Preempting the State: Is It Legal?

We will find out!  In California, Senate Bill 822 is awaiting Governor Brown’s signature for its net neutrality legislation to become law.  The law would prevent Internet Service Providers (ISPs) operating in the state from blocking, throttling, and prioritizing traffic over broadband networks.  States, particularly ones with Democratic Governors and/or Attorney Generals, are arguing, that when the FCC went to light-touch regulation of the Internet, changing the broadband classification from common carrier (Title II) to information service (Title I), the FCC gave up its preemptive authority to dictate what they can do.  (Note: Two years prior to the FCC rule change on net neutrality, the U.S. Court of Appeals stated that the FCC does not have the power to preempt state laws that restrict cities from building their own broadband networks.)

But, in this situation, the FCC believes that it can preempt state laws that conflict with its policy because broadband is an interstate service that does not recognize state lines.  Representing the industry, Jonathan Spalter, President and CEO of USTelecom, argues that “The internet must be governed by a single, uniform and consistent national policy framework, not state-by-state piecemeal approaches.”

Who is right?  Or, who will win?  I’m not sure, but the short-term costs of complying with and legally challenging states that have adopted net neutrality laws or executive orders will be very costly for the ISPs.  Of the 22 states with Democrats as Attorney Generals, 12 have Democrats as Governors.  Oregon and Washington were the first two states to pass laws.  As evident by California’s actions, they will not be the last. 

State	Governor	Attorney General
California	X	X
Colorado	X
Connecticut	X	X
Delaware	X	X
Hawaii	X	X
Illinois		X
Iowa		X
Kentucky		X
Louisiana	X
Maine		X
Maryland		X
Massachusetts		X
Minnesota	X	X
Mississippi		X
Montana	X
New Mexico		X
New Jersey	X	X
New York	X	X
North Carolina	X	X
Oregon	X	X
Pennsylvania	X	X
Rhode Island	X	X
Vermont		X
Virginia		X
Washington	X	X
West Virginia	X

https://www.ustelecom.org/news/press-release/ustelecom-statement-net-neutrality-bill-california-state-senate

FCC vs. LFAs: Who knows what’s best for US?

At its September 26^th meeting the FCC will propose two important regulatory changes that will have an impact on municipalities.  One of the proposed rule changes would impact the deployment of 5G wireless.  The other would modify local franchising requirements for cable services. 

Arguing that fewer rules and lower costs will speed the deployment of 5G across the country, including into small, rural communities, the FCC wants to “establish shot clocks for state and local approvals for the deployment of small wireless facilities, and provide guidance on streamlining state and local requirements on wireless infrastructure deployment.”  Sounds great!  But, local franchise authorities (LFAs) don’t necessarily think so.  LFAs perceive the “need for speed” as a move to take a source of revenue away from them.

Also, at the September meeting, the Commission will consider a Second Further Notice of Proposed Rulemaking to address two issues remanded to the FCC last year from a case brought before the 6^th Circuit Court of Appeals.  In the case, the Court ruled that the FCC cannot bar LFAs from requiring franchisees to provide non-cable services and the FCC must better support why it expanded its definition of franchise fees to include non-cash requirements toward the 5% cap on LFA franchise fees.  In a recent blog post, Ajit Pai, the FCC Chairman, stated that the Commission plans to put-forth proposals that promote competition and encourage cable operators to invest in new facilities and services. The LFAs will be sure to weigh in as they look to protect their interests (once again).

https://www.fcc.gov/document/fcc-announces-tentative-agenda-september-open-meeting-4

Dysfunction Creates Opportunity

Over the weekend, it was announced that Les Moonves, Chairman and CEO of CBS, stepped down from his posts as the sexual misconduct allegations against him increased in quantity and details.  With the announcement, came word that CBS had reached a lawsuit settlement with its controlling shareholder, National Amusements Inc. (NAI) that included the replacement of 6 members of the CBS Board of Directors and a commitment by NAI to not propose a merger with Viacom for at least 2 years from the date of the settlement.  (It doesn’t mean others can’t.)

In the [short-run or long-run] moment of dysfunction at CBS, does it present opportunity for a CBS merger or acquisition by/with others in the media space?  Let’s assume it does and speculate, one more time, on who those partners/buyers might be.  

The other broadcasters (ABC, FOX, NBC) are out as they are busy making other deals AND there is that thing called antitrust that will prevent any of those tie-ups from happening.  Likewise, the wireless carriers are out as AT&T is busy fighting to keep Time Warner, Verizon has expressed little/no interest in content, and T-Mobile and Sprint are awaiting regulatory approval of their merger.  Then, there are small content players like Discovery. They are not in the financial positions to be acquirers.  The FAANG firms (ex-Netflix) could be potential acquirers with the underlying motivation to accelerate content ownership and scale.  The streaming music service, Spotify, is a potential suitor as it already partners with Hulu and Showtime (owned by CBS) and it could be interested in video content to get at economies of scope and a more diversified portfolio (bundle) of services that it goes direct to the consumer with.  But, lastly, I come back (again) to Lionsgate.  Lionsgate with CBS (and Viacom) makes a lot of sense as it would greatly increase its leverage in content negotiations with oligopolistic distributors at the box office and on the small screens.

