Archives For OVD

On Friday the the International Center for Law & Economics filed comments with the FCC in response to Chairman Wheeler’s NPRM (proposed rules) to “unlock” the MVPD (i.e., cable and satellite subscription video, essentially) set-top box market. Plenty has been written on the proposed rulemaking—for a few quick hits (among many others) see, e.g., Richard Bennett, Glenn Manishin, Larry Downes, Stuart Brotman, Scott Wallsten, and me—so I’ll dispense with the background and focus on the key points we make in our comments.

Our comments explain that the proposal’s assertion that the MVPD set-top box market isn’t competitive is a product of its failure to appreciate the dynamics of the market (and its disregard for economics). Similarly, the proposal fails to acknowledge the complexity of the markets it intends to regulate, and, in particular, it ignores the harmful effects on content production and distribution the rules would likely bring about.

“Competition, competition, competition!” — Tom Wheeler

“Well, uh… just because I don’t know what it is, it doesn’t mean I’m lying.” — Claude Elsinore

At root, the proposal is aimed at improving competition in a market that is already hyper-competitive. As even Chairman Wheeler has admitted,

American consumers enjoy unprecedented choice in how they view entertainment, news and sports programming. You can pretty much watch what you want, where you want, when you want.

Of course, much of this competition comes from outside the MVPD market, strictly speaking—most notably from OVDs like Netflix. It’s indisputable that the statute directs the FCC to address the MVPD market and the MVPD set-top box market. But addressing competition in those markets doesn’t mean you simply disregard the world outside those markets.

The competitiveness of a market isn’t solely a function of the number of competitors in the market. Even relatively constrained markets like these can be “fully competitive” with only a few competing firms—as is the case in every market in which MVPDs operate (all of which are presumed by the Commission to be subject to “effective competition”).

The truly troubling thing, however, is that the FCC knows that MVPDs compete with OVDs, and thus that the competitiveness of the “MVPD market” (and the “MVPD set-top box market”) isn’t solely a matter of direct, head-to-head MVPD competition.

How do we know that? As I’ve recounted before, in a recent speech FCC General Counsel Jonathan Sallet approvingly explained that Commission staff recommended rejecting the Comcast/Time Warner Cable merger precisely because of the alleged threat it posed to OVD competitors. In essence, Sallet argued that Comcast sought to undertake a $45 billion merger primarily—if not solely—in order to ameliorate the competitive threat to its subscription video services from OVDs:

Simply put, the 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.…

Thus, at least when it suits it, the Chairman’s office appears not only to believe that this competitive threat is real, but also that Comcast, once the largest MVPD in the country, believes so strongly that the OVD competitive threat is real that it was willing to pay $45 billion for a mere “increased ability” to limit it.

UPDATE 4/26/2016

And now the FCC has approved the Charter/Time Warner Cable, imposing conditions that, according to Wheeler,

focus on removing unfair barriers to video competition. First, New Charter will not be permitted to charge usage-based prices or impose data caps. Second, New Charter will be prohibited from charging interconnection fees, including to online video providers, which deliver large volumes of internet traffic to broadband customers. Additionally, the Department of Justice’s settlement with Charter both outlaws video programming terms that could harm OVDs and protects OVDs from retaliation—an outcome fully supported by the order I have circulated today.

If MVPDs and OVDs don’t compete, why would such terms be necessary? And even if the threat is merely potential competition, as we note in our comments (citing to this, among other things),

particularly in markets characterized by the sorts of technological change present in video markets, potential competition can operate as effectively as—or even more effectively than—actual competition to generate competitive market conditions.

/UPDATE

Moreover, the proposal asserts that the “market” for MVPD set-top boxes isn’t competitive because “consumers have few alternatives to leasing set-top boxes from their MVPDs, and the vast majority of MVPD subscribers lease boxes from their MVPD.”

But the MVPD set-top box market is an aftermarket—a secondary market; no one buys set-top boxes without first buying MVPD service—and always or almost always the two are purchased at the same time. As Ben Klein and many others have shown, direct competition in the aftermarket need not be plentiful for the market to nevertheless be competitive.

Whether consumers are fully informed or uninformed, consumers will pay a competitive package price as long as sufficient competition exists among sellers in the [primary] market.

The competitiveness of the MVPD market in which the antecedent choice of provider is made incorporates consumers’ preferences regarding set-top boxes, and makes the secondary market competitive.

The proposal’s superficial and erroneous claim that the set-top box market isn’t competitive thus reflects bad economics, not competitive reality.

