GCR Quarterly Launch 2018

Internet saved the TV star

Charles McConnell and Pallavi Guniganti

22 October 2018

In June, the US Department of Justice lost its lawsuit to block the merger between AT&T and Time Warner. Charles McConnell and Pallavi Guniganti explore how the changing landscape of content creation and distribution enabled the third-biggest telecommunications company in the world to buy what was once the largest media company

“If there ever were an antitrust case where the parties had a dramatically different assessment of the current state of the relevant market and a fundamentally different vision of its future development, this is the one. Small wonder it had to go to trial!”

– Judge Richard Leon

Many Americans – including their current president – believe the video programming and distribution industry is too concentrated. On the day, in 2016, when AT&T announced its US$85.4 billion acquisition of Time Warner, then presidential candidate Donald Trump called the deal “an example of the power structure I’m fighting”, and promised that his administration would not approve it “because it’s too much concentration of power in the hands of too few”. He also criticised the 2011 merger between cable and internet provider Comcast and the television and film conglomerate NBCUniversal – a deal that was conditionally cleared under the Obama administration – as concentrating “far too much power in one massive entity”.

The Department of Justice’s (DOJ) antitrust division argued during its quest to block the AT&T/Time Warner tie-up that just a few companies hold the keys to getting content into homes throughout the US. Consumers rely on traditional cable or satellite television companies and wireless communications providers to access content, and consolidation has hit both of those industries in the past decade. In some markets, there are only one or two choices for a television provider, and the wireless communications industry has just four meaningful competitors nationwide.

The DOJ identified AT&T as one of the companies that holds those keys, by providing communications and digital entertainment services, while distributing content to subscribers through its subsidiaries DirecTV and U-Verse. Although the DOJ conceded that there are a lot of options for content, it pointed out that Time Warner provides some uniquely “must have” programming in the US, including the 24-hour news network CNN, college basketball’s March Madness tournament, the NBA playoffs, other live sports on TNT and TBS, and HBO programmes such as Game of Thrones.

The government challenged the companies’ vertical merger based on a bargaining leverage theory that the merged company could use Time Warner’s “must have” Turner-owned content as a weapon when negotiating with content distributors, once Time Warner secured DirecTV as a guaranteed distributor. By threatening to withhold the Turner channels, Time Warner would force non-AT&T distributors to accept higher costs for the Turner content, the DOJ hypothesised. Those costs would then be passed onto the distributors’ customers, resulting in hundreds of millions of dollars in annual consumer harm.

That bargaining leverage theory sat front and centre throughout the trial. But the merging companies urged Judge Richard Leon to reject that hypothesis and instead take a close look at the competitive landscape of the media and telecommunications world, including the role of advertising.

AT&T and Time Warner touted their tie-up as a crucial step toward competing better in a rapidly evolving market that has seen the rise of major new players in the content creation and distribution spaces. This evolution, which was triggered by the invention and development of high-speed internet, has left traditional content creators and distributors scrambling to deal with declining video subscriptions and stagnant television advertising revenues.

Competition with FANGH

Five companies that increasingly dominate consumers’ attention spans were referenced during opening arguments, then made a written appearance in the first two pages of Judge Leon’s opinion. Though the normal shorthand for Facebook, Amazon, Apple, Netflix and Google is the FAANG companies, the judge left out Apple – which continues to be known primarily for hardware – and swapped in Hulu. The government downplayed the FANGH companies’ significance to the relevant market of multichannel video distribution, even as the defendants highlighted the behemoth size of their individual revenue streams and content creation budgets when compared to those of AT&T and Time Warner.

For several years, US antitrust agencies have been fending off claims by merging companies that entry by one or more major internet companies would keep their market competitive. A precursor to this now commonplace argument came in the 2011 H&R Block/TaxAct merger litigation, when the companies said hybrid products, blending traditional full-service tax preparation with online “do it yourself” offerings, were a basis to broaden the definition of the market to include the DIY products. The claim of incipient competition from internet companies threatening the market share of H&R Block and TaxAct dominated their defence of the deal.

Two years later, Bazaarvoice justified its acquisition of PowerReviews – its primary competitor in providing software for ratings and reviews – by pointing to user-created reviews on Amazon, Google and Facebook as part of the relevant market.

In 2016, the federal judge ruling on the challenge to the Staples/Office Depot merger began his opinion: “Drawing an analogy to the fate of penguins whose destinies appear doomed in the face of uncertain environmental changes, defendant Staples and defendant Office Depot argue they are like ‘penguins on a melting iceberg’, struggling to survive in an increasingly digitised world and an office-supply industry soon to be revolutionised by new entrants like Amazon Business.”

