FCC’s Sallet: OVD Was Key to Comcast-TWC Denial

Explains reasoning behind recommendation against deal
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It does not come as a huge surprise, but FCC general counsel Jon Sallet says that the crux of the FCC media vetting team's opposition to the Comcast-Time Warner Cable deal came down to online video distribution (OVD) and the combined company's ability to "throw sand in the gears" of online video competitors.

The FCC did not release its handicapping of the deal because Comcast and Time Warner Cable withdrew their merger after they got the signal that the commission staff were recommending denial and almost certainly had the votes at the commission to follow that lead.

Because there was never an official decision, there was not an official record published, though the FCC briefed the parties on why they were getting the boot.

"[T]he core concern came down to whether the merged firm would have an increased incentive and ability to safeguard its integrated Pay TV business model and video revenues by limiting the ability of OVDs to compete effectively, especially through the use of new business models,"  said Sallet in Sept. 25 remarks to the Telecommunications Policy Research Conference, according to a prepared text supplied to B&C.

Sallet said that given that the FCC had not released its reasoning behind the denial, he would try to fill in the gaps. That included that the minimal horizontal overlap of the two companies' businesses did not equate with approval.

He talked about an over-the-top regime that was changing even as the deal was being vetted, citing Dish's Sling service and HBO and CBS stand-alone service launches and said the staffers feared a combined Comcast-TWC would try to nip those in the bud. "We understood that entrants are particularly vulnerable when competition is nascent," he said. "Thus, staff was particularly concerned that this transaction could damage competition in the video distribution industry by increasing both Comcast’s incentive and its ability to disadvantage OVDs and thus retard or permanently stunt the growth of a competitive OVD industry. In doing so, consumers would be denied the benefits that innovative competition could bring."

He said that included the concern that onerous interconnection deal terms could prevent an OVD from gaining the national distribution needed to compete with Comcast-TWC.

But the view toward the impact of the deal on OVDs was holistic, suggesting that no volume of deal conditions short of a laundry list of "thou shalt nots" would have made the combination of two of the Big Four cable and broadband companies acceptable.

"The question was not only whether a single kind of action – access to devices, or data caps or interconnection or video programming terms – by itself would degrade competition," he said. "It was also whether the merged company would possess the toolkit that would allow it to put sand in the gears of competition through the totality of its efforts."

Sallet said that, ultimately, the staff concluded that "the verifiable benefits of the proposed transactions – such as faster broadband speeds for TWC customers, cost savings, enhanced competition for business customers – were viewed by staff as incapable of outweighing the potential harms” of disadvantaging OVDs.

The following is Sallet's lengthy, but enlightening, explanation of how the FCC reached the OVD-driven decision that a Comcast-TWC meld was not in the public interest.

"An OVD that seeks to successfully compete with a traditional cable system needs a few things. It needs programming. It needs access to broadband providers’ networks and it needs to be certain that, once delivered to those networks, its video traffic will find its way to the intended consumer. It may also need access to devices used by consumers. And, it needs to ensure that consumers are not dissuaded from using its OVD services because of retail broadband terms and conditions that might raise the price of online video in a discriminatory way. The AT&T commitment [he pointed out that in the DirecTV merger that was approved, "AT&T is prohibited from excluding its affiliated video services and content from data caps on its fixed broadband connections"], addresses the potential for discrimination in the application of data caps, for example.

"The portrait of OVD business models changed markedly during the pendency of the applications and these changes sharpened the focus on potential harms to the basic building blocks of OVD services. What must have seemed publicly as a series of high-profile conflicts between Netflix and large broadband providers in the winter and spring of 2014 gave way in the fall of that year and the early months of 2015 to a new phenomenon – the emergence of a variety of business models offering different flavors of OVD services. For example, DISH’s Sling service offered so-called linear programming of the same kind offered by Pay TV systems, including ESPN. Sony announced its plan to link the supply of programming to its popular gaming console. Owners of programming, including HBO and CBS, launched standalone online services.

"The potential for increased consumer welfare as a result of these market developments was obvious – greater competition and potential competition leading to lower prices, greater output and new innovation. In other words, for the first time, multiple OVD services were launching or planning to launch services to provide consumers the ability to stream live, linear programming, including sports, as part of packages that threatened revenue streams derived from traditional Pay TV packages. In general, these new offerings may allow consumers to purchase smaller bundles or view current programming without the need for a contract with a cable company containing the traditional bundle or a traditional set-top box.

"We understood that entrants are particularly vulnerable when competition is nascent. Thus, staff was particularly concerned that this transaction could damage competition in the video distribution industry by increasing both Comcast’s incentive and its ability to disadvantage OVDs and thus retard or permanently stunt the growth of a competitive OVD industry. In doing so, consumers would be denied the benefits that innovative competition could bring.

"We looked at theory and we looked at facts and we arrived at a series of important conclusions about the nature of the marketplace and competition.