Firm	Market Share
	2017	2016	2015	2014	2013	Avg. 2013-2017
Disney	21.8	26.3	19.8	14.9	14.9	19.5
Time Warner (WB/New Line)	18.4	16.7	16.9	18.8	21.3	18.4
NBC/Universal	15.0	14.1	22.3	11.4	13.3	15.2
News Corporation (AT&T/Fox)	12.9	13.3	12.4	17.9	10.2	13.3
Sony	9.8	8.3	8.9	12.0	10.6	9.9
Lionsgate	8.0	5.8	5.9	6.8	9.3	7.2
Viacom (Paramount)	4.8	7.7	5.9	9.7	8.4	7.3
% of Box Office	90.7	92.2	92.1	91.5	88.0	90.9
Combined Disney/Fox	34.7	39.6	32.2	32.8	25.1	32.9
Combined Lionsgate/Viacom	12.8	13.5	11.8	16.5	17.7	14.5

https://www.boxofficemojo.com/studio/?view=company&view2=yearly&yr=2017&p=.htm

Gaining Loyalty

Streaming Service	Regular Monthly Price	Regular Bundled Price	Student Prices
			Pre 9/2017	9/2017-8/2018	Post 8/2018
Spotify	9.99	12.99	4.99	4.99	4.99
Hulu	7.99
Showtime	10.99
	28.97

For college students who enjoy streaming music and movies, the recent deal by Spotify that bundles its service with Hulu and Showtime for $4.99 per month, is too good to pass up. It speaks volumes on two things:

1)  The elasticity of demand for these services is significantly greater for the cash-strapped college student.  But, as a firm, when you can segment the market based on those differences and the firm has some degree of market power, charging a lower price to those incremental subscribers that exceeds your incremental costs is a win for them too.  Third degree price discrimination in action.

2)  If subscribers love the services and perceive the switching costs to be high, Spotify and its partners can extend loyalty well beyond the end of college. A long-run benefit for sure!

An Update on T-Mobile-Sprint

While I think the T-mobile/Sprint horizontal merger and resulting increase in market concentration has the outward signs of "no way regulators will approve it", there are other factors that continue to make me think that the DOJ just might approve it.

In addition to what I described in my earlier blog (June 25th), the DOJ may look favorable on the firms' verbal commitments to retain the pre-paid options (Boost, Virgin, and MetroPCS) that make mobile calling more affordable for lower income HHs and the [strong] argument that a combined T-Mobile/Sprint can create a viable competitor in a larger number of markets for in-home broadband using 5G wireless and Level3.  The greater scale would give the new T-Mobile the leverage it would need to negotiate lower programming costs so that it could effectively compete in duopolistic markets controlled by the likes of Comcast and AT&T.  Essentially, the decline in the number of mobile competitors may be tolerated by the DOJ, if there is an offsetting gain in the number of competitors in the broadband market.  There is a lot of speculation and promises.  Let's see what the DOJ believes and/or holds the firms to if the merger is approved in one form or another.

A Review of the Paramount Pictures Antitrust Case (1948)

Seventy-years ago, after World War II but prior to the jump in television set ownership, going to the movies was the most popular form of entertainment for Americans.   In 1948, 3,352 million people went to the movies (compared to 1,225 million in 2017).  What they saw and where they watched it were controlled by five vertically-integrated major studios and three smaller ones.  The stranglehold by these firms included control of movie creation by signing actors and directors to non-compete contracts and control of exhibition by owning first-run theaters or contractually obligating independent theaters to purchase blocks of movies (good and bad ones) without the ability to view them ahead of time (blind bidding).  Antitrust action was brought against the 8 studios.  In a case brought to it on appeal, the Supreme Court ruled in United States v. Paramount Pictures (1948) that vertically integrated studios must divest their theaters and stop their anticompetitive and monopoly trade practices. 

While most of these studios still exist today in one form or the other, a lot has changed, including the rise and subsequent disruption of the television industry by technology that allows consumers to watch video content whenever and wherever they want.  Nearly 50% of theaters are owned by just five firms (Regal Entertainment, AMC, Cinemark, Carmike, and Cineplex) that operate multiple screens at each location. Content creation is now for multiple platforms--the box office, the TV set, and electronic devices connected to the internet.  