That same year, Los Angeles Times owner Tribune Publishing said its purchase of two suburban newspapers would hurt neither readers nor advertisers because both could go online. It said local news readers could switch to Google News, Apple News, search engines or various media, while advertisers could go to many of the same sites in order to reach those readers.

Every single one of those arguments failed. Federal judges from California to Washington, DC, rejected merging companies’ claims that their deals would not harm competition because of rivalry from internet businesses.

In contrast, Judge Leon ultimately sided with AT&T and Time Warner’s portrayal of the FANGH factor. On the second page of his opinion he wrote: “Vertically integrated entities like Netflix, Hulu and Amazon have achieved remarkable success in creating and providing affordable, on-demand video content directly to viewers over the internet. Meanwhile, web giants Facebook and Google have developed new ways to use data to create effective – and lucrative – digital advertisements tailored to the individual consumer.”

An example of this internet insurgency could be seen exactly one month after Judge Leon’s ruling: on 12 July, Netflix shattered HBO’s streak of 17 consecutive years of receiving the most Emmy nominations, which recognise the best of US prime-time television programming.

To further illustrate such shifts in the industry, some argue that lines are beginning to blur between telecommunications and media companies. The five companies Judge Leon referenced – and a slew of others – are finding innovative ways to deliver large volumes of content to consumers, which directly threatens incumbents such as AT&T and Time Warner.

In the end, the judge accepted the companies’ claim that those “tectonic changes” in the marketplace drove AT&T to purchase Time Warner.

“We just watching Netflix, she ain’t got no cable, okay though.”

– DJ Khaled, “I’m the One”



Judge Leon said he accepted the government’s proposed product market for the purposes of deciding the case, but that doing so did not obligate him “to ignore the rising role of SVODs [subscription-based video-on-demand services] in the broader multichannel video programming and distribution market”.

Throughout the trial, the government tried to convince him that companies such as Netflix do not belong in the relevant market because its product is not a substitute for Time Warner’s content. A vast majority of Netflix subscribers also have traditional pay-television subscriptions, the DOJ argued; if anything, Netflix and others are complementary to a DirecTV or Comcast Xfinity subscription. The government’s economic expert, Carl Shapiro, pointed in his report to past statements by distributors such as AT&T and Charter that described Netflix and Hulu as complements to traditional cable, while regarding Sling and other “skinny” bundles, which still include live television programming, as actual substitutes.

Original content by Netflix and Amazon “has evidently not been sufficient to prevent Turner and other major video content aggregators from significantly raising their affiliate fees over time, including via escalator clauses commonly imposed in existing contracts with MVPDs,” Shapiro wrote. He said the cost of Turner content had risen because it is unique, valuable and highly desired by consumers, particularly the live events and sports programming.

“I therefore do not expect that the presence and growth of Netflix, Amazon and other creators of video content will be sufficient to deter or counteract the Turner fee increases that I predict would result from the merger between AT&T and Time Warner,” the DOJ’s expert concluded. His rebuttal of AT&T’s expert testimony continued to hammer this point: original programming from Netflix, Amazon and Hulu is all very well, but traditional programmers such as Time Warner still command rising affiliate fees for their content.

One of the first things Judge Leon did in the background discussion of the industry he included in his ruling – which touches on the bargaining theory – was lay out the two ways programmers such as Turner make money. He said they do so through affiliate fees from packaging the content and licensing it to distributors; and through the sale of advertising seen during the programming. Traditionally, Turner’s revenues from each have been roughly equal, Judge Leon explained. Both affiliate fees and advertising revenue depend on the broad distribution of Turner’s content. Because of that need for broad distribution, the judge gave significant weight to the testimony of Time Warner executives who denied they would have any increased leverage through the threat of blackouts. This aspect of the government’s theory “does not make sense as a matter of logic and, more importantly, that has not been supported by sufficient real-world evidence,” he wrote.

With that settled, Judge Leon turned to distribution. For this market definition, he clearly sided with the defendants over the government. Lumped into the market are traditional multichannel video programming distributors (MVPD) such as AT&T and Comcast; virtual MVPDs such as Dish’s Sling, Hulu’s live TV and Google’s YouTube TV; and subscription video-on-demand services such as Netflix, Hulu and Amazon Prime.

