The Comcast-Time Warner merger is about monopsony, not monopoly

2/13/2014 06:24:00 PM
Mergers are evil. While merging cable companies aren't the worst travesty ever, the precedent we set today will bite when Sauron's forces emerge. We ought to enforce the Sherman Act's blanket prohibition against monopolization as a per-se rule in all cases.
I think Matthew C. Klein makes too many assumptions in predicting that the merger between Comcast and Time Warner, the two largest cable TV providers, will actually be good for consumers, but he makes an important point that it won't be bad for consumers in the typical way we think of mergers causing monopolization, because cable TV is already comprised of regional monopolies. The cable industry is regulated according to the "natural monopoly" paradigm because the fixed capital costs are immense, and there is simply no social benefit to multiple redundant cable lines owned by competing providers. So while multiple cable providers exist nationally, they aren't competing for individual customers anywhere. To the extent that monopolization leads to price hikes and bundling designed to extract consumer surplus, this has already happened and won't be affected one way or another by the merger.

But that's not to say that the merger doesn't decrease competition--it just doesn't affect competition for TV viewers. What it could affect is the competitive of the input market, where cable providers negotiate with networks to license TV programming. Previously, Comcast and Time Warner had to compete with each other to get licenses, thereby driving up the bids on network programming. Now, that competition is gone, and (aside from broadcast networks who use airwaves) cable networks have no choice but agree to whatever price the new Com-Warner Cable monopsonist offers. Klein assumes that by decreasing the amount they pay to networks for licensing, Com-Warner could potentially benefit consumers with cheaper prices. I'm not sure I agree with Klein, for several reasons.

First, Kleins model of how monopoly pricing works is wrong. Let's do the math. Let represent the monopolist's total cost of producing Y units of output (which is strictly convex increasing), and let P be the price the monopolist charges per unit of output. Then total profit is given by:
Profit is concave in Y, so profit-maximizing choices of P and Y must satisfy:
Together with the customers' demand curve, this tells the monopolist how much Y to produce and what price P to charge. But we can see here that cost only enters into the decision on the right hand side of the equation above, and even then it is only the first derivative, not total cost. Fixed capital is fixed--it does not depend on Y at all. My assertion is that network licenses are a form of fixed capital--as pure intellectual capital, the cost of licensing material does not depend one bit on how many copies you produce. This means that networking fees don't enter into the cable provider's decision making at all, so long as revenues are higher than the fees. As Klein notes, network fees represent only half of cable providers' revenue, so they clearly aren't a constraint. Therefore, it would not be profit-maximizing for Com-Warner to pass off any of the cost savings from lower network fees to customers--customers won't see higher prices, but Com-Warner will pocket any savings. Now, cable is a little different than the standard market modeled above, but I've modeled cable companies more explicitly before, and shown that licensing fees basically don't matter to subscribers--it's all about bundling.

Second, I think Klein really misrepresents the statistics here. He cites the fact that half of the cable revenues go to network licensing, but that sounds low to me, not high--this is another way of saying that cable companies' mark-up is 50 percent, way above the standard 35 percent typical of most industries. There could be legitimate reasons for cable company's absurdly high mark-ups, since they do face unusually large infrastructure costs, but prima facie, it appears like they've already been pretty successful keeping licensing fees low.

Third, while Klein is pretty clearly wrong in saying that the deal would benefit consumers, he could be even more wrong than that: this could still harm consumers. If Com-Warner is successful at bargaining network license fees down, then that means the budgets for all your favorite TV shows will be cut, possibly resulting in cheaper, less enjoyable programming. This won't increase the prices you pay, but it could decrease the quality of product you get, and without decreasing the price either.

Finally, we have to note there is a very real possibility this won't change anything at all. Presumably, as a monopsonist, Com-Warner would be aware of how their treatment of networks affects the quality of the programming they can provide, and thus the willingness of customers to pay for cable bundles. Thus, they have a vested interest in ensuring that networks continue to produce quality programming, and may opt not to cut costs, in order to avoid loosing customers.