But it gets worse. The NPRM doesn’t actually deny the importance of OVDs and app-based competitors wholesale — it only does so when convenient. As we note in our Comments:

The irony is that the NPRM seeks to give a leg up to non-MVPD distribution services in order to promote competition with MVPDs, while simultaneously denying that such competition exists… In order to avoid triggering [Section 629’s sunset provision,] the Commission is forced to pretend that we still live in the world of Blockbuster rentals and analog cable. It must ignore the Netflix behind the curtain—ignore the utter wealth of video choices available to consumers—and focus on the fact that a consumer might have a remote for an Apple TV sitting next to her Xfinity remote.

“Yes, but you’re aware that there’s an invention called television, and on that invention they show shows?” — Jules Winnfield

The NPRM proposes to create a world in which all of the content that MVPDs license from programmers, and all of their own additional services, must be provided to third-party device manufacturers under a zero-rate compulsory license. Apart from the complete absence of statutory authority to mandate such a thing (or, I should say, apart from statutory language specifically prohibiting such a thing), the proposed rules run roughshod over the copyrights and negotiated contract rights of content providers:

The current rulemaking represents an overt assault on the web of contracts that makes content generation and distribution possible… The rules would create a new class of intermediaries lacking contractual privity with content providers (or MVPDs), and would therefore force MVPDs to bear the unpredictable consequences of providing licensed content to third-parties without actual contracts to govern those licenses…

Because such nullification of license terms interferes with content owners’ right “to do and to authorize” their distribution and performance rights, the rules may facially violate copyright law… [Moreover,] the web of contracts that support the creation and distribution of content are complicated, extensively negotiated, and subject to destabilization. Abrogating the parties’ use of the various control points that support the financing, creation, and distribution of content would very likely reduce the incentive to invest in new and better content, thereby rolling back the golden age of television that consumers currently enjoy.

You’ll be hard-pressed to find any serious acknowledgement in the NPRM that its rules could have any effect on content providers, apart from this gem:

We do not currently have evidence that regulations are needed to address concerns raised by MVPDs and content providers that competitive navigation solutions will disrupt elements of service presentation (such as agreed-upon channel lineups and neighborhoods), replace or alter advertising, or improperly manipulate content…. We also seek comment on the extent to which copyright law may protect against these concerns, and note that nothing in our proposal will change or affect content creators’ rights or remedies under copyright law.

The Commission can’t rely on copyright to protect against these concerns, at least not without admitting that the rules require MVPDs to violate copyright law and to breach their contracts. And in fact, although it doesn’t acknowledge it, the NPRM does require the abrogation of content owners’ rights embedded in licenses negotiated with MVPD distributors to the extent that they conflict with the terms of the rule (which many of them must).   

“You keep using that word. I do not think it means what you think it means.” — Inigo Montoya

Finally, the NPRM derives its claimed authority for these rules from an interpretation of the relevant statute (Section 629 of the Communications Act) that is absurdly unreasonable. That provision requires the FCC to enact rules to assure the “commercial availability” of set-top boxes from MVPD-unaffiliated vendors. According to the NPRM,

we cannot assure a commercial market for devices… unless companies unaffiliated with an MVPD are able to offer innovative user interfaces and functionality to consumers wishing to access that multichannel video programming.

This baldly misconstrues a term plainly meant to refer to the manner in which consumers obtain their navigation devices, not how those devices should function. It also contradicts the Commission’s own, prior readings of the statute:

As structured, the rules will place a regulatory thumb on the scale in favor of third-parties and to the detriment of MVPDs and programmers…. [But] Congress explicitly rejected language that would have required unbundling of MVPDs’ content and services in order to promote other distribution services…. Where Congress rejected language that would have favored non-MVPD services, the Commission selectively interprets the language Congress did employ in order to accomplish exactly what Congress rejected.

And despite the above noted problems (and more), the Commission has failed to do even a cursory economic evaluation of the relative costs of the NPRM, instead focusing narrowly on one single benefit it believes might occur (wider distribution of set-top boxes from third-parties) despite the consistent failure of similar FCC efforts in the past.

All of the foregoing leads to a final question: At what point do the costs of these rules finally outweigh the perceived benefits? On the one hand are legal questions of infringement, inducements to violate agreements, and disruptions of complex contractual ecosystems supporting content creation. On the other hand are the presence of more boxes and apps that allow users to choose who gets to draw the UI for their video content…. At some point the Commission needs to take seriously the costs of its actions, and determine whether the public interest is really served by the proposed rules.

Our full comments are available here.

