The Honorable Robert Pitofsky
Chairman
Federal Trade Commission
6th St. & Pennsylvania Avenue, N.W.
Room 338
Washington, D.C. 20850
VIA FACSIMILE
RE: Proposed Time Warner/Turner Broadcasting Merger
Dear Chairman Pitofsky:
The Federal Trade Commission is currently considering a draft consent order for the proposed merger between Turner Broadcasting, Inc. and Time Warner. While the FTC has not publicly disclosed the terms of any potential settlement, private sources and press accounts have published the alleged broad outlines of a potential consent order.
The Office of Advocacy was established in 1976 by Congress to represent the interests of small businesses before federal agencies. The Office is concerned that the proposed merger will create an entity that will hold a large concentration of cable programming. Such a concentration may be sufficient to exercise monopoly power in the industry, interfere with competition among cable programmers and distributors, and preclude potential entrants. Small cable operators are particularly dependent upon Time Warner and Turner to obtain cable programming and are thus particularly vulnerable to the exercise of market power by Time Warner. The Office of Advocacy is specifically concerned that the new entity be required to supply satellite cable programming at reasonable wholesale rates to small cable operators. A failure by the FTC adequately to address the potential for anticompetitive conduct by a post-merger Time Warner toward small cable operators could handicap smaller competitors' ability to compete, increase Time Warner's ability and incentive to charge what are, in effect, monopoly prices, and ultimately reduce the level of competition in the video marketplace.
I. BACKGROUND
The Office of Advocacy is aware that press reports can be inadequate or incomplete. Having said that, the media and discussions with interested parties are the only sources available to us as to the elements of the proposed merger and potential consent order. The discussion that follows is based on the following facts:
In September 1995, Time Warner agreed to purchase Turner Broadcasting, Inc. for $7.5 billion. Turner Broadcasting, Inc. is the largest single supplier of cable programming services. Time Warner is the second largest cable multiple system operator ("MSO") and has extensive programming interests of its own. The merged companies would control such programming as Cable News Network, Home Box Office, Turner Network Television (TNT). Together, the companies would make the largest media company in the world, with more than $20 billion in annual revenue encompassing cable television, satellite television, books, magazines, movies, music, competitive telephone and internet services.
II. ANTI-TRUST CONCERNS
A. Does the proposed merger violate § 7 of the Clayton Anti-Trust Act?
The Clayton Act bars a merger if its effect may be to lessen competition substantially or create a monopoly. FTC v. Coca- Cola, Co. 641 F.Supp. 1128, 11 (D.D.C. 1986) vacated as moot, 829 F.2d 191 (D.C. Cir. 1987); FTC v. PPG Industries, Inc., 798 F.2d 1500,1501 (D.D.C. 1986). In enacting the Clayton Act, Congress desired to outlaw substantial increases in concentration through acquisition by a dominant concern. Without more, substantial mergers in heavily concentrated industries are presumed illegal. FTC v. Coca Cola, at 1138. A court must be guided by the view that "a merger which produces a firm controlling an undue percentage share of a relevant market, and results in a significant increase in the concentration of firms in that market, is so inherently likely to lessen competition that it must be enjoined in the absence of a showing that the merger is not likely to have such anti-competitive effects. Id.; United States v. Philadelphia National Bank, 374 U.S. 321, 363, 83 S. Ct. 1715, 1741, 10 L.Ed 2d 915 (1963). The lawfulness of an acquisition turns on the purchaser' s potential for creating, enhancing, or facilitating exercise of "market power" - the ability of one or more firms to raise prices above competitive levels for a significant amount of time. U.S. v. Archer-Daniels- Midland Company, 866 F.2d 242, 246 (8th Cir. 1988), cert. denied, 493 U.S. 809 (1989).
In the present situation, the merger of the two entities would create a significant concentration of market share in the cable programming industry. Most significant is the control the merged entity would have over extremely popular services like CNN and TNT.
There may not be a clear answer to the question raised here but there are grounds for concern that the merger comes close to violating the Clayton Act. Thus, the Office of Advocacy urges that the consent order contain provisions adequate to guard against Time Warner's use of its market power to bundle programming and to prevent price discrimination in markets where Time Warner is dominant or where price discrimination can be used to increase market share.
