increased demand of the single merged entity. rather than from any increase in the entire industry demand. The Applicants have made no such demonstration. Moreover, they have not even alleged that
the cost savings could not result absent the merger because the components used by EchoStar and DirecTV individually are not sufficiently similar. Thus, for example, if set-top box manufactures would use the same computer chips and hard drives, regardless of whether the parties merged, then any volume-related cost savings resulting from the growth in total market demand would not be deemed merger specific. Similarly, the Applicants cite several factors for the reduced churn that contributes significantly to their total projected costs savings. It is not clear. however that one of the factors contributing to reduced chum - the adoption of "best practices at call center", service centers, and on installations - is merger specific. Likewise, the Applicants claim that churn will be reduced because the merged entity
will be able to offer a bundled MVPD broadband product. As dihcussed below, however, it is not clear that the ability to bundle broadband service with DBS service is merger-specific.

209. Second, many of their other claimed cost savings appear to be either speculative or
lacking in credibility. For example, according to the Applicants' own estimates, a significant percentage of the claimed cost savings will not accrue before 2006. As previously indicated, benefits that are projected to occur only in the relatively distant future are normally discounted because they are inherently less certain. This speculative nature of future benefits becomes particularly problematic if it is claimed, as Applicants do here, that certain benefits will continue into perpetuity. Specifically, the Applicants apply a terminal multiple of REDACTED, which 1s intended to measure the "going forward" value of cash flow for all benefits efficiencies that are present in year 2007. By applying this terminal multiple,
Applicants are basically claiming that the year 2007 efficiencies will continue forever. Claiming perpetual cost savings would always raise credibility issues, but those concerns are increased here, since some of the claimed cost savings appear to be of a limited duration. For example. the Applicants assumed that the merger would yield a reduction in piracy COst of REDACTED per gross add in the first year and REDACTED per gross add in each year thereafter, for a total savings of REDACTED in piracy costs. The projected reduction in piracy costs, however, is premised on changes in the conditional access software that will be implemented with the box swap. While this change in conditional access may initially reduce piracy, it is not at a ll clear that the incidence of piracy will not begin to rebound.

210. In other cases, the Applicants either have clearly exaggerated the likely cost savings or
have simply failed to provide adequate justification for their efficiency estimates. For example, the Applicants have not adequately substantiated their claimed savings in programming costs. In particular, they have not demonstrated that programming costs will necessarily fall to the extent they predict based on the merged entity’s larger subscriber base. We note in this regard that the record indicates that REDACTED. Similarly, they have not provided sufficient evidence to support their claimed installation efficiencies and distribution efficiencies or the cost reductions associated with reduced churn. In addition, the Applicants frequently fail to distinguish claimed cost savings that would result in a reduction in marginal cost from cost savings that would result in a reduction in fined cost. For example, it is not clear whether the Applicants’ projected savings in advertising, marketing, and distribution, which it claims will contribute to a significant reduction in SAC represents savings in marginal cost or fixed cost.

211. In addition, the Applicants’ analysts of cost savings takes the form of a business case
analysis, rather than a welfare analysis that speciLcdly considers whether claimed cost reductions result in net increases in social surplus, which can be balanced against any anticompetitive effects of the merger. Certain of the Applicants’ claimed efficiencies appear to represent no true cost savings, but rather only a transfer of surplus. For example, it appears that a portion of the claimed reduction in SAC costs actually relate to a reduction in the subsidy DirecTV and EchoSrar currently provide to retailers and new subscribers to cover part of the cost of equipment and installation. Since a reduction in the subsidy simply means that the retailer or customer will pay more, there is no cognizable efficiency gain from this
portion of SAC. Reductions in these “expenses,” rather. may he indicative of the elimination of competition and the resulting consumer harms. Similarly. we agree with NRTC and Pegasus that reductions in churn may more accurately be considered indicative of the reduction in consumer choice and so cannot be counted as a public benefit. Finally. any savings in programming costs that result from a change in bargaining power represent a
shift in surplus between programming providers and DBS operators, but not necessarily an increase in total surplus.

212. To summarize, as described above, the Applicants have failed to demonstrate that certain of the claimed efficiencies are merger-specific. Other claimed cost savings appear too speculative, while others simply are not credible. Finally, other alleged cost savings do not appear to be true efficiencies but rather represent a shift in surplus between parties without any necessary increase in social welfare. Again, as discussed above, what is important is the extent to which these lower costs lead to lower prices and can offset the reduction in competition, rather than whether the merged entity will achieve a lower cost structure as a per se matter.


This will be a difficult argument for XM and Sirius to make as well that this is a public benefit. Public welfare arguments are tricky, tricky, tricky.

Claim f. Strong platform for future innovation: This will fail point 2. There is no reason to believe that the combined companies will strive harder to make more innovative products as a result of the merger. The healthy competition between the two has given us the wonderful products that we enjoy today. This simply is not credible.

One could make a few substitutions here and have to the citation that began this post and make the FCC case against the satellite radio merger:

The Applicants have failed to meet their burden of proof to show that, on balance, the
proposed merger is in the public interest. In this case, the record indicates that substantial potential public interest harms may result from the transaction, which in turn creates the need for Applicants to demonstrate that substantial and cognizable merger-specific public interest benefit will flow from the combination. The record before us irrefutably demonstrates that the proposed transaction would eliminate a current viable competitor from every market in the country, whether those markets are currently served by internet radio, cell phone providers, terrestrial radio or are markets in which no service exist, at best resulting in a merger to duopoly, and at worst a merger to monopoly. It would combine two satellite radio competitors who are currently fairly evenly balanced in terms of the assets necessary for effective competition in the SDARS market. Each has, over a number of years, at great expense, acquired the necessary spectrum licenses, developed and deployed the necessary equipment (satellites, earth stations, and consumer premises equipment), developed the necessary resources for marketing and consumer support, and acquired a substantial base of customers. Perhaps most significantly, each holds licenses for half the total available bandwidth that allow broadcast to the entire continental United States - licenses they seek in this proceeding to transfer to a single new entity. Accordingly, the barrier to entry for any entity seeking to compete in the market for satellite provision of SDARS service would be enormous. Sufficient widespread entry into MVPD markets via terrestrial wireless and wireline platforms, at least within the next two years, is not substantially easier in that respect.

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