24 October 2016

AT&T, Time Warner and the rise of the mega-firm


The proposed merger between AT&T and Time Warner is the biggest of big news – and not just in business circles. Bernie Sanders is already fulminating against the deal, with Donald Trump and Hillary Clinton not far behind.

At $86 billion, the planned tie-up between America’s largest telecoms company and one of its largest media firms is a huge deal in every sense. But it’s also one that’s hugely revealing about the state of the modern economy – and its flaws.

The logic behind the deal is simple. In the not-so-olden days, companies like AT&T made money by owning the pipes. If you wanted to make a phone call, or use the internet, or watch cable TV, you paid them for the privilege.

That’s still a good business to be in: last year, for example, AT&T reported revenues of $146.8 billion. But it’s not as good as it used to be. It’s facing increased competition in mobile, where it doesn’t have much to differentiate itself from rival operators. And cable, long its cash cow, is also looking weak.

The business model on which the TV business rests is that people pay a premium for premium content – Americans shell out for cable, Brits pay their Sky subscription. Some of that money sticks with the content provider; the rest of it gets shared out among the people who own the channels that are being provided (who will also get money from the advertisements they show).

But the internet upends all that – as it has so many other things. By buying a little USB stick from Google or Amazon, or a number of other devices, you can get a collection of channels and shows that isn’t as impressive as what you’d get on your cable or satellite deal, but impressive enough to make you think twice about paying the hefty monthly charge. Or you can just mess around for free on YouTube.

Next, stir in the fact that firms like Netflix and Amazon are spending billions to produce must-see shows that you can’t actually get via your cable/satellite deal. So why not take the cheaper option and be able to watch Daredevil/Transparent/Stranger Things at the same time?

This is the phenomenon that has petrified a generation of telecoms executives: “cord-cutting”. (There’s no UK equivalent yet, so in honour of Sky’s signature product, I’m going to suggest “dish-ditching”.)

The problem isn’t so much that they’ll lose these customers completely: they’ll still be reliant on AT&T’s pipes for internet access, for example – at least until Facebook or Google start bouncing broadband off balloons or micro-satellites or whatever else they’ve got up their sleeves.

But the pipes will become commoditised – the value in the system, and the leverage, will belong to whoever produces the content people are watching.

To which AT&T’s response is simple: it’ll buy the content. The purchase of Time Warner – home of Bugs Bunny, Superman, Game of Thrones, Harry Potter, CNN and the NBA – is essentially an $86 billion guarantee that AT&T will own enough of what you like that you’ll be willing to sign up to its services. It’s no coincidence that the merger talks emerged at exactly the same time that AT&T was gearing up its own cord-cutting offering, an “over-the-top” online package called DirecTV Now.

For Time Warner, this deal provides a guaranteed distribution platform – both on TV and crucially, via mobile, where AT&T is also a giant. For AT&T, there’s also a clear rationale – although commentators such as Matthew Ingram of Fortune have argued that it’s not a very convincing one.

But it’s less clear quite what the benefits are for customers.

The economics of content supremacy – of cord-cutting and dish-ditching – have led to the era of what John Landgraf, head of the FX network, famously christened “Peak TV”. If content is king – or rather, the kingmaker – then everyone needs content. Which has led to an explosion in the number of high-quality TV series, to the point where it’s next to impossible to keep up with them all.

But at the same time, it’s led to a kind of Balkanisation. Here in the UK, if you’re a football fan, you have to subscribe to Sky for most of the Premier League matches, but BT – adopting exactly the same strategy as AT&T – for the Champions League, Europa League, FA Cup and the rest of the Premier League (due to the rights being split by the EU).

It’s the same more broadly. Yes, there’s more stuff than ever to watch. But you could never watch all of it anyway – not unless you want to pay subscriptions to three or four or five different companies.

The model here, in other words, isn’t television as we’ve known it, but the world of video games. Just as Microsoft and Sony and Nintendo have their own exclusive titles chained to their own exclusive consoles, so will the content barons have their own exclusive bundles. Family A will be a Netflix household, Family B will be Team Sky. And it won’t be just TVs that are partitioned this way, but mobiles too.