The government was most adamant that subscription video-on-demand services did not belong in the relevant market, but Judge Leon wrote: “SVODs offer low-cost subscription plans as compared to traditional MVPDs and continue to gain market share in the video programming and distribution industry. Indeed, while traditional MVPDs are losing subscribers at a steady clip, Netflix added two million subscribers in the last quarter alone.”

The judge’s opinion flies in the face of the government’s attempts to downplay the rate at which subscribers are leaving or reducing traditional pay-TV – known as cord-cutting and cord-shaving, respectively.

Which way the wind blows

The industry is seeing a rise in the number of over-the-top content services that reach consumers through the internet, including virtual MVPDs and subscription video-on-demand services, Judge Leon said. He said the latter have been successful in part because of the “value conferred by vertical integration”. Vertical integration reduces the bargaining friction that happens when programmers and distributors negotiate over fees. Moreover, the ability of SVODs to distribute directly to consumers on the internet gives them better access to data about viewers – which informs content decisions for all SVODs – and advertising for those such as Hulu and YouTube TV, which is not purely subscription-based.

Judge Leon said the decline in traditional pay-TV subscribers can be attributed to the rise in popularity of virtual multichannel video programming distributors (VMVPDs) and SVODs, so it was perhaps no surprise that he did not hesitate to include them in the relevant market. “The decline in traditional MVPD subscriptions is just one symptom of the increasingly competitive nature of the video programming and distribution industry,” Judge Leon wrote. “Indeed, several witnesses testified that competition in the industry is more intense today than ever before.”

More than just accepting that fact, traditional programmers and distributors have reacted to the competitive threat that VMVPDs and SVODs pose, Judge Leon said. He quoted Nobel laureate Bob Dylan: “You don’t need a weatherman to know which way the wind blows.”

The judge also cited the testimony of a Charter executive who said that Netflix competes with traditional TV providers for viewers’ limited time in each day, and the testimony of an AT&T executive who spoke of “the time-and-attention competition now from the likes of Facebook, from the likes of Google, from the likes of Netflix.”

As Netflix and Amazon continue to grow their content offerings, and as new players jump into the market – rumours have long swirled about Apple making a play to develop its own television programming, and it already serves as a gatekeeper for content through Apple TV and its iTunes store – Judge Leon seemed convinced that competition will thrive. It was under those premises that he told the DOJ’s antitrust division that it fell well short in proving the AT&T/Time Warner merger would likely harm competition.

At the same time, he also declared Netflix an adequate substitute for HBO for the purpose of distributors’ promotional offerings to subscribers. The judge noted that Netflix has a programming budget more than double that of HBO, and competes for much of the same writing, acting and production talent to create programming. “Put simply, HBO is in the fight of its life!” Judge Leon wrote.

Nearly everyone in the antitrust world has an opinion on Judge Leon’s opinion. Some criticise the judge for allowing further consolidation in an already concentrated market, while others praise his vision of a rapidly changing industry that has seen a boom in new and innovative competitors.

Michael O’Rielly, a commissioner at the Federal Communications Commission, sits firmly in the latter camp, as he made clear during a June speech at the Mackinac Center for Public Policy. He praised the ruling allowing the merger as “a monumental and headline-grabbing judicial decision [that] solidified that the video marketplace is exponentially broader than many in government can conceive or would like to admit”.

In a scathing criticism of regulators that rely on traditional market definitions, O’Rielly pointed out that many see the FCC and the DOJ as “stuck in administrative molasses, seeking to apply sectoral market analysis, preserve questionable bright-line tests and continue the imposition of rigid restrictions as part of transactional reviews the same way now as in 2008, 1988 or 1958”. If anything, O’Rielly has pushed for a broader market definition of the media industry – one that includes all participants from newspapers to streaming music services. Only if the FCC and the DOJ accept that kind of dynamic understanding of the marketplace can they conduct a fair and accurate analysis, the FCC commissioner said.

Roslyn Layton, a visiting scholar at the American Enterprise Institute, echoed O’Rielly’s concerns that the government is stuck using bright-line, rigid rules, which fail to capture the competitive realities of today’s media and telecoms landscape. Competition enforcers use a lot of rules of thumb when it comes to mergers – theories of foreclosure in vertical mergers and the loss of a competitor in horizontal deals – Layton said, but a lot of those assumptive theories of harm have been proven wrong. In US v AT&T, “the empirical data won,” she said.

