Sirius/XM: An Antitrust Problem?

Keith Sharfman —  28 June 2006

After scoffing for months at the suggestion that satellite radio firms Sirius and XM should merge, Sirius CEO Mel Karmazin admitted this week that it’s something he’d like to see happen but expressed doubts about the antitrust authorities permitting the deal to go through. See stories here and here.

Karmazin is right that the proposed Sirius/XM merger presents some antitrust issues. But he may be wrong in thinking that the issues are insurmountable.

Take the issue of product market definition. Karmazin appears ready to concede that the relevant product market is satellite radio and that Sirius and XM are duopolists who by merging would become a monopoly. But why concede that? Satellite radio competes with regular radio for listeners. And many cars are now equipped with television and dvd players, which passengers (though not drivers) can watch. iPods can be hooked up to car speakers. And it is only a matter of time before Internet content (including audio streaming) will be widely available via portable wireless devices that are usable in cars. Satellite is just one medium among many through which it is possible to transmit content. And the market for audio content is quite thick, with Sirius and XM holding only a small combined share.

Even assuming that the agencies will define the product market narrowly to include only satellite does not end the inquiry. Neither XM nor Sirius nor a combined Sirius/XM can stop anyone else from supplying content via the satellite medium. There isn’t a discernible barrier to entry here. So if Sirius/XM raises prices unduly, one would have reason to expect entry into the satellite medium by other firms.

Another point to emphasize is the efficiencies associated with the merger, which would create an entirely new product for which there is clearly some demand. There are doubtless many Sirius subscribers who would like to hear some XM content and vice versa. Now the only way to do that is to buy two sets of hardware and subscribe to both. For these consumers at least, things would be better if they could buy all the content they want from a single provider. And in this sense at least, the merger would be unambiguously pro-consumer.

One final point: even short of a merger, it may still be possible for the two firms to facilitate “one stop shopping” for content by means of cross-licensing agreements permitting each firm to sell the other firm’s content to its own subscribers. But if this is permitted, then wouldn’t it be pointless to block a full blown merger?

18 responses to Sirius/XM: An Antitrust Problem?

  1. 

    Regan–I’m afraid that I can’t give you any investment advice. Very sorry about that.

  2. 

    Hey Keith,

    New to investing, but learning. I have a small amount invested in Sirius, about 2,000 shares. I just read your post, and was wondering in your opinion what WOULD happen to my shares if there were a “friendly” merger between xm & sirius in the future. Obviously it’d be good for both companies and the consumer…but what would happen to my shares exactly or most likely?

    Forgive my nieve question. From what I read recently, Sirius is gaining ground on subscriptions to XM…and are looking to be cash flow positive in 2007.

    If sirius is now at almost $5 a share and XM is at $14…would the value of my sirius shares likely go up or down with a friendly merger?

    Thanks for any info or advice, and again forgive my silly question. I am young and just starting out.

    Cheers,

    Regan

  3. 

    David:

    Thanks once again for your stimulating comments. We do indeed seem to disagree about what constitutes a barrier to entry. I am following the definition of George Stigler, who defined an entry barrier as “a cost advantage that an incumbent firm enjoys compared to entrants.� On this view, the high cost of satellites would not constitute a barrier, because entrants and incumbents face precisely the same costs, high though they may be. Exclusive dealing arrangements also would not constitute barriers under this definition, because entrants have the same costs as incumbents and are free to offer the same or better terms to Subaru et al. that XM has offered. (Remember, by the way, that Subaru always has the option to renegotiate or breach its contract with XM. I agree with you that such arrangements do not necessarily violate Section 1. Only those that unreasonably foreclose entry are problematic under Section 1. And as I say, if existing arrangements like XM’s deal with Subaru are thought to be problematic, the agencies could condition approval of the merger on an abandonment of exclusivity.)