B. Potential Price Restraint: The Availability of Wholesale Cable Programming Rates
The Office of Advocacy is specifically concerned that the proposed Time Warner-Turner merger not be approved without mandating that the merged entity make cable programming available to legitimate buying groups like the NCTC at wholesale rates. A refusal by the merged entity to offer cable programming at wholesale rates to buying groups could amount to an unlawful price restraint which should be precluded by appropriate protections in any consent agreement.
According to press accounts, the issue of this proposed merger's effect on wholesale pricing is not a new one to the Commission.(1) Wholesale price discounting is a widely accepted practice in the market for cable programming as it is in many product markets. The larger multiple system operators ("MSO") routinely benefit from substantial wholesale discounts. If legitimate buying groups such as NCTC do not have access to wholesale rates, their members operate at a significant competitive disadvantage in an increasingly competitive video marketplace.
Small cable operators and other multichannel video programming distributors have for many years used buying groups or cooperatives to gain access to wholesale prices for cable programming. The principal vehicle for small cable operators' wholesale purchases is the National Cable Television Cooperative ("NCTC"), a buying group originally formed in 1984. NCTC's members serve over 8 million homes in all 50 states and most U.S. territories representing over 20 million American consumers.(2) The NCTC currently supplies a package of cable programming at significantly reduced wholesale rates to over 5,300 cable systems or approximately 45% of all cable systems and almost 12% of all subscribers nationally.(3) Wholesale discounts are typically in the 25-40% range. The vast majority of the cable operators that have joined NCTC are small businesses serving suburban, small town and rural customers.
In its review of the proposed merger, the Commission's staff has been apprised of the long history of alleged anticompetitive conduct engaged in by Time Warner in its dealings with the program buying groups such as the NCTC. It is a matter of record that Time Warner effectively refused to sign a programming contract with NCTC for the first eleven years of its existence, in spite of the fact that other cable programming suppliers like Turner and TCI routinely sell to buying groups like the NCTC at wholesale rates. It was only after certain members of Congress put extraordinary pressure on Time Warner during Congressional consideration of the Telecommunications Act of 1996 that Time Warner finally agreed to sell some of its programming services at wholesale rates to NCTC members.(4) The contract they have, however, is relatively short term with no assurance of renewal.(5) Should the proposed merger be approved without adequate protection for buying groups like NCTC, Time Warner will be in a position to deny the members of such groups access at reasonable wholesale rates not just to its existing programming but to the extensive collection of programming owned by Turner as well.
C. Time Warner and the Members of NCTC are Direct Competitors
Some parties may raise the concern that the Commission is not in a position to grant relief to members of buying groups like NCTC because Time Warner and members of buying groups like NCTC do not compete directly against each other. This is simply not the case. The members of the NCTC compete directly with Time Warner in two ways: (1) with Primestar Partners, Inc. ("Primestar"), a medium-power direct broadcast satellite (DBS) venture, of which Time Warner owns the largest single block of equity; and (2) through the increasing incidence of so-called "overbuilds" by Time Warner and the members of NCTC in each other's franchise areas.
1. Direct to Home Satellite Competition
Time Warner, through its ownership interest in Primestar, competes directly with all of the members of buying groups like the NCTC. Primestar is one of several direct to home (DTH) satellite services that are now available to consumers across the country. In recent years, DTH satellite services like Primestar have become the most significant competitors to cable operators.(6)
The direct to home satellite industry is by far the single fastest growing segment of the video marketplace and the single most important source of competition to the members of buying groups like the NCTC. In the past few years subscribership has grown exponentially with the advent of digitally-compressed DBS services. DTH satellite programming providers like Primestar are an even more important source of competition to the largely suburban and rural members of NCTC. The less densely populated states that lead the nation in DTH satellite penetration rates are the same states that have disproportionate numbers of NCTC members.