The trend from the 1950s to today is that enforcers must look more at data, she said, which they are reluctant to do. Layton did give them an out, however, explaining that the relevant data for a given merger is not easy to come by – and competition authorities often can’t get the right data for their assessment. If an agency wants to do a comprehensive study about pricing, it generally focuses on sticker price, Layton explained, but what consumers often pay in a mobile phone or television bundle is not the sticker price. Prices are different for every consumer, and may depend on factors such as how long they have been with a given company. Because getting the right data is difficult, antitrust enforcers fall back on rules like the Herfindahl-Hirschman index, which is widely regarded as the accepted tool for measuring market concentration. With the introduction of product bundles in the technology space, market definition has changed, and is increasingly difficult to define, Layton said. A bundle, by definition, combines products in different markets.

Layton agreed with Judge Leon’s acceptance of Netflix as part of the relevant market, and she suggested that, if anything, the company serves as a gatekeeper of content, with a lot of money that someday could even buy a smaller telecommunications company such as T-Mobile or Sprint.

The other side of the platform

Not to get lost in all of this is the critical importance of advertising, which Judge Leon noted is shifting away from traditional forms toward targeted, digital methods. Rather than buy time for an advertisement on TV networks and hope it reaches as many eyeballs as possible – dubbed the “spray and pray” tactic – companies are using data to target individual consumers more likely to purchase a given product. When it comes to digital advertising, Judge Leon suggested that, if anything, there is not enough competition. But he accepted the argument that the merger would help Turner gain access to AT&T’s data, and thus allow it to compete better in that arena.

“The shift toward digital advertising has been extremely profitable for the tech giants – Google and Facebook, in particular. Indeed, those two entities account for roughly 60% of US digital advertising,” Judge Leon wrote, highlighting Facebook’s advertising revenue going from US$4 billion to US$40 billion between 2012 and 2017. “By contrast, the rise of digital advertising has been costly to Turner and other programmers that rely on television advertising as a major source of revenue.”

Layton also agreed with the judge’s analysis of the advertising industry, while criticising antitrust authorities for not addressing or fully understanding how Google works. The merger allows AT&T to compete with Facebook and Google, which is a positive step, Layton said, adding that she wishes Verizon would get into that game to knock off Google’s monopoly on search. Mergers that facilitate a company’s ability to compete in a new area and bring competition to established players are positive, she said.

Michael Carrier, a law professor at Rutgers University, said he viewed Judge Leon’s analysis of traditional MVPDs losing market share to the VMVPDs and SVODs as correct. Courts are increasingly recognising and accepting the rise of companies such as YouTube and Netflix, he said, and Judge Leon described the industry as competitive. But Judge Leon did seem to follow a one-sided analysis in questioning everything brought by the government and accepting at face value everything the merging companies said, Carrier added.

“The judge credited numerous statements of defendants, such as AT&T’s [chief executive] Randall Stephenson, on the reasons for and benefits of the merger, while questioning numerous aspects of the DOJ’s case, as well as its expert, Carl Shapiro,” Carrier said.

Future appeal

The head of the Antitrust Division also saw Judge Leon’s treatment of the evidence as one-sided. Speaking at the Aspen Ideas festival two weeks after the ruling, assistant attorney general Makan Delrahim said the judge deemed the AT&T chief executive’s testimony on the stand as “absolute truth and a statement of fact all throughout the 172 pages of the opinion”. Judge Leon also did not admit into evidence documents created prior to the merger becoming official, Delrahim said, which were the “really probative documents” that had not been sanitised by defence counsel.

He contrasted the version of a PowerPoint presentation shown at trial, which said it had been approved by two law firms, with a prior draft of the justifications for the merger. “The immediate prior version of it said ‘We’ve got to do this, because we’ve got to keep the TV bundled together, otherwise we’re getting a challenge from the cord-cutters,’” Delrahim said. Though companies can defend an acquisition on the grounds that a failing business would leave the market without the merger, he said, no one had ever been able to defend an otherwise illegal merger based on the inability to compete independently with more efficient rivals entering the market.

“‘Our current business model is getting killed because consumers are going to something that technology has allowed them to do, like Netflix, like Amazon, like Hulu, like Sling, and therefore we need to merge to survive this erosion of our business model,’” was Delrahim’s summary of the defence argument. “I hope it doesn’t become something that other industries use, because that is the quickest way to kill new competition.”

At the time of writing, the final outcome of the merger remained unclear. To keep the DOJ from seeking a stay of the merger that, if granted, would have made AT&T liable for a US$500 million breakup fee, the companies agreed to put a firewall between the Turner networks and AT&T’s distribution channels. AT&T will manage its new content separately from DirecTV and U-verse until the earlier of 28 February 2019 or the resolution of any DOJ appeals.

