DATE: 24.11.12

Presented By

Anuran Saha(63064) Avishek Dasgupta(62997) Subject:

Industrial Economics

Major Players In the Case

EchoStar Communication Corporation (DISH NETWORK) Electronics Corporations (DirecTV) Department of Justice (DOJ) Federal Communications Commission (FCC)

Industry

Satellite Television Service

Operating Market

United States

Both provided multichannel video programming distribution (MVPD) services.

 Satellite Television Service started in 1970s.

 Initial phase - low powered C-Band (4GHz)  DBS started in North America in 1991 by PrimeStar  Higher powered Ku-Band (12.2 – 12.7 GHz)  DirecTV came into picture in 1994 & purchased PrimeStar in 1999  EchoStar Dish network started its service in 1996

Relevant market products within MVPD & subscriber share

MVPD Products

Cable DBS SMATV C-Band MMDS

Percent of Subscribers

78 18.3

1.7

1.1

0.8

On October 28,2001, EchoStar Communications Corporation (Dish Network) announced its intention to acquire the assets of Hughes Electronics Corporations (DirecTV).

But This merger was strongly opposed by DOJ & FCC.

WHY?

 Increase of Efficiency  EchoStar and DirecTV do not compete with each other but with Cable Company.

 Competition with Cable company will be a constraint to charge higher price.

If the merger were allowed to proceed, it would

eliminate competition

between the nation’s two most significant DBS services and substantially

reduce competition

in the MVPD business to the

detriment of consumers

throughout the United States.

SUBSTITUTES

Over The Air C-Band Service Digital Cable System EchoStar & DirecTV X X Close Substitute Substitute to each other

Geographic Market

 DBS companies provided nationwide service whereas cable companies were more focused on local markets.

 EchoStar and DirecTV’s national pricing will depend on cable prices and service offerings at the local level & they have ability to adjust price locally if they chose to do so

 Herfindahl–Hirschman Index is a measure of the

size of firms

in relation to the industry and an

indicator of the amount of competition

among them.

  It is defined as the

sum of the squares

of the market shares of the largest firms

HHI = s 1 2 + s2 2

the i-th firm).

+ s3 2 + ... + sn 2

(where s n is the market share of 

Increases in the Herfindahl index

generally indicate a

decrease in competition

and the market is more towards

monopoly

& vice-varsa.

 1.

2.

Example: 5 players, 20% each : HHI = 5 X 20 2 = 2000 5 players, 1 have 75%, rest each 5%: HHI = 75 2 +4 X 5 2 = 5725

• FCC staff computed concentration indices for geographic markets corresponding to 4984 local cable systems.

• For DBS & All Cable systems (Both Digital & Analog) : Median post merger HHI=5653, median increase = 861 • For DBS vs Digital Cable Systems: Median post merger HHI=6693, median increase = 206  These figures actually

understating the significance

of the proposed merger since DBS was

experiencing rapid growth

at that time.  The

HHI for the proposed merger exceeded the structural screen

in the DOJ/FTC Horizontal Merger Guidelines.

 There were 2 levels of competition 1.

Cable TV vs DBS services 2.

DirecTV vs EchoStar  The mergers claimed that the competition between Cable TV & DBS services is

higher than

the competition between DirecTV & EchoStar, so

to attract

Cable TV customer there is

little chance of post-merger increase of price.

• Both companies’ Equipment and Installation prices dropped from several hundreds to zero.

• EchoStar itself acknowledged DirecTV as competitor in papers filed to court • Similar prices & services

Coordinated Effects

Arise when firms in the industry recognize their mutual interdependence and take actions that sustain their joint profits

Unilateral Effects

Unilateral effects arise when the merged firm has sufficient market power to raise prices above premerger levels with no accommodating price responses from other firms in the relevant markets Merger will create environment in which it will be beneficial for the cable firms to collude Merged firm has enough market power to increase prices above pre-merger levels

 Post-merger price of DBS through the necessary condition for profit maximization (P j - MC j )/P j = - 1/ ɛ jj

Lerner Index of Market Power

 Analysis of the demand of the DBS is complicated by the fact that there is little variation in the price of DBS system.

