Sky TV-Vodafone merger: Commission releases its reasons
April 16, 2017
Just before Easter, the Commerce Commission released the reasoning for its decision to decline clearance in the Sky TV-Vodafone merger. This is the first real opportunity to get a proper feel for the Commission’s approach, and the parties making the application will certainly be going over it carefully to see if they can find any grounds for appeal.
So, what did the Commission decide, and did it get it right?
What’s the Commission’s basic argument?
The Commission’s basic reasoning runs like this. Premium sports rights (read: live rugby) is very popular with a certain segment of New Zealand society. There are no real substitutes for people who want to watch live rugby, and so the holder of those sports rights has some market power.
Sky TV holds those rights at the moment, but is incentivised to exploit them (make them available to customers) in a number of ways. For example, Sky TV will be happy to wholesale those rights to both Vodafone and Spark if that’s how it can make the most money off of those rights.
Under the proposed merger, Vodafone gets access to those rights. And because it competes directly with businesses like Spark, its incentives will likely be very different. Vodafone will likely want to prevent its competitors such as Spark getting access to those rights, so the only way rugby fans can see the games they want will be by becoming a Vodafone customer. This will likely give Vodafone market power in broadband and (in time, when customers want to watch rugby on the go) mobile markets, and competition in those markets will be affected.
It’s not worth Spark or anyone else competing for those broadband customers who love live rugby, because they simply won’t move to a competitor where live rugby isn’t available. This in turn means that Vodafone’s competitors will stop investing in new, innovative services because they won’t have the chance to win a sufficient number of customers to make it worthwhile. For smaller competitors, they may never achieve sufficient scale and so may go out of business altogether.
That all sounds pretty speculative. How does the Commission know how Vodafone (and its competitors) will react?
Great question, and good on you for bringing a healthy scepticism to your reading of the Commission’s reasoning.
What the Commission is really giving us in the story above is a theory of harm. It’s telling us what could go wrong with competition in the markets it’s looking at. But it’s only a theory, because it is talking about a future market and we have no direct evidence about what that future market looks like.
To really scrutinise the Commission’s reasoning, we should first ask if its theory of harm is plausible, and if so whether it is likely that the identified harm will actually eventuate.
I think it is pretty clear that the Commission’s theory of harm is plausible. It’s actually pretty standard stuff from a competition law perspective. The shared understanding about the economics of how markets work suggest that exclusive rights to live rugby could easily give Vodafone the ability and incentive to harm competition in the markets in which it operates. There is no real gap in the Commission’s logic from a competition law perspective.
But, I hear you say, even a plausible argument can still be very speculative. How can the Commission know that the market will play out this way? Great question. That requires us to consider how likely it is that the theoretical harm identified by the Commission will eventuate in practice.
On this point, the Commission takes a very conservative approach. It says that it cannot exclude the chance that this type of harm will eventuate, so it must consider it to be a real possibility. In other words, the likelihood of harm to competition eventuating is not high, but it is high enough to be taken seriously. And as it can’t exclude this possibility of harm, it has to decline the application for clearance.
How can the Commission justify this very conservative approach?
This is the point, I think, where reasonable people (including competition law experts) may differ. Some people will argue that the Commission doesn’t have the evidence to justify a conclusion that there is a real prospect of harm eventuating. Others will say the evidence is relatively clear.
The Commission’s justification for its position is based on two factors.
The first is that this is not a standard merger between two businesses that compete directly with each other. In that standard case, the Commission isn’t really concerned about incentives all that much. Both businesses want to aggressively harm their competitors before they merge and after (when they are one business). So the key question is whether the size of the merged business gives it a new ability to harm competition.
In this case, Sky TV and Vodafone aren’t direct competitors. One is a satellite broadcaster and the other is a telecommunications company. The concern here is one of vertical integration – that merger will give the merged business control over upstream and downstream markets all at once. After the merger Vodafone would control the content (rugby) and the network (Vodafone broadband and mobile) that delivers that content to its customers. That’s vertical integration.
The Commission’s key point about mergers that create vertical integration, I think, is the incentives for the merged entity can completely change and it is very difficult to anticipate what those incentives might be. In short, there is a high degree of uncertainty about how the merged business might act in any future market scenario.