Time Warner's significant ownership of Primestar makes it one of the chief, if not the chief, direct competitor to the members of NCTC.(7) Primestar currently serves approximately 1.3 million homes, large enough to make it one of the top ten MSOs were it a wireline video provider. Primestar's growth rate has been remarkable. As recently as the summer of 1994, Primestar served only 70,000 subscribers and had only minor subscribership growth.(8) By January 1995, Primestar's subscribership had reached over 250,000.(9) Between November 1995 to June 1996, Primestar's subscribership rose from 880,000 to 1,275,000, a 77% annual growth rate.(10) Most industry observers expect strong growth to continue for the next several years. Jim Gray, an official for Primestar, recently projected having as many as 2 million subscribers by year end 1996 and as much as 45% of a 13 million dish market (or 5.85 million subscribers) three years later.(11)
Clearly, Primestar's growth has come and will continue to come primarily at the expense of NCTC's members' systems and other existing cable programming distributors. Time Warner's ownership of significant Primestar equity gives it a clear, unambiguous and immediate incentive to discriminate against the members of NCTC.(12) The Commission must ensure that the members of NCTC are protected against anticompetitive conduct by Time Warner acting through Primestar.(13)
2. Overbuild Competition
Time Warner and the members of the NCTC also compete directly against each other in an increasing number of markets through so-called "overbuilds". Overbuilds occur when one cable operator constructs a wireline cable system within the same franchise area as another, existing cable operator. Direct competition between wireline cable systems in the same geographic market via overbuilds have historically been rare. Over the past year or two, however, there has been a marked increase in the incidence of overbuilds. This is another area in which Time Warner and the members of buying groups like the NCTC compete directly.
The following are examples of cases where Time Warner and members of the NCTC have overbuilt each other in the same geographic markets:(14)
* Time Warner is overbuilding Horry Telephone Cooperative, Inc., a member of NCTC, in Conway and Myrtle Beach, South Carolina. The overbuild area includes approximately 5,000 subscribers.
* Ameritel, Inc. is preparing an overbuild of the Time Warner owned system service the Pearl Harbor Naval Base. The overbuild area includes approximately 1,500 subscribers.
* Time Warner is beginning to overbuild Massillon Cable Television, Inc., an NCTC member in Jackson Township, Ohio. The overbuild area currently includes approximately 250 subscribers out of the 30,000 basic subscribers served by Massillon Cable.
* Liberty Cable, a satellite master antenna television operator and an NCTC member, is overbuilding Time Warner in New York City. The overbuild area includes about 30,000 subscribers in the New York City area. * Cable Management Associates and Time Warner are in an overbuild situation in Monroe and Blanchard, Louisiana in an area with approximately 2,000 basic subscribers.
* NET Cable and Time Warner currently are in an overbuild situation in franchise areas covering Pittsfield, Suamico and Little Suamico, Wisconsin. * CFW Cable and Time Warner compete in an overbuild situation in the Shenandoah Valley, Virginia. The overbuild area includes about 2,000 homes.
* Star Cable Associates and Time Warner compete against each other in Arcola, Texas. Star Cable's system has approximately 300 subscribers.
Regardless of who overbuilds whom, it is clear that each overbuild situation pits Time Warner directly against members of NCTC, giving Time Warner a significant economic incentive to discriminate against NCTC members. It is clear that Time Warner has no incentive to sell to its competitors at reasonable wholesale discounts. Without a requirement that they sell at wholesale rates, competition would be reduced through the inappropriate exercise of market power by Time Warner versus competition through other appropriate means of competition such as improved service, expanded programming choices, and the like.
Direct competition with Time Warner through overbuilds is already a reality for the above-referenced operators and other NCTC members. While these numbers may not be large compared to the industry as a whole, these numbers and trends represent an important development within the cable industry -- one that the Commission must factor in its determination of the possible anti- competitive impacts of the proposed Time Warner/Turner merger.
III. CONCLUSION
Time Warner and the members of buying groups like the NCTC are direct competitors both through Time Warner's financial interest in Primestar and through direct overbuilds between Time Warner and the NCTC members. Because of this competition, Time Warner will have increasing incentives to discriminate against their direct competitors in the sale of cable programming at wholesale rates. The Office of Advocacy therefore recommends that the approval of the proposed merger be contingent upon agreement on language in the consent order mandating the continued availability of Time Warner's programming at wholesale prices.