Last week, FCC General Counsel Jonathan Sallet pulled back the curtain on the FCC staff’s analysis behind its decision to block Comcast’s acquisition of Time Warner Cable. As the FCC staff sets out on its reported Rainbow Tour to reassure regulated companies that it’s not “hostile to the industries it regulates,” Sallet’s remarks suggest it will have an uphill climb. Unfortunately, the staff’s analysis appears to have been unduly speculative, disconnected from critical market realities, and decidedly biased — not characteristics in a regulator that tend to offer much reassurance.

Merger analysis is inherently speculative, but, as courts have repeatedly had occasion to find, the FCC has a penchant for stretching speculation beyond the breaking point, adopting theories of harm that are vaguely possible, even if unlikely and inconsistent with past practice, and poorly supported by empirical evidence. The FCC’s approach here seems to fit this description.

The FCC’s fundamental theory of anticompetitive harm

To begin with, as he must, Sallet acknowledged that there was no direct competitive overlap in the areas served by Comcast and Time Warner Cable, and no consumer would have seen the number of providers available to her changed by the deal.

But the FCC staff viewed this critical fact as “not outcome determinative.” Instead, Sallet explained that the staff’s opposition was based primarily on a concern that the deal might enable Comcast to harm “nascent” OVD competitors in order to protect its video (MVPD) business:

Simply put, the 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.

The justification for the concern boiled down to an assumption that the addition of TWC’s subscriber base would be sufficient to render an otherwise too-costly anticompetitive campaign against OVDs worthwhile:

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.

The FCC theorized that, by acquiring a larger footprint, Comcast would gain enough bargaining power and leverage, as well as the means to profit from an exclusionary strategy, leading it to employ a range of harmful tactics — such as impairing the quality/speed of OVD streams, imposing data caps, limiting OVD access to TV-connected devices, imposing higher interconnection fees, and saddling OVDs with higher programming costs. It’s difficult to see how such conduct would be permitted under the FCC’s Open Internet Order/Title II regime, but, nevertheless, the staff apparently believed that Comcast would possess a powerful “toolkit” with which to harm OVDs post-transaction.

Comcast’s share of the MVPD market wouldn’t have changed enough to justify the FCC’s purported fears

First, the analysis turned on what Comcast could and would do if it were larger. But Comcast was already the largest ISP and MVPD (now second largest MVPD, post AT&T/DIRECTV) in the nation, and presumably it has approximately the same incentives and ability to disadvantage OVDs today.

In fact, there’s no reason to believe that the growth of Comcast’s MVPD business would cause any material change in its incentives with respect to OVDs. Whatever nefarious incentives the merger allegedly would have created by increasing Comcast’s share of the MVPD market (which is where the purported benefits in the FCC staff’s anticompetitive story would be realized), those incentives would be proportional to the size of increase in Comcast’s national MVPD market share — which, here, would be about eight percentage points: from 22% to under 30% of the national market.

It’s difficult to believe that Comcast would gain the wherewithal to engage in this costly strategy by adding such a relatively small fraction of the MVPD market (which would still leave other MVPDs serving fully 70% of the market to reap the purported benefits instead of Comcast), but wouldn’t have it at its current size – and there’s no evidence that it has ever employed such strategies with its current market share.

It bears highlighting that the D.C. Circuit has already twice rejected FCC efforts to impose a 30% market cap on MVPDs, based on the Commission’s inability to demonstrate that a greater-than-30% share would create competitive problems, especially given the highly dynamic nature of the MVPD market. In vacating the FCC’s most recent effort to do so in 2009, the D.C. Circuit was resolute in its condemnation of the agency, noting:

In sum, the Commission has failed to demonstrate that allowing a cable operator to serve more than 30% of all [MVPD] subscribers would threaten to reduce either competition or diversity in programming.

The extent of competition and the amount of available programming (including original programming distributed by OVDs themselves) has increased substantially since 2009; this makes the FCC’s competitive claims even less sustainable today.

It’s damning enough to the FCC’s case that there is no marketplace evidence of such conduct or its anticompetitive effects in today’s market. But it’s truly impossible to square the FCC’s assertions about Comcast’s anticompetitive incentives with the fact that, over the past decade, Comcast has made massive investments in broadband, steadily increased broadband speeds, and freely licensed its programming, among other things that have served to enhance OVDs’ long-term viability and growth. Chalk it up to the threat of regulatory intervention or corporate incompetence if you can’t believe that competition alone could be responsible for this largesse, but, whatever the reason, the FCC staff’s fears appear completely unfounded in a marketplace not significantly different than the landscape that would have existed post-merger.

