Fusing the Satellite Radio Babies

The wisdom of Solomon will be required in deciding whether to allow XM and Sirius to merge.
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Had your fill of discussion about the satellite radio merger? Well, better get used to the topic. It will probably be kicked around for some time before it goes away — including on these pages. This is mainly because, despite initial appearances, the proposed merger is in many ways different than anything ever confronted in the digital media environment.

Let’s consider the unique features presented by this proposal and what makes handicapping its outcome so difficult.

Lack of precedent

On its surface, the merger seems similar to that proposed by DirecTV and Echostar, the two satellite television services in the United States. That deal was ultimately rejected by both the FCC and the Justice Department in 2002. But there are important differences between that proceeding and this one.

First, a fundamental argument made in the satellite TV case was that the operators were just competing as two among many Multichannel Video Service Providers (MVSPs), and that the proposal should have been considered just like a merger of two cable companies. All these operators provide essentially the same content (other than some differentiated pay-per-view offerings), and are thus pure delivery services — nearly commoditized, in that they compete mostly on the basis of price. Efficiencies generated by a merger in such a case would allow lower costs to consumers, and the merged service could better compete against other (cable) services.

While this argument might seem compelling, it ultimately failed to persuade regulators, at least in part because in rural areas satellite TV does not have any competition from cable services, so moving to a single satellite provider would have eliminated the competitive market in those large zones of the country.

In the satellite radio case, however, this argument doesn’t apply, because the two services are not providing identical content. While their respective music services may be similar, they are actually exclusive to each, and most third-party content is also exclusive to one or the other service (e.g, NFL and Howard Stern on Sirius, MLB and Oprah on XM, etc.). Thus satellite radio services are not pure service providers, but content creators/providers, as well.

Thus the only “competing-in-the-broader-marketplace” argument that satellite radio can make is that together they compete with the amalgam of audio services from terrestrial radio, Internet radio, MP3 players, media-enabled phones, etc. — some of which did not even exist when satellite radio services were initially licensed.

Much of this broader space is beyond the scope of FCC jurisdiction, however, and in any case all these players offer distinctly differing services, which although they may ultimately “compete” at a conceptual level for listeners’ ear time, they do not offer truly competitive services from a strict regulatory or business-model analysis.

Taking the competitive argument to that high a level is almost like saying TV competes with print because consumers use their eyes to consume both mediums.

So by this analysis, the closest thing to actual, direct competition to satellite radio is terrestrial radio, but even here, the national vs. local service footprint and the subscription vs. free model differentiate the two formats. And from a purely regulatory perspective, the two media are covered by different rules (both at the FCC and the Copyright Office), which also makes it difficult for regulators to consider them in the same market space. In particular, the FCC looks at these two licensees as the sole recipients of Satellite Digital Audio Radio Service (SDARS) allocations, and the commission tends to avoid placing an entire regulated service’s future into a single entity’s hands.

Recall also that satellite TV started with several players, who were allowed to merge down to two entities, but then could consolidate no further. In contrast, satellite radio began with only two licensees — already at the minimum to ensure competitive service — which the FCC recognized by adding an unusual, proscriptive rule in its original satellite regulations explicitly disallowing either licensee from subsequently acquiring or merging with the other.

More recently, FCC Chairman Kevin Martin has taken the even more unorthodox step of publicly commenting on the merger and its unlikelihood of approval. (The commission rarely voices its opinion on controversial issues likely to come before it in advance of their official consideration, although Martin claims he was just citing the existing rules in this case.)

Nevertheless, all that would be required for the FCC to reverse itself on this position would be a rules change — something that the FCC has historically done in response to changing market conditions, and a point that even Martin noted as possible in a postscript to his earlier comment. So it could happen.

Antitrust issues

A larger hurdle than FCC approval may be the antitrust proceeding that the U.S. Justice Department will pursue, as a matter of normal practice for any such proposed action (under the Hart/Scott/Rodino Act).

This takes the form of a business analysis conducted largely by economists, which will take a hard look at the numbers, facts and private vs. public interest benefits of the case, ultimately rendering a judgment on whether to allow it — independent of whatever decision the FCC should make.

It is likely that the two regulatory processes will proceed in parallel, but probable that neither agency will issue its decision until both are at least close to completion. Of course, the merger needs approval from both departments to proceed, but only one denial to be disallowed. (As difficult a time as XM and Sirius have had on Wall Street recently, one wonders what will happen to their stocks if the merger is not approved.)

