Ed Lotterman: Comcast's Time Warner deal a textbook case for economists

ed@edlotterman.comMarch 4, 2014 

Comcast's proposed purchase of Time Warner Cable surely warms the hearts of many econ profs. The deal represents a sort of one-stop-shopping case study of all the key issues in what economists term "industrial organization" or what the public knows as "antitrust." Let's examine some of these.

First, the deal involves both "monopoly" and "monopsony." Most people know that monopoly refers to a market dominated by only one seller. Monopsony is a lesser-known term and a less common situation -- when there is only one buyer in the market.

If either monopoly or monopsony occurs to any significant extent, the free market conditions needed for an optimal outcome for society break down. The result is that resources are wasted. For a given set of available land, labor and capital, humans get fewer of their needs met. This waste of resources is what most concerns economists, but the public focuses more on the unfairness of such situations in which either a buyer or seller has no competition and thus has great pricing power.

The monopoly side of the Comcast deal involves selling cable services to the public. Astute observers -- and deal proponents -- will note that even without Comcast buying Time Warner, virtually any retail cable customer anywhere in the U.S. already faces a monopoly. There generally is only one available cable service in any given municipality, regardless of how many such firms there are nationally.

That is true because, like wired telephones, electricity or gas, providing cable services to households involves a large investment in physical distribution facilities. These are large "fixed costs." There also are significant "economies of scale" in that the average cost per customer drops as the size of the operation gets bigger, in this case, at least in one geographic area.

Variable operating costs are low, however. So once a cable operator is established, it could use "predatory pricing" to keep out competitors, lowering rates when challenged by a new entrant but then jacking them back up when that challenger is driven away.

In a situation like this, where many of the costs are fixed and average costs drop with a bigger "plant," it is common to have an operation that has the lowest average operating costs but also is enough to cover all available customers. If government took action to force competing firms, average costs for customers would rise because each firm would have higher average costs. This situation of a "natural monopoly" is common in utilities like cable TV, copper telephony, electricity and gas.

The best solution in this case is to allow the monopoly to operate but to regulate the rates it can charge so that it cannot force customers to pay the excessive "monopoly rents" that a completely unregulated monopoly could.

For traditional utilities, such regulation usually is done at the state level and involves detailed analysis of the allowed costs in the utility's "rate base."

For cable TV, it is largely local government regulation within a framework established by state and federal law.

As was first true for other utilities, cable operators opened business in the most densely populated areas first, where the average cost per customer served was lower than in thinly settled rural areas. They thus had to secure franchises on a municipality-by-municipality basis. This initially resulted in a patchwork quilt pattern of franchises. As the industry consolidated, one or another of the larger firms generally established hegemony in a given area.

In theory, if service is bad or rates high, a city council generally could refuse to renew a franchise at some contractual interval. In practice this is extremely rare. Moreover, rates and rate increases generally are not regulated as formally as states regulate electric and gas rates.

Rates for a "basic" cable package are subject to the greatest scrutiny, but those for premium ones often are whatever the monopolist decides is the profit-maximizing rate without pricing out too many customers. As all micro-econ students learn, this is a higher price and a lower quantity sold than is most economically efficient or optimal for society as a whole. That is one aspect of seller-side monopoly. There is another.

The fewer the companies, the fewer the choices open to municipalities when franchises come up for renewal. Given the advantage of a company that already has infrastructure in place, this issue largely may be moot, but not entirely. This is a question of the degree to which cable service is a "contestable market." Do potential new sellers have any chance to challenge existing firms? If not, city councils have little bargaining power.

The monopsony side comes out in cable companies' willingness to buy the creative content that they offer to their customers. The less competition among buyers, the lower the price that program producers can get for their work. The outcome is a mirror image of monopoly. The price paid for content is lower than societally optimal as is the quantity purchased. Once again there is economic inefficiency.

The arguments are not all against cable companies, however. It is correct to argue that they face stiff competition from other technologies such as Netflix or TiVo that offer downloadable or streaming content. The cable companies, however, also have power in this area, enjoying considerable market share in broadband Internet service, the kind needed to watch streamed content uninterrupted. We saw this play out in another deal in recent days: Netflix agreeing to pay Comcast to better stream its content over Comcast's wires.

Still, the lines between television, the Internet and cell phones are eroding rapidly. Regardless of the lack of competing cable operators, cable companies are losing content-viewing market share to digital programming. They cannot raise prices too much, particularly for content like movies, without accelerating the swing to these new sources.

This mimics the situation faced by the AT&T telephone system 50 years ago. AT&T had long enjoyed a monopoly, albeit regulated. But new technology, including microwave long-distance transmission, allowed new entrants to cream off its most profitable business. The Justice Department broke up AT&T, but the results of that action were small compared with the market effects of new communications technology that engulfed the existing system.

Similarly, railroads' pricing power, long thought to require regulation, fell rapidly with better highways, trucks, buses and airplanes.

So the fact that the a monopoly position often depends on technology at any given time is an important one.

My personal opinion is that the Justice Department should put the kibosh on this deal, just as it should have prevented most of the recent mergers in the airline industry.

The economy is more competitive in many sectors than it was 30 years ago. But that does not mean that antitrust enforcement is never needed to preserve economic efficiency.

Economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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