Just as there are third-party firms like EA and Activision that make games for more than one console, there may still be entertainment companies that share their content around (Disney is an obvious contender, though it’s equally likely that they will set up yet another bundled offering, as predicted by this in-depth piece over at REDEF). Time Warner will almost certainly do much of this as well – as the ever-perceptive Ben Thompson of Stratechery has noted, much of that $86 billion valuation derives from the fact it sells its content to everyone: cordoning off all of it will be destructive of value.

But the headline attractions for AT&T and other content producers/carriers, the most jealously guarded possessions, will be the big exclusives – the few rare jewels that you’d actually shell out for, like HBO or sports rights or the best movie packages. Possessing them ensures that you can’t be commodified, can’t be shut out of the conversation. They’re the table stakes in the great media poker game – or if you prefer your metaphors more martial, the equivalent of a few thousand bannermen or an open line of credit at the Iron Bank of Braavos in this particular Game of Thrones.

If this is the vision of the entertainment future, you have to admit that it isn’t terribly inspiring – or compelling. Yes, it’s better that companies are seeking competitive advantage by producing the best shows rather than because they own the pieces of wire that connect to your TV or landline. But it hardly seems that futuristic. The media landscape was meant to splinter into a thousand glittering shards, not consolidate into a few monolithic lumps.

And the fact that it’s happened like this reflects something broader – and more alarming – about the modern economy: its tendency towards gigantism.

It was long thought that the internet was the bane of big: giant slow-moving firms would find themselves torn to shreds by a swarm of disruptive competitors.

But we’re increasingly realising that the online economy actually tends towards monopoly, because the best firms can scale up so much more quickly, and attract so many more customers, than the second-best. Once you’ve got Google, you don’t need another search engine; once you’ve got Amazon, you don’t need another online store.

But as I pointed out in my recent book, The Great Acceleration, a high-speed economy promotes gigantism on other ways.

First, there are financial imperatives. Companies need to keep shareholders happy. That means delivering a certain level of growth, quarter after quarter. If you are operating in a mature sector of a mature economy – or one that is highly competitive – that is very hard to do.

The obvious solution is to buy growth – even if it is destructive of long-term value, as most mega-mergers are. Indeed, leaving aside all the strategy stuff above, a simple way of looking at the Time Warner acquisition (as Thompson argues) is a low-growth company – facing dwindling margins on its cable and mobile businesses – buying a higher-growth one.

The next reason that firms are getting bigger is to gain leverage over others in the food chain. The bigger a firm gets, the more pressure it can exert: a mega-firm like Target or Amazon, for example, can force down the prices they pay to their suppliers. That leads the same suppliers to band together – either to resist that pressure, or to pass it on to their own suppliers.

The result is that the supply chain becomes dominated by the giants – we’re now in a situation where, as I wrote in my book, giant firms like Cargill and Tyson have carved up the produce market between them. Just this week, British American Tobacco has announced a $47 billion bid for the remaining share of its US rival Reynolds.

In industry after industry, the market is narrowing down to three or four big incumbents, in a wave of mergers and buyouts. And when these giants confront each other, the earth quakes – or at least Marmite disappears from the shelves.

Size isn’t by itself a bad thing. It’s economies of scale that have enabled Tesco and Wal-Mart to feed us extraordinarily cheaply – or IKEA to cut the inflation-adjusted price of its signature Poang chair from $300 to $79 between 1990 and today.

But the problem is that there’s another reason firms become larger – to increase their leverage over their customers. As Adam Smith said, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

AT&T was already broken up once by the federal government for getting too big for its boots. (Technically, the current AT&T is one of the regional “Baby Bells” that were created in the process – it bought its parent a few years later.) Yet the Time Warner merger is of a scale where the federal government will have to give approval, because of the potentially market-distorting effects.

Of course, the greatest guarantee of good behaviour from companies – by which I mean delivering low prices and good service – isn’t government supervision, but competition from their rivals. The fewer the number of rivals, the less the competition. Especially in markets like the one AT&T and Time Warner operate in.

That, after all, is the very point of this merger. Your mobile phone contract may be a fungible good, able to be switched out with another. But your Game of Thrones fandom isn’t – or your support for Arsenal, or the Chicago Cubs. Media firms are, in a very specialised sense, in the business of creating and monetising addictions – and then using their monopoly of supply to profit handsomely.

AT&T may well get approval for this mega-merger, and it may even be able to make it work. But it’s hard to see the ecology of mega-firms that’s emerging as one in which companies compete on their merits, rather than simply their muscle.

Robert Colvile is the Editor of CapX.