But, while there are new market participants with deep pockets creating content for the small screens (e.g. Netflix, Amazon), the box office is still dominated by a handful of media conglomerates.  Between 1995-2018, the top 5 studios accounted for more than ¾ of domestic box office receipts.  Some part of each of these firms was a defendant in the 1948 case.  (The other three defendants were RKO, MGM, and United Artist.)  While movie attendance is down relative to 1948, how a film does at the box office matters greatly to today’s vertically-integrated giants’ successes with downstream distribution, licensing deals, and merchandising sales.  

Studio	1995-2018 Market Share of Domestic Box Office**
Walt Disney/20th Century Fox*	27.79
AT&T (Warner Brothers/New Line)	15.12
Sony/Columbia Pictures	12.10
Comcast (Universal)	11.45
Viacom (Paramount)	10.69
* pending acquisition; **US, Can, Guam, PR Source: Statista	77.15

In early August as part of its initiative to terminate or modify legacy antitrust judgments that no longer serve to protect competition, the Department of Justice launched a review of the Paramount consent decrees.  As part of its review, it requested interested parties to submit comments on the following issues by October 4^th:

• Do the Paramount Decrees continue to serve important competitive purposes today?
• Individually, or collectively, are the decree provisions relating to (1) movie distributors owning movie theatres; (2) block booking; (3) circuit dealing; (4) resale price maintenance; and (5) overbroad clearances necessary to protect competition? Are any of these provisions ineffective in protecting competition or inefficient? Do any of these provisions inhibit competition or cause anticompetitive effects?
• What, if any, modifications to the Paramount Decrees would enhance competition and efficiency? What legal justifications would support such modifications, if any?
• What effect, if any, would the termination of the Paramount Decrees have on the distribution and exhibition of motion pictures?
• Have changes to the motion picture industry since the 1940s, including but not limited to, digital production and distribution, multiplex theatres, new distribution and movie viewing platforms render any of the Consent Decree provisions unnecessary?
• Are existing antitrust laws, including, the precedent of United States v. Paramount, and its progeny, sufficient or insufficient to protect competition in the motion picture industry?

Source: https://www.justice.gov/atr/paramount-decree-review

I would argue that the provisions of the consent decree that prevent studios from owning theaters (for the most part) and prohibit anticompetitive vertical restraints (e.g. block booking and circuit dealing) should remain in place.  There are no pro-competitive justifications to remove them.  The media giants are bigger and more vertically-integrated than ever.  They have tremendous market power.  Regulators should be on the lookout for anticompetitive behavior (e.g. foreclosure, bundling, exclusive dealings) across all content delivery platforms.  In fact, the Paramount case provisions matter more today, not less.

How much competition is necessary to replace regulation?

The quick answer is…it depends on the market.  Last week, the United States Court of Appeals, 8^th Circuit, upheld most of the FCC’s 2017 Business Data Services (BDS) Order in which the Commission established new criteria for determining market competitiveness for dedicated communication lines for businesses.  The net effect of the Order and it being upheld is that price cap regulation of BDS is eliminated in many of the country’s 3,233 counties.  In its decision, the Appeals Court stated that

“We recognize that the relevant data presents radically different pictures of the competitiveness of the market depending on the economic theory applied and the weight given to conflicting pieces of evidence.  But the FCC may rationally choose which evidence to believe among conflicting evidence in its proceedings, especially when predicting what will happen in the markets under its jurisdiction.  Thus, we deny the petitions for review as to the Competitive Market Test because the FCC’s resolution of competing evidence was not arbitrary and capricious.”

In its 2017 Order that came more than 10 years after a Notice of Proposed Rulemaking on the issue, the FCC argued that “the absence of entry in specific areas may be due to regulated prices inadvertently being set below competitive levels.  Such prices make entry unprofitable, are harmful to long run incentives to invest, can lead to inefficient short run levels of production and consumption, and can prevent entry indefinitely.”

Consequently, the Commission ordered that since competition for high bandwidth (> 45 mbps) services was robust now or expected over the medium term, price regulation was no longer necessary.   For lower bandwidth (< 45 mbps) services, it established a Competitive Market Test to determine if price cap regulation should be eliminated.  The Commission considered a geographical market, a county, competitive if 50% of the buildings within that county had a competitive provider with a network within half mile or if 75% of the census blocks within that county had cable broadband service. 

The FCC argued that nearby facilities restrained prices in the short term and could provide reasonable competition in three to five years.   While the Commission acknowledged that prices might rise after deregulation, they believed that entry would occur and drive prices down to competitive levels.  This is a BIG assumption in an industry that is characterized by high sunk costs (and risk) associated with entry.  The FCC believed, however, that, in this market, it only takes one competitor to enter to put significant downward pressure on prices.   Will that happen?  Time will tell, but let’s hope it does as competition is always preferred to regulation.  
FCC Order