Another more remote possibility is that the merger would be allowed, but a legal monopoly would be declared, requiring additional regulation to be placed on the merged entity — similar to that imposed upon utilities or cable companies, by which all pricing and service changes must be approved by an oversight process. Recent trends in regulatory philosophy have tended away from this model, however, so such a move would be quite “retro,” and therefore unlikely.

Already sub-merged?

The satellite radio operators are portraying the merger as necessary to the survival of satellite radio and thus in the public interest. As with any such merger, elimination of redundant corporate infrastructure and reduced promotional expenses would improve the financial condition of the converged company. Yet streamlining the two services into one could also reduce content offerings and consumer choice.

Also consider that to keep legacy receivers of both services working, not much could be changed in either service’s delivery architecture. Both of the very different satellite systems used by the two operators would have to be kept operational, including terrestrial repeaters — at least for a significant period of time. So the requisite retention of both distribution systems limits the technical efficiencies that the merger can achieve, at least in the short term.

The two head ends could be combined into one, providing significant savings, but probably resulting in a net reduction of content origination facilities. Meanwhile, both operators’ expensive content acquisition deals would have to be kept in force (no net savings there) or cut back (again causing service reduction).

It’s not yet clear if or how the converged operation’s channels might be remapped to allow both legacy delivery systems to access the combined companies’ content (which the operators have promoted as another consumer benefit of the merger). Future receivers and/or a revamped transmission system could eventually eliminate this problem, but not without substantial new development costs and high capital expenditures.

On the other hand, the two services could be retained in their current form by the merged operator for legacy customers, with new dual-system receivers and a higher-priced, “full-access” subscription tier offered as an upsell and to new customers. This would be the simplest arrangement to achieve, and would minimize the impact of the merger to existing customers, but also provide them no benefit. Meanwhile, it would also constrain the cost savings to be achieved via reduced redundancy of content offerings.

Meanwhile some analysts have questioned whether the merger really will help the new entity reach profitability, given its forebears’ spending habits. They believe that the continued red ink suffered by XM and Sirius is not a result of a weak market for their services, or an artifact of promotional battles between them, but due instead to purposeful (and in their view, unwise) business decisions resulting in excessive costs for certain high-profile content deals — all of which seem likely to be carried over to the new company.

Thus they believe that the sum of the parts will still show red, and the DNA of the new company could tend to keep things that way.

Others have taken a similarly dim view of the merger — and in particular the urgency with which it’s been painted by its proponents — pronouncing it more like a circling of the wagons or a retreat strategy, rather than a move forward to increased strength.

Consumer impact

As with any monopoly, the obvious risk to consumers of a single satellite radio operator is lack of pricing constraints. But it could also be argued that the broader marketplace will exert its own self-limiting forces here, and if the value proposition is exceeded by increased subscription fees, churn will increase and audiences will decline, regardless of the number of players.

Moreover, even in the existing competitive market, prices have not declined, but in fact increased. (You may recall that the initial monthly subscription price differential between the services was erased in 2005 — and not by the more expensive service dropping its price, but by the cheaper one raising its price to match the other’s. So much for competition keeping prices low.)

Instead, the more realistic risk of the merger to consumers may be that a sole operator would have greater freedom and ability to increase the commercial load carried by the services — a move that’s already been hinted at by the operators.

Note also that to most users, satellite radio is already an effective monopoly, because once a consumer decides which service to go with, the purchase of a receiver and subscription locks them into that one service — at least for a significant period of time. The lack of interoperability in current receivers guarantees that this would continue almost indefinitely under the status quo (despite the FCC’s long-stated preference otherwise), but ironically, a merger could reverse this situation.

Another way to look at the merger portrays it simply as two “premium-content” or “pay-radio” services merging, as if HBO and Showtime were to merge and thereby offer expanded service via the same cable box that previously only received one of the two services. Of course, this approach might also include justification for an increased subscription price for the new, expanded service.

Finally, consider the impact that satellite radio has had on terrestrial radio. Would the latter’s current initiatives toward HD multicasting, reduced commercial clutter and the addition of title and artist data to radio displays have happened if satellite radio didn’t provide competitive incentive? In that respect, even though the results are still in progress, satellite radio has made terrestrial radio better, thereby benefiting consumers — even those that are not currently its customers.

Thus whatever happens, the demise of satellite radio is arguably not in the public interest. What, if anything, regulators should allow or disallow toward that end remains to be seen. Either way, their decisions will be difficult to reach, generate great interest and discussion among many observers, and ultimately have strong resonance throughout the digital media marketplace for some time to come.

Comment on the satellite merger or any topic toradioworld@imaspub.com.

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