One of the arguments made in the proposed Comcast-Time Warner merger is that these two, very large cable companies do not actually compete. They are in different markets. This is something Tyler Cowen, for example, has pushed as a reason the merger should go ahead. Now this might be a good argument as to why, straight out horizontal stories won’t cut it to prevent this merger and we would have to look elsewhere. But what should cause us to have pause was an issue raised in this excellent commentary on the state of the industry by John Oliver. Now it is 13 minutes long and the part I want to address is buried within but it is so good that anyone who reads this blog would surely prefer to devote 13 minutes of their scarce attention to it first. Go ahead, I’ll wait.

The part I want to address is where John Oliver asks: how is it that cable companies are not competing? After all, we can drum up a story of last mile bottlenecks and sunk investment and non-contestable markets. But the truth remains that somehow these two giants have managed to avoid competition in “the way a drug cartel divides up territories” (to quote Oliver).

I don’t have a definitive answer to this but we are all fans of situations where economic theory provides stories that are hard to plausibly deny. And just last week I released an NBER Working Paper co-authored with Martin Byford, that provides a theory as to why cable companies in the US don’t compete. Here is the abstract to “Collusion at the Extensive Margin.”

We augment the multi-market collusion model of Bernheim and Whinston (1990) by allowing for firm entry into, and exit from, individual markets. We show that this gives rise to a new mechanism by which a cartel can sustain a collusive agreement: Collusion at the extensive margin whereby firms collude by avoiding entry into each other’s markets or territories. We characterise parameter values that sustain this type of collusion and identify the assumptions where this collusion is more likely to hold than its intensive margin counterpart. Specifically, it is demonstrated that Where duopoly competition is fierce collusion at the extensive margin is always sustainable. The model predicts new forms of market sharing such as oligopolistic competition with a collusive fringe, and predatory entry. We also provide a theoretic foundation for the use of a proportional response enforcement mechanism.

You don’t have to read the paper. You already know the argument: potential competitors stay out of each other’s turf and divide the market. The point of the paper is that this type of collusion is understudied in economics and, indeed, one of the implications is that it has consequences for mergers.

Why this is relevant is because, if this is the reason Comcast and Time Warner do not currently compete more extensively, then to allow them to merge precisely because they don’t compete seems to be rewarding and cementing that very behaviour. Thus, those who say Comcast and Time Warner should merge because they don’t compete should also explain precisely why they don’t now and ought not to compete in the future.

15 Responses to How is it exactly that cable companies in the US don’t compete?

  1. […] at 4:47 on June 3, 2014 by Mark Thoma Joshua Gans: How is it exactly that cable companies in the US don’t compete?, by Joshua Gans: One of the arguments made in the proposed Comcast-Time Warner merger is that these two, very large […]

  2. Mike Huben says:

    Precisely the wrong question is being asked of regulators when firms that do not compete are attempting to merge. The proper question is why is there no competition, and what can regulators do to force competition?

    • Husks says:

      Competition happens naturally if regulators stay out of the way. Problem is, as stated below, that there would be a lot less infrastructure investment if there was genuine competition since the risk reward ratio is not going to justify it at the level we have seen.

      • Mike Huben says:

        Unregulated competition leads to monopolies when there are increasing returns to scale such as network externalities.

      • Wouter Vos says:

        Wow how stuck can you be in your beliefs. Have you seen how massively behind the US are on this? What about risk reward in other countries? I guess the US dumbness would have cost them long ago, had the NSA not stolen economical success with spying on their allies.

        The solution is to open up access to networks. The problem currently is exactly that regulators stay away. That allows companies to avoid competition and raise the barrier to entry.

        I guess this is how the US get stuck on everything. Just say competition and assume things will fix themselves.

        Google actually tried to break up the market, but is being blocked because of corporate power. Is that what you mean by ‘staying away’?

  3. […] How is it exactly that cable companies in the US don’t compete? […]

  4. Brad says:

    They don’t compete because the expected returns of “over-building” a cable infrastructure are so bad. This is the same reason other firms so rarely attempt to “over-build.” The rough economics are $1000+ per home passed, 20% penetration likely and at best 40% EBITDA margins. With $150/month in sub revenue IRR’s are just terrible. Take a look at the returns of Verizon’s Fios.

  5. kaleberg says:

    This was well studied in the early 20th century. Look up “natural monopolies” which are businesses in which it is obvious that the most efficient structure is to have a single provider. Examples included judicial systems, armies, electric power, telecommunications and road systems. This theory guided a program of regulation that electrified America and fleshed out our telephone and highway systems. The problem was that there was a lot of money to be made if one were allowed to relax regulations, then use monopoly positions to collect rents and arbitrage. All it took was a handful of economists and a lot of campaign contributions.

    Now people can ingenuously say that they don’t understand how we all don’t have three driveways, one for each of the major roadway systems each built and maintained by competing private competitors.

  6. […] To see how that might arise, think about, oh I don’t know, Comcast and Time Warner. These are cable companies/ISPs who are the largest of their kind in the US. I suspect that there is lots of cross ownership of mutual funds of each of these. Why? Because they happen to each focus on different regions in the US and so any mutual fund worth their salt would want to diversify their portfolio to hedge geographic risk. And so ask yourself: how readily would the boards of those companies improve massive infrastructure investments to expand the reach of their networks into the territory of the other? With cross-ownership, they wouldn’t have a powerful incentive. (Actually, we can now just add that to the list). […]

  7. […] To see how that might arise, think about, oh I don’t know, Comcast and Time Warner. These are cable companies/ISPs who are the largest of their kind in the US. I suspect that there is lots of cross ownership of mutual funds of each of these. Why? Because they happen to each focus on different regions in the US and so any mutual fund worth their salt would want to diversify their portfolio to hedge geographic risk. And so ask yourself: how readily would the boards of those companies improve massive infrastructure investments to expand the reach of their networks into the territory of the other? With cross-ownership, they wouldn’t have a powerful incentive. (Actually, we can now just add that to the list). […]

  8. […] that Comcast and Time-Warner don’t actually compete with each other—they’ve divvied up the nation between themselves and mostly don’t step foot on the other’s territory, so they […]

  9. […] that Comcast and Time-Warner don’t actually compete with each other—they’ve divvied up the nation between themselves and mostly don’t step foot on the other’s territory, so they […]

  10. Charles Wood says:

    Here’s what I don’t get: how is this kind of collusion legal?

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