AT&T’s Flawed Arbitration Proposal

By: Gene Kimmelman, CEO & President of Public Knowledge, and Steve Salop, Professor of Economics & Law at Georgetown University Law Center

If AT&T acquires Time Warner, there are myriad ways for the vertical merger to result in reduced competition.

Back in November, the Department of Justice sued to block AT&T’s proposed takeover of Time Warner. Among other things, the DOJ was concerned that the merger would give AT&T the incentive and ability to use Time Warner programming to harm its rivals — by withholding programming entirely, for instance, or simply charging more for it or putting terms on its carriage that give AT&T an advantage in the marketplace over rival video distribution services. Traditional cable companies like Charter, Cox, and Dish, and online services like Hulu, Sling TV, and Youtube TV would be directly harmed by these practices — but ultimately consumers would pay the price, through higher bills, less choice, and lower-quality offerings.

So now the trial is proceeding, and the stakes are high. If the government wins, AT&T’s merger plans are over (pending any possible appeals). And if AT&T wins, the public — and the marketplace — will likely be harmed.

But, there’s another wrinkle. Just last week, U.S. District Judge Richard Leon raised the question of whether an arbitration condition would be enough to address the potential harms from the merger. This is a merger remedy that AT&T has proposed, and said it could abide by. This proposal would create a mechanism where both sides in a fee dispute concerning Time Warner programming would present a rate to a third-party arbitrator, who would pick the one that was more reasonable. AT&T-Time Warner would not be permitted to take channels off the air and cut the distributor off from its content during the arbitration process. Could such a remedy protect the video marketplace from AT&T’s increased leverage and its ability to use its valuable programming to hold back competition?

Unfortunately, AT&T’s proposed remedy is deficient in a number of ways, many of which seem impossible to correct. The remedial deficiencies include the following elements:

1. The proposed agreement does not extend to HBO, which is a highly valuable property.
2. The arbitration provision does not include any new Time Warner networks. This creates a huge loophole in that AT&T could shift certain Turner content (e.g., valuable sports content), along with newly produced content, to a new network not covered by the provision.
3. The provision assumes that AT&T will act in good faith and subject all disputes to the arbitration process. But AT&T can avoid the process by threatening to terminate a carriage agreement for some reason other than price (e.g., terminate an existing contract “for cause”), in which case the arbitration process would not kick in.
4. The proposal asks the arbitrator to determine the “fair market value” (FMV) for the content. The term “FMV” is not defined. Nor can it be defined in a way that can be accurately operationalized by a commercial arbitrator. In principle, FMV is the price that Time Warner would have charged, and the conditions it would have required, for the content if it had remained independent. But there is no way to know what this price would have been — there are only imperfect models, and comparisons. This hypothetical price is not the type of analysis commercial arbitrators normally carry out. They focus on whether contractual terms are “commercially reasonable,” not whether they are “competitively reasonable.”

Even if the arbitrator were an antitrust expert and FMV is defined as the price that would have been charged but for the merger, FMV would be virtually impossible to calculate. Let’s review why:

1. The arbitrator cannot use as a benchmark the price that AT&T/Time Warner charges to distributors that do not compete with it. Unlike in Comcast/NBCU, there are no such non-competing distributors in this matter. DirecTV, DirecTV Now, and Hulu are everywhere.
2. The FMV depends on the array of content being provided. This would make determination of FMW and creation of a proper benchmark very difficult. The content of Disney, Fox, Viacom, and others differ in value to subscribers and distributors from what is being provided by Time Warner. Content — particularly high-value content — is simply not a commodity product.
3. The content of the various networks also changes over time. The value of the Turner content may change over time as its sports content changes or as the value of the sports content changes, or if the popularity of the networks change in other ways.
4. These changes over time also apply to the potential benchmarks. The content of competitors also changes over time. Disney is contemplating an acquisition of some of the Fox channels that will change the relative valuations of both the bundle of Disney networks and the bundle of Fox networks. Viacom may be acquired by CBS, which will create changes in their valuations. In addition, each of these companies may add or subtract networks over time. Since they negotiate over the bundle of networks, that leads to a further complication.
5. The networks owned by NBCU could not be used as FMV benchmarks. Once the consent decree expires, Comcast will have the incentive to use the bargaining leverage that flows from its vertical integration to raise its prices. The same problem will be magnified if permitting AT&T to acquire Time Warner leads to vertical acquisitions of content providers by other distributors like Charter, Cox, and Verizon.
6. The FMV also depends on the particular characteristics of the distributor. Dish has a different customer mix and may have different content needs than, say, Cox, Verizon, or Youtube TV. It would be very difficult for the arbitrator to take these differences into account in determining the FMV for each in comparison to one another.
7. Carriage agreements are very complex and may differ among content providers and among distributors. In addition to price, they may include minimum subscriber commitments, channel placement, video-on-demand provisions for current and library content, linear streaming rights, duration of the contract and so on. The FMV would depend on every term of the agreement. This would make comparisons very difficult.
8. If the arbitrators chose a particular competitor to use as a benchmark, that decision could change the competitor’s pricing incentives. The competitor would know if it raised its price, that price increase would then lead to a higher price for Turner content as well. This could give the competitor an incentive to raise its prices, which would make the benchmarking exercise anticompetitive.

The proposed arbitration’s weaknesses don’t stop here. There are also concerns regarding the arbitration process itself:

1. During the arbitration process, which could take a long time, the distributor will face uncertainty over the price that it will end up paying. This will incentivize the distributor to accept a higher price to avoid the risk.
2. If some (for example, small) distributors accept high prices in order to avoid the uncertainty during a long arbitration, AT&T can then try to use those inflated prices as a benchmark to apply to other distributors. This spillover effect also incentivizes AT&T to fight much harder in the arbitration process than would a distributor, which can skew the process.
3. The arbitration provision will expire in seven years, which could easily fall short of the time needed to address competitive concerns, as illustrated by the premature expiration of the Comcast/NBCU consent decree.
4. AT&T’s proposed arbitration provision is not overseen by a court and cannot be restructured if it fails to perform its function of eliminating the increased bargaining leverage flowing from the merger.

If Judge Leon finds that through the acquisition of Time Warner, AT&T has violated the antitrust law, these shortcomings in the proposed arbitration remedy demonstrate why remedies of this kind cannot fully address the merger’s competitive harms. Protecting competition and innovation will require much more than the arbitration framework that AT&T and Time Warner have proposed.

In particular, press reports indicate that AT&T rejected the DOJ proposed divestiture remedies that would be more effective in lessening the anticompetitive impact of the merger, if it is allowed to proceed. But prohibiting the merger remains the likely preferred remedy.