Tim Brennan is a professor in the School of Public Policy at the University of Maryland (Baltimore). He was the FCC’s Chief Economist in 2014 and a consultant to the FCC staff in 2015 when it was evaluating AT&T’s purchase of DirecTV.
Published January 2, 2018
The biggest event in antitrust these days is the Justice Department’s opposition to AT&T’s proposed acquisition of Time Warner Inc., the media conglomerate with brands ranging from HBO to CNN to the Warner Brothers film studio. (Time Warner Inc. is distinct from Time Warner Cable, the video delivery and internet service provider that Comcast tried to buy in 2015.) The clash would be notable if the only issue were size: AT&T’s paying about $85 billion for Time Warner, putting it in or near the top-ten largest acquisitions of all time. But it is also making headlines because of President Trump’s vocal opposition to the merger and ongoing disparagement of CNN.
In antitrust circles, though, the distinguishing feature of this merger is that it is “vertical.” That is, the parties are not direct competitors but links in a supply chain that, in this case, creates and then distributes entertainment and news. Time Warner uses AT&T’s video capability, including DirecTV, to deliver CNN, HBO and other Time Warner content to viewers.
By contrast, the great majority of mergers that attract antitrust scrutiny are “horizontal” – i.e., between competitors. The notion that increasing market concentration reduces competition (and thereby leads to higher prices or lower quality) is generally accepted, though the potential effect of any specific merger is often disputed. Vertical mergers typically get less attention because they have no direct effect on competition at any stage of the supply chain.
The Fine Print
It is, however, widely agreed that a vertical merger, sometimes called “vertical integration,” can be anticompetitive in some settings:
Potential competition. Suppose company B is a customer of company A, which has monopoly power. But in the future, B could plausibly enter A’s business as a competitor and force A to lower prices or improve quality. Then a vertical merger between today A and B would be anticompetitive because it would remove a threat to A’s market power in the future.
Supply foreclosure. Suppose companies B, C, D and E each supplies a widget that A and its competitors use. If A buys up all four widget suppliers, A’s competitors have fewer options for getting widgets, and thus may not be able to compete effectively against A. Note, by the way, that a merger wouldn’t necessarily be needed to get from here to there: agreements between A and the four suppliers to make widgets exclusively for A would have the same effect. For this reason, a supply foreclosure merger might be more likely prosecuted as monopolization by A rather than as a horizontal merger between B, C, D, and E.
Evasion of regulation. A has a monopoly over a good or service X, but a regulator caps the price it can charge for X. If A then buys a business B that uses X and then denies or delays access to X to B’s rivals, it may then be able to raise the price of B’s product, effectively evading the regulatory price cap. This issue, incidentally, was at the heart of the historic antitrust case in which an earlier incarnation of AT&T was forced to divest the regulated local telephone monopolies that it owned across the nation.
None of these possibilities applies to this merger. Time Warner and AT&T are not potential entrants into each other’s markets; this merger is not part of a succession of vertical mergers; neither firm is regulated.
Going Outside the Box: When Should Vertical Mergers Be Stopped?
The Justice Department has a different complaint, arguing that this vertical merger would make “exclusive dealing” more likely on the part of AT&T or Time Warner. For example, AT&T would be tempted to exclude HBO’s competitor Showtime from its distribution network. Or turn this around: HBO might be more likely to provide its content only to AT&T, putting Comcast and other competing video distribution services at a disadvantage in the market.
The Justice Department has an opportunity to clarify the conditions that determine when a vertical merger creates opportunities for exclusive dealing not available to the unmerged companies, and when exclusive dealing is harmful to consumers.
Thus, in deciding to pursue this case, the Justice Department has an opportunity to clarify the conditions that determine (1) when a vertical merger creates opportunities for exclusive dealing not available to the unmerged companies and (2) when exclusive dealing is harmful to consumers.
Consider the first: When is a vertical merger necessary for exclusive dealing? If Time Warner or AT&T could profit through exclusive or discriminatory dealing in the supply chain, the companies wouldn’t need to merge to make exclusive dealing compacts. Indeed, exclusive dealing without merger is common – the long-standing deal between the National Football League and DirecTV to provide access to every Sunday game is a good example. Exclusive dealing between content producers and video companies is typical: most TV shows and films you can watch on Netflix are not available on Hulu, and vice versa.
The link between a vertical merger and exclusive dealing should not be assumed; it needs to be proven. The absence of exclusive dealing prior to the merger may be simply because it is more profitable to deal with everyone than hardly anyone. This puts the burden squarely on the Justice Department to explain why, if exclusive dealing between AT&T and Time Warner were profitable, it hasn’t happened already. The DOJ should be required to state its argument with sufficient generality and verifiability so that other businesses contemplating a vertical merger can figure out whether it would provoke antitrust opposition.
But this is still not enough to make the case. Which brings us to the second question: When is exclusive dealing harmful? Even if the AT&T/Time Warner merger would lead to exclusive dealing, the burden should be on the DOJ to identify conditions for when exclusive dealing would harm consumers and show that those conditions hold in this case.
Such harm cannot be presumed. Exclusive dealing may make cooperative marketing and product support more effective and less costly, with some of the benefits passing through to consumers. Moreover, exclusive dealing can actually increase competition by facilitating market entry. DirecTV’s exclusive right to sell the all-you-can-watch pass to every NFL Sunday game seems an apt example. Consequently, the Justice Department’s burden here is hardly trivial.
Posing these questions does not presume that they lack answers. The Justice Department may yet show how vertical mergers lead to consumer harm because they facilitate exclusive dealing. One possibility: Perhaps vertical integration could facilitate exclusive dealing by reducing the difficulties in hammering out anticompetitive deals between the parties. Here, too, you would need tangible evidence that the exclusive dealing leads to higher prices or lower quality.
One could infer from the remedies the Justice Department has reportedly considered – spinning off DirecTV from AT&T or the Turner cable networks (which include CNN) from Time Warner – that the DOJ has something else in mind. Both Time Warner’s purchase of Turner in 1995 and AT&T’s purchase of DirecTV 20 years later were at the time approved by the government. Perhaps with hindsight the DOJ has decided that one or both mergers were mistakes because of possible supply foreclosure. (Disclaimer: I was a consultant to the FCC staff reviewing the potential impact of the AT&T/DirecTV merger.)
If the DOJ can use the AT&T/Time Warner merger to provide useful guidance to explain when vertical integration is necessary to carry out otherwise profitable exclusive dealing (when no expansion of power in any individual market is occurring) and when exclusive dealing is harmful, it will have filled in a gap about the competitive significance of vertical integration that all too frequently has been assumed away.