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 in 2015, when it was evaluating AT&T’s purchase of DirecTV.
Published September 17, 2018
In January, I wrote a piece on AT&T’s proposed “vertical” acquisition of Time Warner, which the Justice Department sought to block. Unlike typical “horizontal” mergers, which almost automatically raise red flags, AT&T and TW do not compete with each other. AT&T delivers video by cable, satellite and mobile devices, while Time Warner (which sold its cable service two years ago) owns some top programming networks — notably, HBO and CNN. And now, in spite of a federal judge’s green light, the government is back in court to try to block the corporate union.
The Story to Date
The Justice Department’s primary concern is that the merger would strengthen Time Warner’s position in bargaining with other video distributors because, were negotiations to fail, AT&T would pick up market share and profits at the expense of competitors unable to carry TW programs. This strengthened bargaining position, the argument went, would lead to higher program prices that would be passed on to consumers.
In June, Federal District Court Judge Richard Leon issued a 172-page opinion allowing the merger to go through. DOJ decided to appeal, filing a brief in August. Here, I offer an updated analysis of the case, based on Judge Leon’s opinion.
First and perhaps foremost: although the judge ruled against the government, claims that this was nothing more than a reincarnation of horizontal-is-all Chicago school antitrust doctrine are simply incorrect. The judge neither dismissed DOJ’s vertical bargaining theory in this case nor presumed that vertical mergers only enhance efficiency.
If Judge Leon had simply ruled against DOJ on the basis of Chicago school doctrine, he could have saved a lot of trees. In fact, the decision relied on four arguments. First, and most surprising, the judge spent many pages defending the view that the legal standard for preventing a merger is that harm was likely, and not merely possible. I thought that this standard was settled — and I doubt DOJ claimed otherwise.
However, in bringing this up, Judge Leon invited us to recall that the text of the Clayton Antitrust Act of 1914 proscribes mergers where the effect “may be substantially to lessen competition.” Under prevailing “originalist” principles of statutory interpretation, one could reasonably conclude that, by “may,” Congress meant “possible” rather than “likely.” Presumably Congress could have said “likely” in 1914 if that’s what it meant, as long as the effect would be “substantial.”
If the case makes it to the Supreme Court — I believe no merger case has since the 1970s — this would be a fascinating question. However, since DOJ has not so far indicated that it will appeal on this ground, I wouldn’t expect the appellate courts to touch it.
Second, Judge Leon concluded that the markets defined as relevant to antitrust analysis by DOJ were out of date because video distribution is changing so quickly. The model in which bundles of program channels delivered to fixed locations by cable or satellite is giving way to one in which individual services or programs are streamed over the internet, often to mobile devices.
While Judge Leon’s view of the future sounds plausible, it isn’t universally accepted. Moreover, even as a new technology eats into an old one, market power may exist in what remains. A monopoly over the brick-and-mortar retailing that Amazon has not displaced could still be problematic for consumers. In any event, the judge’s decision did not critically turn on this assertion.
Judge Leon’s third point is the one that DOJ seems most interested in challenging. The judge concluded that the concern that the merged companies would withhold program services such as HBO or CNN was not credible. DOJ’s core premise is that the harm from this merger depends on the merger making the withholding a more credible threat, weakening video distributors’ bargaining positions. If Judge Leon’s finding is, in fact, a reasonable conclusion from the trial record, it’s hard to imagine that DOJ’s appeal will be successful.
The judge’s fourth argument — the one that took up the most space — amounted to a point-by-point challenge to the testimony of DOJ’s lead expert, Carl Shapiro of the University of California (Berkeley), who specializes in antitrust economics and was a former chief economist at the Justice Department’s Antitrust Division. Press reports suggest that Shapiro faced serious questions on the accuracy of the data he was provided and the credibility of its sources. Unless DOJ can show that Judge Leon was biased in evaluating Shapiro’s claims, contesting this part of Judge Leon’s decision seems a non-starter. This, I think, is why DOJ’s appeal came as a surprise to many.
I wish that the outcome of the case had clarified the legal question of why vertical integration matters and what evidence is necessary to prove an antitrust transgression. To this end, I’m disappointed that Judge Leon and the contesting parties did not join the issue of why vertical integration might give TW more incentive to exercise HBO’s or CNN’s market power than it already has.
Look closely at this issue for a moment. Suppose CNN signs a contract with video distributor X (say, a mobile phone company), which pays CNN on a per-subscriber basis — as is typical. Once signed, in bargaining with competing mobile phone company Y, CNN can say that if the deal falls through, X will have a bigger market share. Consequently, CNN has a stronger threat to withhold service from Y by virtue of its deal with X. So far, so good. But note that no merger between CNN and X is required to strengthen CNN’s bargaining position with Y. It follows simply from standard terms of program contracts.
Whether vertical integration is ever proper fodder for antitrust, and why, is not a question to be dismissed out of hand. Indeed, even Judge Leon appears to have largely accepted the presumption that vertical integration can matter. The basis of his decision was the absence of factual support that it matters here.
The absence of clarity as to why vertical mergers can matter is not surprising. AT&T and TW could not defend the merger by saying, “Hey, we already have market power without merging.” On the other hand, they could have argued that if either had market power, we would have already seen it exercised in the way DOJ fears — perhaps through exclusive dealing contracts. That it wasn’t would be evidence that the effect of the merger wouldn’t “be substantially to lessen competition.”
So, no matter how the appeal in the AT&T/TW case fares, we will apparently have to wait for the next big vertical merger that’s challenged by the government to get legal clarification on why vertical mergers increase incentives to exercise potential market power that is already there.