SKY WARS : The SKY WARS : The Attempted Merger of Attempted Merger of EchoStar and DirecTVEchoStar and DirecTV

Presented by:Brennan

HanTasmin

Intention to MergeIntention to Merge

On October 28,2001, EchoStar Communications Corporation (Dish

Network) announced its intention to acquire the assets of Hughes Electronics

Corporations (DirecTV).

• EchoStar and DirecTV are two Direct Broadcast Satellite (DBS) Companies.

• Provide multichannel video programming distribution (MVPD) services.

• Consumers of these services are located in United States.

What are They?What are They?

• Launch time: June,1994• DBS Type: Higher Power all-digital DBS Service• Requirement: a receiving dish the size of a large

pizza.• Attraction for Consumers: more programming

with a smaller dish antenna.• 1999: Purchased Primestar and migrated all

primestar subscribers to its equipment.

Directv: Some factsDirectv: Some facts

• Launch Time: March, 1996.• DBS Type: Higher Power all-digital DBS Service.• Receiving Format: The receiving dish formats are

similar for EchoStar and DirecTV.• Company size: Smaller than DirecTV.• Compatibility: Two systems were not compatible,

since they used different signal encryption methods.

Echostar: Some factsEchostar: Some facts

• Only these two companies were ruling in DBS market.

• 1997-2001, Sales of DBS System was growing fast.

• DirecTV had grown to 10.9 million subscribers.• EchoStar had more than 7.5 million customers.• EchoStar had capacity for 500 channels.• DirecTV had capacity for 460 channels.

Some positive facts for both Some positive facts for both companiescompanies

• 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.

Merger’s ArgumentsMerger’s Arguments

(Department of Justice (DOJ) and the Federal Communications Commission (FCC))

• 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.

Opponents’ ArgumentsOpponents’ Arguments

What are the relevant Market Products?

• Services within MVPD cable (according to FCC):»Cable»Direct Broadcast Satellites (DBS)»Multi-channel Multipoint distribution

services (MMDS)»Satellite Master Antenna Television

(SMATV)»C-band

Product market definitionProduct market definition

MVPD Subscribers

Percent of MVPD Subscribers

Cable 78

DBS 18.3

SMATV 1.7

C-Band 1.1

MMDS 0.8

National MVPD Subscriber Shares National MVPD Subscriber Shares (june 2001)(june 2001)

• C-band service- highly inefficient - not an acceptable substitute• Over –the- air broadcast television-poor reception ,

does not include various programs (i.e. ESPN or CNN) -not an acceptable substitute• Digital Cable Systems-higher quality, more channels,

Pay-per view movie -closer substitute for DBS• EchoStar and DirecTV are the closest substitutes for

each other (narrower market for same service and highly concentrated).

SubstitutesSubstitutes

• DBS companies provide nationwide services

• Cable companies provide local services.

• EchoStar and DirecTV’s national pricing will depend on cable prices and service offerings at the local level.

• EchoStar and DirecTV have targeted promotions at local level and have ability to adjust price locally if they chose to do so

Geographic MarketsGeographic Markets

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

• For DBS vs All Cable systems :

Median post merger HHI=5653, median increase = 861

• For DBS vs Digital Cable Systems:

Median post merger HHI=6693, the median increase = 206

Note- these figures actually understating the significance of the proposed merger since DBS was experiencing rapid growth at that time. And additional growth will increase the market shares. Increased market shares will increase concentration.

Concentration Test: HHIConcentration Test: HHI

• A merged EchoStar and DirecTV would have sufficient market power to raise prices above pre-merger levels;

-Narrow Market ( only two DBS provider) and

Highly concentrated (market share is even growing more)

• DBS subscribers (3%-19%) in some areas will face a monopoly price, where they can not switch their service to Cable companies.

Market Definition AnalysisMarket Definition Analysis

• Would New EchoStar raise prices after the merger?

• Cable may provide competition and cause lower DBS prices,

if the prices are nationwide- non-cable and cable regions alike.

Competitive EffectsCompetitive Effects

• DirecTV v. EchoStar DBS v. Cable

• Proponents claim DBS providers compete more to attract Cable customers than customers of each other.