"First, we concluded that the following was not outcome-determinative: that there was minimal horizontal overlap between the Applicants in the local markets for residential broadband and Pay TV services. This is important. At the outset of the merger review, some commenters said there could be no competitive issue given the lack of horizontal competition in those markets. But we concluded that assessment of the net impact of the proposed transaction required a wider aperture.

"Second, we determined that our analysis needed to take into account the fact that both firms participated in national distribution markets, one for broadband distribution and another for Pay TV distribution. While the merging parties did not compete directly in the distribution of programming to consumers in local markets, OVDs do seek to distribute programming throughout the U.S., and negotiate for nationwide distribution rights. The ability of the larger merged firm to limit OVD distribution of programming nationwide, for example by negotiating contractual provisions that inhibited an OVD’s ability to obtain nationwide online distribution rights, was carefully examined. Similarly, we also considered a national market for interconnection in which ISPs negotiate with OVDs (and their content delivery networks) over the terms by which the OVDs would reach consumers. Post-transaction, an OVD might have needed an interconnection agreement with the merged entity in order to achieve national distribution, so we also considered the ability of the merged company to impose terms that would disadvantage the OVD.

"Third, staff concluded that, with these markets in mind, the combination of video and broadband distribution assets could increase the merged entity's incentives and abilities to take actions against rivals that would pose a competitive threat to online video entry – that is, current and potential competition. Increased incentives are a direct result of the increased footprint of the merged firm. Without the merger, a company taking action against OVDs for the benefit of the Pay TV system as a whole would incur costs but gain additional sales – or protect existing sales – only within its footprint. But the combined entity, having a larger footprint, would internalize more of the external “benefits” provided to other industry members.

"Alongside incentives came ability. Increased bargaining power was the central concern. The combination of distribution assets had the potential to increase the merged entity's bargaining power in both national markets – the market where video distributors negotiate the terms and conditions to distribute video content for programmers and the interconnection market through which broadband providers provide mass-market delivery services to OVDs. Because OVDs are subject to national economies of scale, the merged company could significantly impair an OVD’s ability to compete.

"Consider the circumstance of a new OVD. Success, and the scale necessary for success, might not require access to every consumer in the country, but foreclosure from big swaths of the nation could erect a significant barrier to OVD entry. Suppose there were two cable companies supplying broadband services, East and West, each with 50% of the nation and imagine that an OVD could be financially successful by reaching 50% of American households. Prior to a merger of East and West, an OVD would be successful if it was able to compete in either territory. Having two alternative interconnection partners gives an OVD the potential ability to play Cable East and Cable West off each other. But after a merger, that OVD would have to strike a bargain with only one firm, which would give that company the ability to disadvantage the OVD, or perhaps even exclude the OVD from reaching its subscribers.

Fourth, we looked at how any greater ability might be used, and here we came to another, separate conclusion. The effects of the transaction on the national markets for video programming and interconnection were significant in our analysis, each considered independently. But we also considered them among the other levers available to the merged firm that, combined, presented a risk of competitive harm. For example, we considered their competitive effect when combined with data caps and other retail broadband terms and conditions that raised the price of OVDs for consumers.

"Staff consideration of the cumulative impact of these levers on competition is itself a critical point. The question was not only whether a single kind of action – access to devices, or data caps or interconnection or video programming terms – by itself would degrade competition. It was also whether the merged company would possess the toolkit that would allow it to put sand in the gears of competition through the totality of its efforts. Indeed, for strategic reasons, an entity might have an incentive to spread the effects of anticompetitive actions across multiple forms of actions, and shift their impact over time, in order to attempt to avoid effective monitoring of their impact. Staff did not believe that its concerns could be remedied through conditions.

"Finally, the verifiable benefits of the proposed transactions – such as faster broadband speeds for TWC customers, cost savings, enhanced competition for business customers – were viewed by staff as incapable of outweighing the potential harms. Unlike AT&T/DIRECTV, this was not a transaction in which additional competitive choices would flow to consumers. But as in AT&T/DIRECTV, the staff assessed all of these competition issues in light of consumers’ limited broadband alternatives, particularly at higher download speeds. As the Department of Justice noted, in language equally applicable to the FCC staff perspective, “the transaction would [have left] Comcast with close to 60 percent of all high-speed broadband subscribers in the United States, strengthening its ability to block the adoption of innovative products, including ‘over-the-top’ video services that threaten the traditional cable business model.”

"The FCC staff, with the Chairman’s concurrence, presented these theories and concerns to the Applicants explaining the reasons that they had not met their burden of demonstrating that approval of the transactions was in the public interest, and inviting further dialogue. After listening to the concerns outlined here, as well as important factual analysis that cannot be discussed publicly due to the restraints of confidentiality, the Applicants abandoned the proposed transactions. Thus, the Commission’s work remains incomplete but, perhaps like Dickens’ unfinished work “The Mystery of Edwin Drood,” the staff’s views may be of interest to lawyers, economists and the public generally."

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