OVDs aren’t vulnerable, and don’t need the FCC’s “help”

After describing the “new entrants” in the market — such unfamiliar and powerless players as Dish, Sony, HBO, and CBS — Sallet claimed that the staff was principally animated by the understanding 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.

Sallet’s description of OVDs makes them sound like struggling entrepreneurs working in garages. But, in fact, OVDs have radically reshaped the media business and wield enormous clout in the marketplace.

Netflix, for example, describes itself as “the world’s leading Internet television network with over 65 million members in over 50 countries.” New services like Sony Vue and Sling TV are affiliated with giant, well-established media conglomerates. And whatever new offerings emerge from the FCC-approved AT&T/DIRECTV merger will be as well-positioned as any in the market.

In fact, we already know that the concerns of the FCC are off-base because they are of a piece with the misguided assumptions that underlie the Chairman’s recent NPRM to rewrite the MVPD rules to “protect” just these sorts of companies. But the OVDs themselves — the ones with real money and their competitive futures on the line — don’t see the world the way the FCC does, and they’ve resolutely rejected the Chairman’s proposal. Notably, the proposed rules would “protect” these services from exactly the sort of conduct that Sallet claims would have been a consequence of the Comcast-TWC merger.

If they don’t want or need broad protection from such “harms” in the form of revised industry-wide rules, there is surely no justification for the FCC to throttle a merger based on speculation that the same conduct could conceivably arise in the future.

The realities of the broadband market post-merger wouldn’t have supported the FCC’s argument, either

While a larger Comcast might be in a position to realize more of the benefits from the exclusionary strategy Sallet described, it would also incur more of the costs — likely in direct proportion to the increased size of its subscriber base.

Think of it this way: To the extent that an MVPD can possibly constrain an OVD’s scope of distribution for programming, doing so also necessarily makes the MVPD’s own broadband offering less attractive, forcing it to incur a cost that would increase in proportion to the size of the distributor’s broadband market. In this case, as noted, Comcast would have gained MVPD subscribers — but it would have also gained broadband subscribers. In a world where cable is consistently losing video subscribers (as Sallet acknowledged), and where broadband offers higher margins and faster growth, it makes no economic sense that Comcast would have valued the trade-off the way the FCC claims it would have.

Moreover, in light of the existing conditions imposed on Comcast under the Comcast/NBCU merger order from 2011 (which last for a few more years) and the restrictions adopted in the Open Internet Order, Comcast’s ability to engage in the sort of exclusionary conduct described by Sallet would be severely limited, if not non-existent. Nor, of course, is there any guarantee that former or would-be OVD subscribers would choose to subscribe to, or pay more for, any MVPD in lieu of OVDs. Meanwhile, many of the relevant substitutes in the MVPD market (like AT&T and Verizon FiOS) also offer broadband services – thereby increasing the costs that would be incurred in the broadband market even more, as many subscribers would shift not only their MVPD, but also their broadband service, in response to Comcast degrading OVDs.

And speaking of the Open Internet Order — wasn’t that supposed to prevent ISPs like Comcast from acting on their alleged incentives to impede the quality of, or access to, edge providers like OVDs? Why is merger enforcement necessary to accomplish the same thing once Title II and the rest of the Open Internet Order are in place? And if the argument is that the Open Internet Order might be defeated, aside from the completely speculative nature of such a claim, why wouldn’t a merger condition that imposed the same constraints on Comcast – as was done in the Comcast/NBCU merger order by imposing the former net neutrality rules on Comcast – be perfectly sufficient?

While the FCC staff analysis accepted as true (again, contrary to current marketplace evidence) that a bigger Comcast would have more incentive to harm OVDs post-merger, it rejected arguments that there could be countervailing benefits to OVDs and others from this same increase in scale. Thus, things like incremental broadband investments and speed increases, a larger Wi-Fi network, and greater business services market competition – things that Comcast is already doing and would have done on a greater and more-accelerated scale in the acquired territories post-transaction – were deemed insufficient to outweigh the expected costs of the staff’s entirely speculative anticompetitive theory.

In reality, however, not only OVDs, but consumers – and especially TWC subscribers – would have benefitted from the merger by access to Comcast’s faster broadband speeds, its new investments, and its superior video offerings on the X1 platform, among other things. Many low-income families would have benefitted from expansion of Comcast’s Internet Essentials program, and many businesses would have benefited from the addition of a more effective competitor to the incumbent providers that currently dominate the business services market. Yet these and other verifiable benefits were given short shrift in the agency’s analysis because they “were viewed by staff as incapable of outweighing the potential harms.”