• However…

Proponents of the MergerProponents of the Merger

• Similar prices and similar services

Evidence of Competition between Evidence of Competition between Directv and EchostarDirectv and Echostar

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

• EchoStar itself acknowledged DirecTV as competitor in papers filed to court

• Email saying- “we have signal in Alaska and D(irec)TV doesn’t have much. We don’t have competition there…”

Evidence of Competition between Evidence of Competition between Directv and EchostarDirectv and Echostar

• If DirecTV and EchoStar had prices way below cable, does it mean cable is not a significant competition?

- The companies may be competing to attract actual or potential cable customers.

Difficulties in EvidenceDifficulties in Evidence

• Both EchoStar and DirecTV had prices slightly below cable

Cable $33.81 - 59 Channels EchoStar $31.99 - 60 Channels

Evidence of Competition between Evidence of Competition between Directv and EchostarDirectv and Echostar

• Coordinated Effect – Merger will create

environment in which it will be beneficial for the cable firms to collude

• Unilateral effects – Merged firm has enough market power to increase prices above pre-merger levels

Coordinated and Unilateral EffectsCoordinated and Unilateral Effects

• What we want to know: Post merger price, Pre-merger price (already know)

Unilateral EffectUnilateral Effect

• Post merger price of New EchoStar (Pj - MCj)/Pj=-1/ɛjj

• Elasticity is hard to estimate, because little price change occurred.

• Alternative method : $1 increase in DBS = $1 decrease in all substitute

MVPD

Unilateral EffectUnilateral Effect

ServicePrice

Expanded Basic Premium Cable DBS

Antenna 1.30 .92 .12

Expanded Basic -1.54 .92 .29

Premium Cable 1.26 -3.18 .49

DBS .93 1.17 -2.45

Table 4-2Table 4-2

• P – MC/P = -1/-2.54

• New EchoStar will charge 70 percent above MC

• But, is this larger than pre-merger prices?

Unilateral EffectUnilateral Effect

• In order to find postmerger price we need to know Marginal production cost

• MacAvoy estimates of MC DirecTV $26.80 EchoStar $30.39

• Postmerger prices v. Premerger Prices DirecTV $44.20 v. $31.99 EchoStar $50.12 v. $30.99

Marginal Production cost is estimatedMarginal Production cost is estimated

• Alternative method of estimating Marginal Production Cost:

• Use own- and cross-price elasticity of demand• Elasticity gives premerger Lerner Indices• With premerger Lerner Index and price, we can

get an estimate of MC.• Of course this value of MC will give us postmerger

price

Marginal Production Cost DerivedMarginal Production Cost Derived

• Assumption: both firms choose output levels to maximize profit under assumption that output of other firms are fixed

• Premerger prices would satisfy:

(Pj - MCj)/Pj = -Sj/ɛ

Sj : share of firm j in DBS market

ɛ : elasticity of demand for DBS (negative number)RHS : reciprocal of firm-specific elasticity of demand for

product j.

Nash - Cournot CompetitionNash - Cournot Competition

• (Pj - MCj)/Pj = -Sj/ɛ

• Example: If EchoStar had 40% of share, it’s firm-specific

elasticity of demand would be: reciprocal of 0.4/(-2.54) = -6.4With Premerger Price:Dtv $31.99 + $5.99Estar $30.99 + $5.99We 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

Getting the Marginal CostGetting the Marginal Cost

• Assume that marginal cost does not change

• We have two MC’s – choose the lower one $28.94

• Post-merger price is : P = MC/(1+1/ɛ) 47.73 = 28.94/(1-1/2.54)

Derive Post-Merger Price using MC Derive Post-Merger Price using MC

• Average pre-merger price $37.48• Post-merger price $47.73

-> 27 percent increase

Pre vs. post – merger pricesPre vs. post – merger prices

• Price Increase depends on: - estimated price elasticity - intensity of competition before the

merger - Marginal costs before and after the

merger

Interpretation of resultsInterpretation of results

(Pj - MCj)/Pj = -1/ɛjj

• 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

Interpretation of resultsInterpretation of results

• Churn Data : More consumers move from DBS to Cable than from one DBS company to another.

