Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age (15 page)

In Brian Roberts's view, as he testified in early 2010, Comcast was more than ready to take on the mantle of the world's foremost media company. The NBCU acquisition would be the icing on the cake. As John Malone told
Bloomberg News
in 2010, “Comcast is so big, there's no exit scenario. They are what they are. Nobody is going to buy Comcast, the company. It's too big.”
⁷¹
Malone's TCI cable-systems business had ended up in Comcast's hands, and he admired what Roberts had been able to do. As he told analysts in a conference call in 2011, “As always in the cable business, in my—whatever it is—40 years in it, it's all about government regulation and technological change. But for the moment, cable looks terrific. … In broadband, other than in the [Verizon] FiOS area[s], cable's pretty much a monopoly now.” Malone sounded gruffly wistful. “I never should have sold to AT&T.”
⁷²

The word
monopoly
prompted nervous laughter among Malone's colleagues. “Okay,” one of them said. “Any other questions?”

4

Going Vertical

LESSONS FROM AOL–TIME WARNER

AT THE FEBRUARY 2010 SENATE
antitrust subcommittee hearing, Colleen Abdoulah, the energetic president and CEO of WOW!, one of the small cable operators that competed with Comcast in the Midwest, expressed her worries about Comcast and NBC Universal joining forces. “It concerns me because the combined entity will have powerful abilities and incentives to hurt a competitor like ourselves and increase our costs,” she said, her animated voice a scratchy contrast to Brian Roberts's smooth impassivity.
¹

Like Comcast, WOW! is in the business of distributing video to its subscribers. But that's where the similarities end. WOW! has superb customer service—it has earned number-one rankings several times from
Consumer Reports
—and it is serving more than 475,000 customers, but it has to pay higher prices for content than the big companies do.
²
Content negotiations are crucial for any distributor trying to sell wired data and video services, Abdoulah said, and programmers—the media conglomerates—use their market power and leverage to force competing distributors to buy take-it-or-leave-it bundles at whatever price the programmer wants to charge. “What this means is low-value networks that customers do not want, and are not asking for, are associated with high-value networks that we have to have in order to compete,” Abdoulah said. Marginal channels like NBC Universal's Chiller network are bundled into packages regardless of whether the distributor wants them. There is no such thing as a market price in this context: “Many times during negotiations with both these companies and others,”
she testified, “rate increases can be … 20 percent to as high as 156 percent.” With no power to fight back and few competing programmers to play off against one another, WOW! ends up having to pay more for the programming it must have to compete—like sports and local broadcast TV stations—while wasting channel space on networks that few customers want.
³

When it was his turn to talk, Senator Al Franken (D-Minn.)—a former
Saturday Night Live
writer and performer—growled at NBC Universal's Jeffrey Zucker and Comcast's Roberts about the risks of having the same company control both content and distribution even when the company promises not to favor its own interests.

Franken's focus was on the fate of independent sources of content. Franken knew from personal observation during his time at NBC that getting a program picked up by a distributor that has an interest in making its own programming profitable can be close to impossible for an independent—notwithstanding promises from the distributor. “It is really hard to trust you guys,” he said. “Look, I have had this history where I have seen NBC and I have seen other networks promise something and then do the 180-degree turn on it.”
⁴

It used to be that the TV networks were not allowed to own the programming they aired, but those rules were eliminated in the 1990s.
⁵
NBC had strongly supported erasing them, saying that since it was in the network's interest to support strong independent programmers the strictures were unnecessary. But within a few years, Franken pointed out, NBC was supplying its own primetime programming, and no independent programmer was aired unless it gave up part ownership of its program. Franken's personal experience with NBC-the-broadcaster made him distrust the idea that a distributor could safely be combined with a programmer: “When the same company that produces the programs runs the pipes that bring us those programs, we have a reason to be nervous.”
⁶

Franken had fundamental concerns about the deal that ranged far beyond worries about independent programmers. Brian Roberts had called the merger “vertical,” but Franken was not confident that it was as vertical as Roberts wanted the committee to believe.

As Roberts described it, the deal would merely bring together companies in two different parts of the market. Since they did not overlap, competition
would not be compromised. NBC Universal had no distribution assets—cable systems—and Comcast had only minor programming assets—cable channels and rights to content. Combining the two, Roberts argued, would have little effect on competition because the same number of competitors would be in place after the merger as before. Comcast's cable-distribution system would not expand by virtue of the deal because NBC Universal had no cable systems; NBC Universal's content assets would remain virtually unchanged because Comcast had only modest programming assets. NBC Universal was in fourth place among the content conglomerates—ahead of News Corp. but behind Disney/ABC, Time Warner, and Viacom—and it would still be in fourth place when the deal was completed. The resulting new entity would have only about 12 percent of total revenues for national cable-programming networks.
⁷
Roberts reminded the senators of this several times. He did so for two, seemingly paradoxical, strategic reasons.

The first was that antitrust regulators have recently been much more inclined to allow vertical than horizontal mergers (such as those between two distributors), reasoning that unless the merged entity is dominant in either production or distribution, it will be unable to leverage its power in its original market into a different market. Vertical transactions do not reduce the number of competitors in either the input or the distribution markets, but horizontal mergers do: where there were two competitors in a particular marketplace, after a merger there will be just one. Also, with a vertical merger, there may be greater “efficiencies”: opportunities to save money by combining distribution with production in ways that may bring benefits to consumers.
⁸
Emphasis on the
may:
when Comcast hired the Stanford economist Gregory Rosston to assess the consumer benefits of the NBC Universal deal, he wrote that “the actual form of the consumer benefit will not necessarily be a reduction in Comcast's prices relative to current prices or prices that might otherwise be charged, but consumer benefit could also come from increased investment by Comcast in programming and distribution leading to higher quality and more consumer choice.”
⁹
In other words, prices wouldn't necessarily go down, but consumers might get access to more stuff.