    In terms of the regulatory barrier, we seem to agree. An entrant without a license from the FCC would in effect face infinite costs that are clearly higher than those faced by Sirius/XM. I am assuming however, and you seem to agree, that the FCC should and would grant the entrant a license. But in any case, this potential regulatory barrier is not an appropriate barrier for the agencies to consider in the context of reviewing the merger. The government can’t very well use its own blocking of future competition as a basis for objecting to a merger. To block a merger under Section 7, the government must show that the merger itself harms competition rather than the government’s own regulatory policies. And the government cannot show that here.

  4. 

    Keith, I think we have a difference of opinion over what a barrier to entry. To be clear, a barrier to entry need not be insurmountable. In my comment, I identified three potential barriers to entry: 1) “the not-insubstantial cost of launching a satellite”; 2) regulatory barriers; and 3) XM’s and Sirius’ “exclusive agreements with car manufacturers to place their receivers in cars.”

    As to the first issue, you agree that launching a satellite is “expensive” but posit that “XM and Sirius aren’t the only ones with access to satellites. Many other firms either have or could get access to satellites, and thus there are many potential entrants who in theory could supply satellite radio.” I admit my knowledge of the satellite market is limited but I am sure that the “other firms” who “have or could get access to satellites” would not provide that access to a new entrant for free. Thus, there are cost – here, cash – to either launching your own satellite or leasing the satellite radio capability from a satellite owner/operator. While this barrier is not insurmountable, it does require cash upfront, and a good amount of cash at that.

    Second are regulatory barriers. You agree that there are regulatory, that is FCC, barriers (we’ll set aside the regulatory barriers one would face in launching a satellite generally). You argue that the FCC should license a new entrant. I agree that the FCC probably should do so (the more competitors the better). But this a textbook example of a government licensing requirement, itself a textbook example of a barrier to entry. Again, not an insurmountable barrier, but a barrier nonetheless.

    Third, we have the exclusive agreements that XM and Sirius have entered into with car manufacturers. I assure you that they exist. See, for example, the XM press release regarding its agreement with Subaru at http://www.xmradio.com/newsroom/screen/pr_2006_02_09b.html. The sub-title to the press release is “Subaru to offer XM exclusively on three top-selling 2007 model vehicles.” I could post a dozen more examples, but here is the press release for XM and GM: http://www.xmradio.com/newsroom/screen/press_release_1999_06_08.html. You argue that these agreements would violate Section 1. I think these agreements do not violate Section 1. Are they not similar to, say, the agreement between McDonald’s and Coke in which McDonald’s only offers Coke soda products (soda, diet soda, etc.)? Again, I do not believe that this is an insurmountable barrier (these agreements do not last forever and I am sure GM would prefer to have three bidders instead of two) but it is a barrier to entry nonetheless.

    I do not mean to be disagreeable, but I think there are real barriers to entry to the satellite radio market. Not insurmountable barriers to be sure, but barriers nonetheless (and I would argue that some of these barriers are of some significance).

  5. 

    David:

    Thank you for commenting on my post. I don’t agree with you that the technical difficulty and expensiveness of putting satellites in the sky is a barrier to entry. I also don’t agree that any currently existing exclusive arrangements between auto manufacturers and Sirius or XM would necessarily foreclose entry by other firms. Here’s why.

    You’re right that creating satellite radio is expensive and that not just anyone can put a satellite in the sky. But XM and Sirius aren’t the only ones with access to satellites. Many other firms either have or could get access to satellites, and thus there are many potential entrants who in theory could supply satellite radio. Expensive though it may be, such entry could be financed in the same way that XM and Sirius financed their own forays into satellite radio–i.e., through subscription fees. If XM and Sirius could pay for satellites, others could too, and thus the high cost of satellites is not a “barrier” in the economic sense.