The proposed Time Warner-Turner merger represents an enormously complex deal affecting many aspects of the video programming and distribution marketplace. Given the press accounts of the proposed consent settlement, the Commission appears to have done a creditable job in addressing some of the competitive concerns raised by the proposed Time Warner/Turner merger. But the Commission's job cannot and does not end there. It is the Commission's duty to examine the impact of this proposed merger on all significant markets affected by the merger. This includes the competitive relationship between Time Warner and the members of NCTC. Without adequate provisions to protect small cable operators' access to reasonable wholesale prices for Time Warner's and Turner's programming, the Commission will have failed to address a major area of potential anticompetitive conduct by the proposed merged entity. The history of alleged anticompetitive conduct by Time Warner and the market power incentives to discriminate against its competitors make it likely that, absent such protections, Time Warner will discriminate against the members of buying groups like NCTC.
Please feel free to contact me or my staff, David Zesiger and Jennifer A. Smith at your convenience at (202) 205-6533. We look forward to discussing this matter with you, the Commissioners and the Commission staff in greater detail prior to your resolution of the proposed merger.
Sincerely,
Jere W. Glover
Chief Counsel for Advocacy
cc: FTC Commissioners
William Baer
ENDNOTES
1. Press accounts indicate that one aspect of a draft consent order in the proposed Time Warner-Turner merger may be the requirement that Time Warner and Turner void the 20-year agreement with Telecommunications Inc. ("TCI") to sell their programming at a substantial discount.
2. The Census Bureau estimated that in 1994 the average American household consists of 2.67 people. U.S. Department of Commerce, Bureau of the Census, Statistical Abstract of the U.S., The National Data Book at 57 (1995).
3. Telephone interview with Michael Pandzik, President, National Cable Television Cooperative, Inc. (August 9, 1996).
4. See, 141 Cong. Rec. S8434-6 (daily ed. June 15, 1995) (statements of Sen. Larry Pressler, Sen. J. James Exon, and Sen. Robert C. Byrd). To date, the NCTC still has no agreement with Time Warner to purchase Time Warner-controlled Cinemax, an important pay cable service.
5. The contract is currently set to expire in less than four years.
6. SkyREPORT recently reported that the penetration rate for DTH satellite dishes exceeded 10% in 13 states, up from only 2 states one year ago. The state of Montana topped the list with an overall penetration rate of 18.59%, followed by Vermont with 17.05%. SkyREPORT, August, 1996 at 1.
7. While Primestar is not a wholly owned subsidiary of Time Warner, Time Warner is the single largest shareholder of Primestar equity, owning 32% of its stock. Daily Variety, June 20, 1996, p.1.
8. "Primestar DBS Boxes to Include Multimedia Software," Multichannel News at 32 (May 9, 1994). Primestar's relatively stagnant subscribership growth prior to 1995 was due primarily to the fact that until well into 1994 its service was limited to approximately 10 channels of analog service.
9. "DBS Businesses Flying High," Broadcasting and Cable at 55 (January 9, 1995).
10. SkyREPORT, August 1996 at 8.
11. SkyTRENDS, annual report 1996 p.6
12. The Commission should also note that price competition in the direct to home satellite industry is in its early stages. As price competition heats up, the competition between Primestar and the NCTC members will increase, as will the need for [adequate protection for the members of NCTC. Some indication of the more aggressive price competition can already be seen in Echostar's pricing of its DBS dishes at $199.00 (versus the $600-800 price normally charged by its competitors).
13. Primestar and its cable MSO owners have already been the object of a Department of Justice investigation which resulted in consent judgments against Primestar Partners and its MSO owners (including Time Warner) in September, 1993 and April, 1994. The State of New York v. Primestar Partners, L.P., 1993 WL 720677 (S.D.N.Y.); U.S. v. Primestar Partners, L.P., 1994 WL 196800 (S.D.N.Y.). The consent judgment, however, failed to require that the partners involved in Primestar, including Time Warner, make programming available at reasonably comparable wholesale rates, as the Office of Advocacy argues is necessary in the proposed merger. In the face of this clear history of anticompetitive concerns with Primestar, it is all the more vital that any consent order agreed to in this case require the merged entity to sell programming at wholesale rates.
14. The examples of overbuilds were reported to the Office of Advocacy by the NCTC and its members.