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					  SKY WARS : The
Attempted Merger of
EchoStar and DirecTV

      Presented by:
         Brennan
           Han
         Tasmin
       Intention to Merge


On October 28,2001, EchoStar Communications
 Corporation (Dish Network) announced its
   intention to acquire the assets of Hughes
      Electronics Corporations (DirecTV).
               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.
            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.
          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.
     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.
           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.
         Opponents’ Arguments
  (Department of Justice (DOJ) and the Federal Communications
                       Commission (FCC))




• 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.
    Product market definition
             What are the relevant Market Products?



• 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
National MVPD Subscriber Shares
          (june 2001)

                       Percent of
                       MVPD
    MVPD Subscribers   Subscribers

    Cable                            78

    DBS                         18.3

    SMATV                        1.7

    C-Band                       1.1

    MMDS                         0.8
                   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 substitutes for
  each other (narrower market for same service and highly
  concentrated).
           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
         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.
    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.
           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.
     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…
Evidence of Competition between
     Directv and Echostar

• Similar prices and similar services
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…”
       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.
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
  Coordinated and Unilateral
            Effects

• Coordinated Effect –         • Unilateral effects –
  Merger will create             Merged firm has enough
  environment in which it        market power to increase
  will be beneficial for the     prices above pre-merger
  cable firms to collude         levels
         Unilateral Effect


• What we want to know:

  Post merger price,
  Pre-merger price (already know)
               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
                         Table 4-2

                                          Price
Service          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
           Unilateral Effect


• P – MC/P = -1/-2.54

• New EchoStar will charge 70 percent above MC

• But, is this larger than pre-merger prices?
  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
    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
   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.
     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
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)
   Pre vs. post – merger prices


• Average pre-merger price $37.48
• Post-merger price $47.73



-> 27 percent increase
    Interpretation of results


• Price Increase depends on:
  - estimated price elasticity
  - intensity of competition before the merger
  - Marginal costs before and after the merger
     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
  Merging parties: Churn Data

• Churn Data : More   • Churn data might
  consumers move from   indicate that DTV and
  DBS to Cable than     EchoStar are close
  from one DBS          substitutes and have
  company to another.   similar prices,
                        consequently, the
                        customers will rarely
                        switch between these
                        companies.
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
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.
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
              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.
                   National Pricing

                   Elasticity of demand      Elasticity of demand
                      in cabled areas        in non-cabled areas



            ŋDBS = scŋcDBS + sncŋncDBS


Elasticity of Total Share of demand in    Share of demand in
    Demand             cabled areas        non-cabled areas



   Goolsbee and Petrin, 2004: Low estimates of demand elasticity
                   National Pricing

                    Price of DBS service   Price of DBS service




   QDBS = qcDBS(pDBS) + qncDBS(pDBS)


Total demand for                           Demand in areas without
  DBS services      Demand in cabled areas    access to cable
                              Entry

Satellite Positioning Limitations

“Wing” Locations

New Technology: “Short-Spaced” Orbital Locations

      Barrier: Regulatory Approval
      SES Americom, 2002
      Intelsat, 2005

 Other Barriers: High Costs, Channel Licensing Contracts
                   Remedies


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

Feasible?
      2 Year Time Horizon (in DOJ/FTC Merger Guidelines)
      High Initial Costs
      Terms of Assistance for Cablevision




            … Probably Not.




            Cablevision in 2005
        Efficiencies

Scarce Radio Spectrum
Duplicate Channels


Merger would allow:

       More local coverage
       Additional high-definition content
       More effective competition with cable
Aftermath: What Happened?



   Antitrust authorities blocked the
                merger
                     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.
             Currently (2005):

         EchoStar                            DirecTV

      26 HD Channels                 8 Exclusively HD Channels,
                                    numerous other regional HD
“America‟s largest HD lineup”                 networks
        Pay-Per-View                       Pay-Per-View
     Premium Channels                   Premium Channels
   Local broadcasts in HD             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
            Currently (2006):


        EchoStar                         DirecTV
      Over 170 DMA‟s                  Over 143 DMA‟s
96 percent of TV households     94 percent of TV households




   Beforehand, firms claimed that only a merger
  would give capacity to provide local broadcasts to
                  100 DMA‟s total
How Did they do this?


   Signal Compression Technology
   Additional Satellites
           EchoStar: 4
           DirecTV: 5
           (since 2002)
               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
New developments…

				
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