The assumptions underlying the FCC staff’s analysis of the broadband market are arbitrary and unsupportable

Sallet’s claim that the combined firm would have 60% of all high-speed broadband subscribers in the U.S. necessarily assumes a national broadband market measured at 25 Mbps or higher, which is a red herring.

The FCC has not explained why 25 Mbps is a meaningful benchmark for antitrust analysis. The FCC itself endorsed a 10 Mbps baseline for its Connect America fund last December, noting that over 70% of current broadband users subscribe to speeds less than 25 Mbps, even in areas where faster speeds are available. And streaming online video, the most oft-cited reason for needing high bandwidth, doesn’t require 25 Mbps: Netflix says that 5 Mbps is the most that’s required for an HD stream, and the same goes for Amazon (3.5 Mbps) and Hulu (1.5 Mbps).

What’s more, by choosing an arbitrary, faster speed to define the scope of the broadband market (in an effort to assert the non-competitiveness of the market, and thereby justify its broadband regulations), the agency has – without proper analysis or grounding, in my view – unjustifiably shrunk the size of the relevant market. But, as it happens, doing so also shrinks the size of the increase in “national market share” that the merger would have brought about.

Recall that the staff’s theory was premised on the idea that the merger would give Comcast control over enough of the broadband market that it could unilaterally impose costs on OVDs sufficient to impair their ability to reach or sustain minimum viable scale. But Comcast would have added only one percent of this invented “market” as a result of the merger. It strains credulity to assert that there could be any transaction-specific harm from an increase in market share equivalent to a rounding error.

In any case, basing its rejection of the merger on a manufactured 25 Mbps relevant market creates perverse incentives and will likely do far more to harm OVDs than realization of even the staff’s worst fears about the merger ever could have.

The FCC says it wants higher speeds, and it wants firms to invest in faster broadband. But here Comcast did just that, and then was punished for it. Rather than acknowledging Comcast’s ongoing broadband investments as strong indication that the FCC staff’s analysis might be on the wrong track, the FCC leadership simply sidestepped that inconvenient truth by redefining the market.

The lesson is that if you make your product too good, you’ll end up with an impermissibly high share of the market you create and be punished for it. This can’t possibly promote the public interest.

Furthermore, the staff’s analysis of competitive effects even in this ersatz market aren’t likely supportable. As noted, most subscribers access OVDs on connections that deliver content at speeds well below the invented 25 Mbps benchmark, and they pay the same prices for OVD subscriptions as subscribers who receive their content at 25 Mbps. Confronted with the choice to consume content at 25 Mbps or 10 Mbps (or less), the majority of consumers voluntarily opt for slower speeds — and they purchase service from Netflix and other OVDs in droves, nonetheless.

The upshot? Contrary to the implications on which the staff’s analysis rests, if Comcast were to somehow “degrade” OVD content on the 25 Mbps networks so that it was delivered with characteristics of video content delivered over a 10-Mbps network, real-world, observed consumer preferences suggest it wouldn’t harm OVDs’ access to consumers at all. This is especially true given that OVDs often have a global focus and reach (again, Netflix has 65 million subscribers in over 50 countries), making any claims that Comcast could successfully foreclose them from the relevant market even more suspect.

At the same time, while the staff apparently viewed the broadband alternatives as “limited,” the reality is that Comcast, as well as other broadband providers, are surrounded by capable competitors, including, among others, AT&T, Verizon, CenturyLink, Google Fiber, many advanced VDSL and fiber-based Internet service providers, and high-speed mobile wireless providers. The FCC understated the complex impact of this robust, dynamic, and ever-increasing competition, and its analysis entirely ignored rapidly growing mobile wireless broadband competition.

Finally, as noted, Sallet claimed that the staff determined that merger conditions would be insufficient to remedy its concerns, without any further explanation. Yet the Commission identified similar concerns about OVDs in both the Comcast/NBCUniversal and AT&T/DIRECTV transactions, and adopted remedies to address those concerns. We know the agency is capable of drafting behavioral conditions, and we know they have teeth, as demonstrated by prior FCC enforcement actions. It’s hard to understand why similar, adequate conditions could not have been fashioned for this transaction.

In the end, while I appreciate Sallet’s attempt to explain the FCC’s decision to reject the Comcast/TWC merger, based on the foregoing I’m not sure that Comcast could have made any argument or showing that would have dissuaded the FCC from challenging the merger. Comcast presented a strong economic analysis answering the staff’s concerns discussed above, all to no avail. It’s difficult to escape the conclusion that this was a politically-driven result, and not one rigorously based on the facts or marketplace reality.