After the government filed its notice of appeal in mid-July, AT&T’s chief executive said in an interview with CNBC that the separation of Turner from the company’s distribution arm was not a problem: “When you have content players who are both suppliers and customers, you just have an obligation to treat them that way anyway.”

The path to a successful appeal appears narrow. The Antitrust Division can do little to challenge Judge Leon’s factual findings about content creators ranging from Facebook to Netflix and Hulu. And the motion for an expedited appeal indicated that the DOJ plans to maintain its focus on bargaining theory. It argued that the district court committed a reversible error by only considering the effect of actual blackouts on AT&T’s leverage, and by finding that a distributor’s ownership of a content producer would not affect the latter’s leverage in negotiations with other distributors.

The US Court of Appeals for the District of Columbia Circuit has agreed to expedite the appeal, and may hear oral arguments before November. Part of the DOJ’s argument for a quick hearing was that Judge Leon’s ruling will encourage other companies to make more vertical deals, but these further merger efforts “may be premised in significant part on an erroneous district court decision that should be corrected before these transactions advance and change the landscape of video programming and distribution in this country.”


AT&T, Time Warner and the FANGHs


Alexander Graham Bell’s father-in-law, Gardiner Greene Hubbard, organises Bell Telephone to hold “potentially valuable patents”, principally Bell’s master telephone patent. Hubbard leases out telephones instead of selling them.


AT&T settles its first federal antitrust challenge with Kingsbury Commitment, establishing AT&T as government-sanctioned monopoly, in return for AT&T divesting its interest in Western Union and allowing interconnection with its long-distance network.


Warner Brothers Pictures incorporates; Time magazine begins publication.


After criticism that AT&T monopoly was using US revenues to subsidise its European operations, AT&T divests almost all of its international interests.


US Department of Justice sues AT&T for price-fixing conspiracy, and its subsidiary Western Electric’s monopolisation of the market for telephones. DOJ demands that AT&T divest Western Electric, but ultimately settles for AT&T restricting its activities to the regulated business of the national telephone system.


Time buys stake in American Television and Communications; seven years later it buys complete ownership.


Warner Cable and premium cable company Home Box Office both begin operations.


DOJ sues AT&T for allegedly using monopoly profits from Western Electric, which provided telephone equipment, to subsidise costs of its telecommunications network; DOJ again seeks to force AT&T to divest Western Electric.


AT&T settles for divestiture of its regional Bell operating companies, which provide local service.


Time/Warner merger completed.


Jeff Bezos starts selling books on Amazon.com.


Time Warner acquires the rest of Turner Broadcasting, including CNN and TNT.


Amazon issues its initial – and so far only – public stock offering. Netflix is founded as a DVD rental-by-mail service.


Amazon turns its first profit: US$5 million on revenues of more than US$1 billion.


Harvard undergraduate Mark Zuckerberg launches TheFacebook.


AT&T is acquired by one of its former local phone companies, SBC Communications, which becomes the New AT&T.


Google acquires video-sharing site YouTube. Amazon launches a streaming video service. AOL, NBC Universal, Facebook, MSN, Myspace and Yahoo! are announced as initial distribution partners for a streaming video service, which begins beta testing as Hulu the next year.


Netflix launches streaming video service. Google acquires online advertiser DoubleClick despite antitrust concerns raised by Microsoft and AT&T.


DOJ sues to block AT&T’s acquisition of rival mobile network operator T-Mobile. Facebook becomes second-most visited US website, behind Google.


Netflix begins producing original content.


US Federal Trade Commission resolves its antitrust investigation of Google with voluntary commitments on online advertising and appropriation of content from other websites. Amazon begins producing original content.


DOJ unconditionally clears AT&T’s acquisition of satellite television provider DirecTV; Federal Communications Commission imposes obligations on AT&T that include non-discrimination in data caps against other data services and content.


AT&T announces it will buy Time Warner, prompting opposition from then presidential candidate Donald Trump.


Google launches YouTube TV, a subscription service to stream live television programming. Facebook announces it will spend up to US$1 billion on original shows for its Facebook Watch platform. Disney bids for 21st Century Fox, including Fox’s 30% stake in Hulu, which would give Disney controlling interest in the streaming service. DOJ sues to block AT&T/Time Warner.


Federal trial court allows AT&T/Time Warner to proceed; DOJ appeals.

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