Presented By

Anuran Saha(63064)

Avishek Dasgupta(62997)

Sky Wars: The Attempted Merger of EchoStar and

DirecTV(2002)

DATE: 24.11.12 Subject: Industrial

Economics

Major Players In the Case

Introduction

EchoStar Communication

Corporation (DISH NETWORK)

Electronics Corporations

(DirecTV)

Department of

Justice (DOJ)

Federal Communications Commission

(FCC)

Background DetailsIndustry

Satellite Television Service

Operating MarketUnited 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 PrimeStarHigher 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

Brief History

Relevant market products within MVPD & subscriber share

Product Market Definition

MVPD Products Percent of

Subscribers

Cable 78

DBS 18.3

SMATV 1.7

C-Band 1.1

MMDS 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?

The Merger & the opposition

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 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.

Opponents’ Arguments

SUBSTITUTES

Geographic MarketDBS 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

Substitutes & market

Over The Air X

C-Band Service XDigital Cable System Close Substitute

EchoStar & DirecTVSubstitute to each

other

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 = s12 + s22 + s32 + ... + sn2 (where sn is the

market share of the i-th firm). Increases in the Herfindahl index generally

indicate a decrease in competition and the market is more towards monopoly & vice-varsa.

Example: 1. 5 players, 20% each : HHI = 5 X 202 = 2000

2. 5 players, 1 have 75%, rest each 5%: HHI = 752+4 X 52 = 5725

Concentration test : hhi

• 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.

Concentration test : hhi

There were 2 levels of competition1. Cable TV vs DBS services2. 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.

competition

• 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

Evidence of Competition between Directv and Echostar

Coordinated and Unilateral Effects

Coordinated Effects Unilateral Effects

Arise when firms in the industry recognize their mutual

interdependence and take actions that sustain their joint

profits

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

(Pj - MCj)/Pj= - 1/ɛjj

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.

Unilateral effects

Lerner Index of Market Power

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

- 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

Unilateral effectsService

Price

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

PricesPre

MergerPost

MergerEchoStar 30.99$ 50.12$

DirecTV 31.99$ 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:

(Pj – MCj) / Pj = - Sj/ŋ

Where Sj 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) = -6.4With Premerger Price:DirecTV: $31.99 + $5.99EchoStar: $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

NASH-cournot competition

Assuming that marginal cost does not changeWe 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

Derivation of Post-Merger Price using MC

Price Increase depends on:

- estimated price elasticity

- intensity of competition before the merger

- Marginal costs before and after the merger(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 results

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

Dynamics of consumer adoption of satellite TV

Factors that contributed to relatively low DBS priceCompetition between EchoStar and DirecTVCompetition 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

Dynamics of consumer adoption of satellite TV

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 priceSunk cost on installation and equipmentLong term purchase contractsTime and inconvenience of researching MVPD

alternatives and having one installed

Dynamics of consumer adoption of satellite TV

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.

National Pricing

QDBS = qcDBS(pDBS) + qnc

DBS(pDBS)

QDBS: Total demand for DBS Services

qcDBS : Demand in cable areas

qncDBS: Demand in areas without access to cable

pDBS: Price of DBS Service

ŋDBS = scŋcDBS + sncŋnc

DBS

ŋDBS: Elasticity of Total Demand

Sc: Share of demand in cable areas

Snc: Share of demand in non-cable areasŋc

DBS: Elasticity of demand in cable areas

ŋncDBS: Elasticity of demand in non-cable areas

Estimate by Goolsbee and Petrin, 2004 predicts low demand elasticity

National Pricing

Availability of orbital satellite positions is constrained by regulationAll 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 ApprovalHigh costNew contract for programming, distribution and

installation networkFailed attempt by SES Americom and Intelsat

Potential for new entrants

Remedy Suggested:Divest or lease substantial transponder assets

to CablevisionJoint venture with CablevisionProvide assistance to Cablevision in

establishing retail outletsReality:Unlikely to occur within the two-year time

horizon considered in the DOJ/FTC Merger Guidelines

Huge costTerms of assistance from the merged company

have to be monitored

Potential for new entrants

Arguments:Better use of scarce radio spectrumBroadcast local channels to more communities,

offer additional high-definition contentReduce significant overlap in the satellite

broadcastsMore 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

Efficiencies

Antitrust authorities blocked the merger

Aftermath

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.

Reflections

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

Updates:

EchoStar DirecTV

26 HD Channels 8 Exclusively HD Channels

“America’s largest HD lineup” Numerous other regional HD networks

Pay-Per-View Pay-Per-View

Premium Channels Premium Channels

Local broadcasts in HD Local broadcasts in HD

Over 170 DMA’s Over 143 DMA’s

96 % of TV households 94 % of TV households

Status as of 2007

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

Reflections

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

A. The merger would help to cut down marginal cost

B. More number of customers will subscribe for DBS (Economies of scale)

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

D. There will be only one national pricing for the DBS system

Test Questions (1/5)

Which of the following is true regarding the Herfindahl–Hirschman Index ?

A. A high value of HHI indicates that there is more monopoly in the market

B. A low value of HHI means less competition in the market

C. HHI value can not be more than 10000D. Both A & C

Test Questions (2/5)

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

A. Valid: It protected consumers from price riseB. Valid: It will definitely help to lower the price for

all consumersC. Invalid: It merely averages the price

increase from the merger across all consumers and may increase price for all consumers

D. Invalid: Uniform National Pricing is impossible to achieve

Test Questions (3/5)

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

A. It was unlikely to occur within the two-year time horizon considered in the DOJ/FTC Merger Guidelines

B. There was huge cost and terms of assistance from the merged company would have to be monitored

C. EchoStar and DirecTV were secretly planning to buy off Cablevision

D. Both a) and b)

Test Questions (4/5)

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)

Test Questions (5/5)

Thank you