 So price elasticity is calculated by exploiting the symmetry conditions in demand.

Service

Antenna Expanded Basic Premium Cable DBS

Expanded Basic

1.30

-1.54

1.26

.93

(P – MC) / P = - 1/ - 2.45 = 1 / 2.45 = 40%

Price Premium Cable

.92

.92

-3.18

1.17

DBS

.12

.29

.49

-2.45

- So the merged DBS system will maximize the profit by choosing a Lerner index of about 40% According to MacAvoy the estimated monthly marginal cost: EchoStar = 30.39

DirecTV = 26.80

Using the above equation and own-elasticity -2.45 we get

Prices EchoStar DirecTV Pre Merger 30.99$ 31.99$ Post Merger 50.12$ 44.20$

  A Nash-Cournot competitor maximizes its profit by choosing its output levels under the assumption that outputs of other firms are fixed.

The premerger prices for each network would satisfy the following condition: (P j – MC j ) / P j = - S j /ŋ Where S j is firm j’s share of DBS programming & is the elasticity of demand for DBS expressed as a negative number.

 Example: If EchoStar had 40% of share, it’s firm-specific elasticity of demand would be: reciprocal of 0.4/(-2.54) = -6.4

With Premerger Price:

DirecTV: $31.99 + $5.99

EchoStar: $30.99 + $5.99

We can get MC: (P – MC)/P = 1/6.4 P – MC = P/6.4

P – P/6.4 =MC P (1 – 1/6.4) = 36.98*0.84 = 31.20

 Assuming that marginal cost does not change  We have two MC’s – choosing the lower one = $28.94

we get the post-merger price: P = MC/(1+1/ ɛ ) or 47.73 = 28.94/(1-1/2.54)  So here we can see Average pre-merger price = $37.48

Average post-merger price = $47.73

So we can see a 27% increase

 Price Increase depends on: - estimated price elasticity - intensity of competition before the merger - Marginal costs before and after the merger (Pj - MCj)/Pj = -1/ ɛ jj  Intensity of competition before the merger affects the pre-merger price-cost difference → this difference in cost (price is given) → cost affects post merger price  If actual competition were more intense than assumed, then the price will increase more than predicted  Higher MC → higher prices

 The price of DBS relative to cable had fallen (EchoStar and DirecTV have slashed the cost for equipment and installations)  The Early adopters of satellite TV revealed a higher willingness to pay for DBS relative to cable  Consumer surplus, as the quality-adjusted price of satellite TV net of equipment and installation costs fell relative to cable  After merger, this consumer surplus might have moved to the producers

Factors that contributed to relatively low DBS price  Competition between EchoStar and DirecTV  Competition between DBS and cable New EchoStar would have an incentive to set a low uniform price to build its subscriber base. However, as the installed base of DBS subscribers increases overtime, the merged company may raise prices to exploit the consumer surplus

Authors’ simulation model predicted post merger price increase of more than 15% New EchoStar can exploit customers when installed customer base is large relative to inflow of new customers High Switching cost another reason to increase price  Sunk cost on installation and equipment  Long term purchase contracts  Time and inconvenience of researching MVPD alternatives and having one installed

Argument of proponents of merger: Commitment to a national pricing scheme will protect consumers from price rise Fact: National pricing merely averages the price increase from the merger across all consumers. In fact it may increase for all the consumers.

Q DBS = q c DBS (p DBS ) + q nc DBS (p DBS ) Q DBS:

Total demand for DBS Services

q c DBS :

Demand in cable areas

q nc DBS:

Demand in areas without access to cable

p DBS:

Price of DBS Service

ŋ DBS = s c ŋ c DBS ŋ DBS:

Elasticity of Total Demand

S c:

Share of demand in cable areas

+ s nc ŋ nc DBS S nc:

Share of demand in non-cable areas

ŋ c DBS:

Elasticity of demand in cable areas

ŋ nc DBS:

Elasticity of demand in non-cable areas

Estimate by Goolsbee and Petrin, 2004 predicts low demand elasticity

Availability of orbital satellite positions is constrained by regulation All 3 full-CONUS satellite slot owned by EchoStar or DirecTV: “Wing” Locations with at least 2 satellites New Technology: “Short-Spaced” Orbital Locations Constraints:  Regulatory Approval   High cost New contract for programming, distribution and installation network  Failed attempt by SES Americom and Intelsat

Remedy Suggested:  Divest or lease substantial transponder assets to Cablevision  Joint venture with Cablevision  Provide assistance to Cablevision in establishing retail outlets Reality:  Unlikely to occur within the two-year time horizon considered in the DOJ/FTC Merger Guidelines  Huge cost  Terms of assistance from the merged company have to be monitored

Arguments:  Better use of scarce radio spectrum  Broadcast local channels to more communities, offer additional high-definition content  Reduce significant overlap in the satellite broadcasts  More effective competitor to cable than either company could be on its own

New EchoStar would need less resources to broadcast the existing content, freeing up other resources for additional content, more local channels, or more programming in high-definition format

Antitrust authorities blocked the merger

Pre-merger: Firms argued that they could not make the improvements necessary to match the programming content provided by cable systems on their own Actual: Both EchoStar and DirecTV found ways to increase capacity and expand programming relative to digital cable.

 News Corp. acquired a controlling interest in DirecTV in 2003 which provided needed cash for DirecTV to upgrade its infrastructure  EchoStar reported net negative income from 2000 to 2002. However, its reported net income was positive in every year from 2003 to 2006

EchoStar

26 HD Channels “America’s largest HD lineup” Pay-Per-View Premium Channels Local broadcasts in HD Over 170 DMA’s 96 % of TV households

DirecTV

8 Exclusively HD Channels Numerous other regional HD networks Pay-Per-View Premium Channels Local broadcasts in HD Over 143 DMA’s 94 % of TV households • • •

Cable Networks

Average of 11 HD Channels, including local broadcasts No significant increase over the past two years Relying on ‘bundling’ of internet and phone with TV

Would consumers have been better off if EchoStar and DirecTV were allowed to merge?

 Merger might have allowed the companies to economize on satellite launches  However, the merger posed a considerable risk of higher prices from the exercise of market power  Merger could have allowed New EchoStar to increase prices by as much as $10 per month  Even if the merger increased prices by only $2 per month, this would increase consumer expenditures by more than $500 million per year for DBS service, which likely would exceed the plausible annualized efficiencies  Trade off would be more favourable to the proposed merger if the welfare measure included a contribution from producer profits

Proponents of mergers proposed that it would create substantial efficiencies, because A.

B.

C.

D.

The merger would help to cut down marginal cost More number of customers will subscribe for DBS (Economies of scale)

It would help them to eliminate the overlap in the Satellite broadcasts by EchoStar & DirecTV

There will be only one national pricing for the DBS system

Which of the following is true regarding the

Herfindahl– Hirschman Index ?

A.

B.

C.

D.

A high value of HHI indicates that there is more monopoly in the market A low value of HHI means less competition in the market HHI value can not be more than 10000

Both A & C

Was uniform national pricing a valid or invalid argument by the proponents of merger and why?

A.

B.

C.

D.

Valid: It protected consumers from price rise Valid: It will definitely help to lower the price for all consumers

Invalid: It merely averages the price increase from the merger across all consumers and may increase price for all consumers

Invalid: Uniform National Pricing is impossible to achieve

Why were the remedies suggested by EchoStar and DirecTV for new entrants not feasible?

A.

B.

C.

D.

It was unlikely to occur within the two-year time horizon considered in the DOJ/FTC Merger Guidelines There was huge cost and terms of assistance from the merged company would have to be monitored EchoStar and DirecTV were secretly planning to buy off Cablevision

Both a) and b)

Which of the following is true about Unilateral effect?

A.

Unilateral effects arise in case of a vertical merger B.

Unilateral effects arise when firms in the industry recognize their mutual interdependence

C.

Unilateral effects arise when the merged firm has sufficient market power to raise prices above pre merger levels

D.

Both a) and c)