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SKY WARS : The Attempted Merger of EchoStar and DirecTV. Presented by: Brennan Han Tasmin. Intention to Merge. On October 28,2001, EchoStar Communications Corporation ( Dish Network ) announced its intention to acquire the assets of Hughes Electronics Corporations ( DirecTV ).

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Presentation Transcript
slide2

Intention to Merge

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

slide3

What are They?

  • 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.
slide4

Directv: Some facts

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.

slide5

Echostar: 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.

slide6

Some positive facts for both companies

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.

slide7

Merger’s Arguments

  • 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.
department of justice doj and the federal communications commission fcc
(Department of Justice (DOJ) and the Federal Communications Commission (FCC))

Opponents’ Arguments

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.

what are the relevant market products
What are the relevant Market Products?

Product market definition

  • 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
slide11

Substitutes

  • 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 substitutesfor each other (narrower market for same service and highly concentrated).
slide12

Geographic Markets

  • 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
slide13

Concentration Test: HHI

  • 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.

slide14

Market Definition Analysis

  • 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.
slide15

Competitive Effects

  • 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.

slide16

Proponents of the Merger

  • DirecTV v. EchoStar

DBS v. Cable

  • Proponents claim DBS providers compete more to attract Cable customers than customers of each other.
  • However…
slide17

Evidence of Competition between Directv and Echostar

  • Similar prices and similar services
slide18

Evidence of Competition between Directv 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…”
slide19

Difficulties in Evidence

  • 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.

slide20

Evidence of Competition between Directv and Echostar

  • Both EchoStar and DirecTV had prices slightly below cable

Cable $33.81 - 59 Channels

EchoStar $31.99 - 60 Channels

slide21

Coordinated and Unilateral Effects

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

  • Coordinated Effect –

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

slide22

Unilateral Effect

  • What we want to know:

Post merger price,

Pre-merger price (already know)

slide23

Unilateral 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

slide25

Unilateral Effect

P – MC/P = -1/-2.54

New EchoStar will charge 70 percent above MC

But, is this larger than pre-merger prices?

slide26

Marginal Production cost is estimated

  • 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

slide27

Marginal Production Cost Derived

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

slide28

Nash - Cournot Competition

  • 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.

slide29

Getting the Marginal Cost

  • (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) = -6.4

With Premerger Price:

Dtv $31.99 + $5.99

Estar $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

slide30

Derive Post-Merger Price using MC

  • 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)

slide31

Pre vs. post – merger prices

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

-> 27 percent increase

slide32

Interpretation of results

  • Price Increase depends on:

- estimated price elasticity

- intensity of competition before the merger

- Marginal costs before and after the merger

slide33

Interpretation 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
slide34

Merging parties: Churn Data

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

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

slide35

Dynamics of Consumer adoption of satellite tv

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

slide36

Dynamics of Consumer adoption of satellite 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.

slide37

Dynamics of Consumer adoption of satellite 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

slide38

National 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.

slide39

Elasticity of demand in non-cabled areas

Elasticity of demand in cabled areas

Share of demand in cabled areas

Share of demand in non-cabled areas

National Pricing

ŋDBS = scŋcDBS + sncŋncDBS

Elasticity of Total Demand

Goolsbee and Petrin, 2004: Low estimates of demand elasticity

slide40

Price of DBS service

Price of DBS service

Demand in areas without access to cable

Demand in cabled areas

National Pricing

QDBS = qcDBS(pDBS) + qncDBS(pDBS)

Total demand for DBS services

slide41

New Technology: “Short-Spaced” Orbital Locations

Barrier: Regulatory Approval

SES Americom, 2002

Intelsat, 2005

Entry

Satellite Positioning Limitations

“Wing” Locations

Other Barriers: High Costs, Channel Licensing Contracts

slide42

Remedies

  • DirecTV and EchoStar Proposals:
  • Transponder Assets
  • Joint venture: set-top boxes and local programming
  • Retail outlets
slide43

Cablevision in 2005

Remedies

Feasible?

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

High Initial Costs

Terms of Assistance for Cablevision

… Probably Not.

slide44

Efficiencies

Scarce Radio Spectrum

Duplicate Channels

Merger would allow:

More local coverage

Additional high-definition content

More effective competition with cable

slide45

Aftermath: What Happened?

Antitrust authorities blocked the merger

slide46

Reflections

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.

slide47

Currently (2005):

DirecTV

8 Exclusively HD Channels, numerous other regional HD networks

Pay-Per-View

Premium Channels

Local broadcasts in HD

EchoStar

26 HD Channels

“America’s largest HD lineup”

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

slide48

Currently (2006):

EchoStar

Over 170 DMA’s

96 percent of TV households

DirecTV

Over 143 DMA’s

94 percent of TV households

Beforehand, firms claimed that only a merger would give capacity to provide local broadcasts to 100 DMA’s total

slide49

How Did they do this?

Signal Compression Technology

Additional Satellites

EchoStar: 4

DirecTV: 5

(since 2002)

slide50

Consumer Effects

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

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