    As to exclusive contracts between Sirius/XM and auto makers, I’m first of all not aware that any exist or, if they do, what the precise terms are. But to the extent there are any such contracts foreclosing entry, they likely would violate Section 1 and thus be voidable. Moreover, any Sirius/XM merger could be approved conditionally upon relaxation of such exclusive dealing arrangements if those are truly thought to be an issue.

    The only real barrier to entry that I see here is regulatory. Any new entrant would need to be licensed by the FCC in the same way that XM and Sirius are licensed. But why wouldn’t the government license a new entrant? That seems like a much better way of fostering competition than blocking a Sirius/XM merger. Wouldn’t you agree?

  6. 

    Keith, you write that “[e]ven assuming that the agencies will define the product market narrowly to include only satellite does not end the inquiry. Neither XM nor Sirius nor a combined Sirius/XM can stop anyone else from supplying content via the satellite medium. There isn’t a discernible barrier to entry here.”

    I admit upfront that I know next to nothing about the engineering behind satellite broadcasting. Nonetheless, I would think there are some barriers to entry. First, the not-insubstantial cost of launching a satellite (i.e, the cost to build it and launch it). Second, I would think that not just anyone can launch something into orbit. Aren’t there various governmental and/or international regulations? See, for example, http://www.findarticles.com/p/articles/mi_m6007/is_2001_Wntr/ai_75622168/pg_34. (That said, the inner geek in me who used to build rockets and shoot them off in the park when I was in grade school _loves_ the idea of sending my own object into orbit.) Third, one key to the growth of both XM and Sirius are their exclusive agreements with car manufacturers to place their receivers in cars (most radio is listened to in a car).

    I don’t know enough about the particular markets or how they work to really analyze this situation, but I think your statement that “There isn’t a discernible barrier to entry here” is a bit of an overstatement.

  7. 

    Good point, Thom. The Blockbuster decision was unfortunate, though in that case the target (Hollywood) was hostile to the deal and presented antitrust arguments against the deal to the agency. My analysis of Sirius/XM presupposes that the deal would be friendly. Also, Blockbuster and Hollywood had a bigger combined share of video rental market (even if one includes Netflix and pay-per-view) than XM and Sirius have of radio (even if one excludes other media). It’s inconceivable that regular radio–which is clearly an extremely close substitute–would be excluded from the product market defintion. Whereas nothing like regular radio exists in the video rental market.

  8. 

    I agree that the product market probably should not be limited to satellite radio, but I seriously doubt the regulators would concur. After all, these are the same folks who threatened to block (and successfully thwarted) a merger between Hollywood Video and Blockbuster.

  9. 

    Excellent comment and all good points, Josh. I agree that product market definition is the central question. While there may not be a high degree of substitution between TV/DVD/CD/Ipod and satellite, I think there is certainly a great deal of substitution between regular radio and satellite. And once wireless Internet audio streaming becomes a reality, that too is likely to be a close substitute.

    On the issue of cross-licensing versus merger, you make a good point. Some of the efficiencies associated with the merger might well be achieved by cross-licensing. But not all. There would be additional and ongoing transaction costs associated with such a regime, as well as duplicative administration. And so long as cross-licensing of content isn’t happening now, I don’t see why these efficiencies wouldn’t all be considered “merger specific.” I agree that already existing cross-licensing would not be merger specific. But theoretical cross-licensing that hasn’t happened yet and may never happen in the absence of a merger should not be subtracted from the merger’s efficiencies. Seems to me that the agencies cannot prove that cross-licensing will happen if it isn’t happening already.

  10. 

    Nice post Keith. The ball game here is certainly the market definition issue and what the elasticities look like between satellite and these other alternatives. But I want to focus on what I think is a tension between your final two points. If it is true, as you suggest, that it may still be possible for the firms to achieve the “one stop shopping” content efficiencies that you mention with cross-licensing agreeements, (holding aside the normative question of whether this requirement is good for consumers) doesn’t the claim that these efficiencies are “merger specific” under the Guidelines’ analysis necessarily fail?

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