SKY WARS : The Attempted Merger of EchoStar and DirecTV

1. SKY WARS : The Attempted Merger of EchoStar and DirecTV Presented by: Brennan Han Tasmin

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

3. 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.

4. 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.

5. 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.

6. 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.

7. 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.

8. (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.

9. 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

10. National MVPD Subscriber Shares (june 2001)

11. 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).

12. 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

13. 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.

14. 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.

15. 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.

16. 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…

17. Evidence of Competition between Directv and Echostar • Similar prices and similar services

18. 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…”

19. 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.

20. 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

21. 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

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

23. 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

24. Table 4-2

25. Unilateral Effect P – MC/P = -1/-2.54 New EchoStar will charge 70 percent above MC But, is this larger than pre-merger prices?

26. 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

27. 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

28. 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.

29. 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

30. 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)

31. Pre vs. post – merger prices • Average pre-merger price $37.48 • Post-merger price $47.73 -> 27 percent increase

32. Interpretation of results • Price Increase depends on: - estimated price elasticity - intensity of competition before the merger - Marginal costs before and after the merger

33. 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

34. 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.

35. 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

36. 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.

37. 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

38. 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.

39. 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

40. 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

41. 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

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

43. Cablevision in 2005 Remedies Feasible? 2 Year Time Horizon (in DOJ/FTC Merger Guidelines) High Initial Costs Terms of Assistance for Cablevision … Probably Not.

44. Efficiencies Scarce Radio Spectrum Duplicate Channels Merger would allow: More local coverage Additional high-definition content More effective competition with cable

45. Aftermath: What Happened? Antitrust authorities blocked the merger

46. 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.

47. 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

48. 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

49. How Did they do this? Signal Compression Technology Additional Satellites EchoStar: 4 DirecTV: 5 (since 2002)

50. 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