• Churn data might indicate that DTV and EchoStar are close substitutes and have similar prices, consequently, the customers will rarely switch between these companies.

Merging parties: Churn DataMerging parties: Churn Data

• Observe the price change of satellite TV• Price of DBS has fallen (equipment and

installation) – Early adopters’ higher willingness-to-pay

• Before merger- Consumer surplus exists due to competition and willingness-to-pay

• After merger- surplus may move to producers

Dynamics of Consumer adoption of Dynamics of Consumer adoption of satellite tvsatellite tv

• The two forces that check price increase 1. Competition between DTV & EchoStar 2. Competition between DBS & Cable

(remains)

DBS prices could stay low because new consumers are more price-elastic, but after DBS subscribers increase they might exploit the installed base of DBS subscribers.

Dynamics of Consumer adoption of Dynamics of Consumer adoption of satellite tvsatellite tv

• New EchoStar will raise prices if installed base is relatively larger than arrival rate of new customers

• Switching cost: 1.Sunk cost in installation and equipment 2. Long-term purchase contracts 3. Time and inconvenience of researching

and having installed MVPD alternatives

Dynamics of Consumer adoption of Dynamics of Consumer adoption of satellite tvsatellite tv

National PricingNational Pricing

What Will Protect Consumers?

The Firms’ Answer:

Commitment to National Pricing

In actuality, national pricing simply averages the price increase from the merger across all

consumers.

Goolsbee and Petrin, 2004: Low estimates of demand elasticity

ŋŋDBSDBS = s = sccŋŋccDBSDBS + s + sncncŋŋncnc

DBSDBS

Elasticity of Total Demand

Share of demand in cabled areas

Share of demand in non-cabled

areas

Elasticity of demand in cabled

areas

Elasticity of demand in non-

cabled areas

National PricingNational Pricing

QQDBSDBS = q = qccDBSDBS(p(pDBSDBS) + q) + qncnc

DBSDBS(p(pDBSDBS))

Total demand for DBS services

Demand in areas without access to

cableDemand in cabled areas

Price of DBS service Price of DBS service

National PricingNational Pricing

Satellite Positioning Limitations

“Wing” Locations

New Technology: “Short-Spaced” Orbital Locations

Barrier: Regulatory Approval

SES Americom, 2002

Intelsat, 2005Other Barriers: High Costs, Channel Licensing Contracts

EntryEntry

DirecTV and EchoStar Proposals:

• Transponder Assets

• Joint venture: set-top boxes and local programming

• Retail outlets

RemediesRemedies

Feasible?

2 Year Time Horizon (in DOJ/FTC Merger Guidelines)

High Initial Costs

Terms of Assistance for Cablevision

… Probably Not.

Cablevision in 2005

RemediesRemedies

Scarce Radio Spectrum

EfficienciesEfficiencies

Duplicate Channels

Merger would allow:

More local coverageAdditional high-definition contentMore effective competition with

cable

Antitrust authorities blocked the merger

Aftermath: What Happened?Aftermath: What Happened?

Pre-merger, firms believed that they could not make the improvements

necessary to match the programming content provided by cable systems on

their own

The reality: both EchoStar and DirecTV found ways to increase capacity and

expand programming relative to digital cable– without merging.

ReflectionsReflections

EchoStar

26 HD Channels

“America’s largest HD lineup”

Pay-Per-View

Premium Channels

Local broadcasts in HD

DirecTV

8 Exclusively HD Channels, numerous other regional HD

networks

Pay-Per-View

Premium Channels

Local broadcasts in HD

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

Currently (2005):Currently (2005):

Beforehand, firms claimed that only a merger would give capacity to provide local

broadcasts to 100 DMA’s total

EchoStar

Over 170 DMA’s

96 percent of TV households

DirecTV

Over 143 DMA’s

94 percent of TV households

Currently (2006):Currently (2006):

Signal Compression Technology

Additional Satellites

EchoStar: 4

DirecTV: 5

(since 2002)

How Did they do this?How Did they do this?

Considerable risk of higher prices

Estimate of $10 increase in monthly rate

Even with just a $2 increase, still exceeds the plausible efficiency gains from the merger

Consumer EffectsConsumer Effects

New developments…New developments…