The second contextual feature is that New Zealand telecommunication markets are in a state of flux. Fibre broadband is being rolled out, and we are on the verge of 5G mobile technology. This is a highly intense phase of competition among telecommunications businesses, and the market will change a lot as a result of that competition.
If a major player in that market, like Vodafone, were to gain market power, through premium sports rights for example, then it might have an unfair advantage in that market. Times of high competition are times of great benefits to consumers. Those benefits could be lost (that is, the competitive harm could be particularly great) if the Commission’s theory of harm were to eventuate in these market conditions.
So, the Commission has a plausible theory of harm to competition, genuine uncertainty as to the incentives of the business with market power in a position to cause that harm, and a risk of significant damage to consumers if that theory of harm eventuates. That starts to look like good grounds to adopt a conservative approach.
What does the law say?
This is a good point to pause and consider exactly what the Commission is required to do legally when considering a clearance application. Despite the way I have characterised the Commission’s argument so far, I don’t think the Commission would agree that it is adopting a ‘conservative’ approach. It would argue that it is simply applying the usual statutory test to the letter.
The test that the Commission must apply before it can grant clearance for a proposed merger is that it is satisfied that the proposed merger will not (likely) have the effect of substantially lessening competition in a New Zealand market. If the Commission is not so satisfied, then it cannot grant clearance. This means in the presence of uncertainty, the Commission cannot grant clearance because it cannot be satisfied that there is no real chance of competitive harm.
In a context where both the incentives of the merged business and the dynamics of the market in question are effectively unknown, the burden on the applicants is always going to be very high. The very things that create doubt in the Commission’s mind make it difficult to provide the kind of proof that will satisfy the Commission. The applicants are, in a way, trying to disprove a (highly speculative) negative. Even with the best advice and evidence that will be very difficult to achieve.
But did the Commission get it right?
The Commission’s logic is credible, but that doesn’t mean it has made the right decision. There are speculative aspects to the Commission’s reasoning that I personally thought could have been made more robust. For example, the applicants quite rightly pointed to the fact that in overseas markets, premium sports rights do not create the sort of market power that the Commission is concerned about here. As a result, it’s hard to argue that the sort of competitive harm that worries the Commission would ever eventuate.
I have some sympathy for this argument, but the Commission seems to have dismissed it quite summarily. It asserts that New Zealand is different in terms of size and market participants (only one pay‑TV provider) and so the evidence based on overseas experience should carry little weight.
It’s perfectly open to the Commission to adopt this view, but the applicants have raised a plausible argument of their own and so the standard for a successful rebuttal is quite high. We need some solid economic evidence to prefer the Commission’s view of the world over that of the applicants. However, the Commission doesn’t really give us anything to go on here. It just relies on its expertise and judgement, which is difficult to claim is correct in any objective sense.
It’s at points like this, where the economic evidence is ambivalent and the Commission has had to make a call, where its decision might be vulnerable. So regardless of the plausible theory of harm it has constructed and the future market uncertainty it has to deal with, its reasons don’t go far enough to reasonably exclude alternative interpretations of the available economic evidence. That’s the sort of thing that the applicants will be looking for to challenge the Commission’s decision.
There will almost certainly be an appeal. The Commission’s position is based to such an extent on its (expert) opinion rather than ascertainable facts, the applicants will almost certainly want to test those views further in court.
An appeal from a clearance decision proceeds by way of rehearing, so the High Court makes up its own mind based on the evidence presented to it. It does not start with the Commission’s decision, but considers the evidence (including any new evidence) afresh. If the High Court takes a different view of one or more material economic arguments, and that’s a realistic prospect given the different experience of the Commission and the Court with economic evidence, then the Commission’s decision could easily be overturned.
That’s a chance worth taking if you are the applicants in this case. Sky TV and Vodafone will already have sunk large amounts of money into their potential merger, and the cost of a High Court challenge will not be material in that context. What will be interesting is to see if the various parties that actively opposed the merger before the Commerce Commission will also participate. Or will they have faith in the Commission to defend the position it has reached? Either way, I doubt we have heard the last of Sky TV and Vodafone merging in New Zealand.