The second reason for Roberts's emphasis on identifying the merger as vertical integration was that past efforts by distributors to get into
programming (or vice versa) had not worked out. Everyone testifying that day could name examples of failed vertical mergers: Time Warner had just unwound its valuable programming properties (including HBO) from the fortunes of Time Warner Cable, leaving the cable distributor free to go out on its own as a separate company.
¹⁰
DirecTV had similarly parted ways with News Corp.
¹¹
But the big story was AOL–Time Warner, whose much-touted (and much-feared) vertical-integration deal—in which AOL had purchased Time Warner in exchange for $165 billion in AOL stock—had dissolved ignominiously at the end of 2009 after ten fractious years.
¹²
The AOL–Time Warner merger had been called one of the biggest failures in American business history.

Roberts's first reason—that vertical mergers do not affect competition—argued for a light touch from regulators; the second suggested that even if the deal went through the combination might eventually fall apart, and so there was no reason for regulators to worry about its impact on the marketplace. As the University of Chicago professor Richard Epstein put it in a statement filed with the Senate Antitrust Subcommittee in March 2010: “It may well be that this merger will crater like the Time Warner/AOL deal. But that is not an antitrust concern, but a sober reminder that bigger is not always better. … [I]t is precisely because all mergers face economic pressures of self-correction that we should regulate them with a light hand.”
¹³

But there were significant differences between AOL–Time Warner and Comcast-NBCU.

When AOL and Time Warner broke up in December 2009—the same week that Comcast announced its plan to buy NBC Universal—it marked a sad end to what had seemed a match made in corporate heaven. Ten years earlier, AOL had been a new-economy powerhouse, a virtual community for early online adopters and an easy gateway to the Internet—if AOL users wanted to get there. Yet even in 1999, it could boast to potential partners that 85 percent of its users’ time was spent on AOL's own content; users rarely ventured out into the Wild West of the Web itself.
¹⁴
And AOL was huge: as the
Wall Street Journal
reporter Andy Kessler put it in 2002, “As PCs and Windows grew, so did America Online—from a million members in 1994 to 10 million in 1997. Other players, Compuserve and Prodigy,
were too stupid to keep up, and the only potential competitors were the phone companies. But phone companies thought online meant someone's sneakers hanging from their telephone wires.”
¹⁵

Steve Case, AOL's cofounder, was graying but still boyish, bright-eyed, and fast-talking when he appeared on a morning financial-news talk show in early January 2010 to discuss the AOL–Time Warner tenth anniversary. He was fitter than he had been a decade earlier and still enthusiastic about the AOL deal—or at least about the promise it had once held. The “deal still makes sense,” he insisted. “AOL helped bring the Internet to so many people.” But as the Internet spread, AOL's reliance on dial-up service was a detriment. Time Warner had seemed to have the right assets to solve Case's problem. “We needed a path to broadband,” he said. “Time Warner was the largest cable operator, and also had a lot of media businesses. They needed a path to a digital future.”
¹⁶
It seemed like a perfect pairing.

AOL's early success was made possible by regulation. Its business depended on having subscribers reach it by using their home phones; subscribers would attach a modem to their computer, connect the computer to a phone line, dial a local Telenet access number, and send data back and forth to AOL's servers. AOL took off only because the phone companies had no legal ability to block it. The common-carriage regulation, which required the phone companies to allow anyone to use their lines, was still alive and well.

Not that the phone companies didn't try to strangle online services in the cradle. In 1987, with the aid of the FCC, they nearly succeeded in imposing added fees on the transmission of data by telephone.
¹⁷
The phone companies themselves were not allowed to get into the data business as a result of the conditions imposed on the AT&T breakup, but they were angling to squash the IBM-backed Prodigy, one of the earliest online-access companies. They had convinced FCC chairman Dennis Patrick that Prodigy should pay per-minute “interstate access charges” for the privilege of being reached by the phone companies’ subscribers, on the theory that the online database companies were, in essence, playing the same role as long-distance companies: using local phone facilities to reach subscribers.

Had the phone companies succeeded, the Internet revolution would have been stalled in its tracks; the extra charges would have made Internet
access a luxury rather than a necessity. Fortunately for American innovation, they failed. In 1987, Representative Ed Markey called Chairman Patrick to a field hearing in Boston and raked him over the coals, suggesting that the FCC and its access charges would handicap the information-based infrastructure of the U.S. economy.
¹⁸
Markey was an early proponent of interactive businesses, claiming at the time that an access fee for computer users would lead to a two-tiered society: the information-rich and the information-poor.
¹⁹
Several online providers, calling themselves “videotex” services, testified that the FCC proposal would destroy their business by increasing their costs many times over.
²⁰
Without cheap, flat-rate access to local residential users, they were sunk. It was the pole-attachment fight all over again.

Chairman Patrick, for his part, argued that it would be only fair to charge the new interactive services the prices that applied to long-distance calls that took advantage of local phone company facilities, and that failing to do so might distort the natural evolution of the marketplace.
²¹
Markey didn't buy it. The local phone companies, represented by Ivan Seidenberg (then of NYNEX, later CEO of Verizon), could tell that things weren't going their way and called for a delay in the ruling. But a delay, said the videotex representatives, would also destroy them; no one would invest in their services with the cloud of potential access charges hanging over them.
²²