AOL was a distribution company, and Time Warner was a content company, but their interests did not align in a way that would make the merger work. For Bewkes, vertical integration makes sense only if the combined company has a large and powerful market share either upstream (in content) or downstream (in distribution), and the integrated AOL Time Warner had neither. Even if AOL had made itself the first screen for users’ Internet access over Time Warner's cable-modem service, it would have guaranteed access to just 15 percent of Americans. Without regulations mandating common carriage for the rest of the cable-distribution landscape, AOL did not have the leverage to force the other carriers to deal with it.
At the same time, AOL remained primarily a highly profitable ISP business (both dial-up and, eventually, broadband) in a regulatory realm that did not require that cable distributors (except in the onetime merger condition imposed on Time Warner) allow competing ISPs to use their cables. (Recall that Comcast, confident that the shadow of common-carriage regulation would never fall on its operations, bought up AT&T Broadband's cable systems in December 2001—and cable-modem Internet access service was a big part of the deal's upside.)56 Yet ironically, the cash flows from AOL's existing business were strong enough to keep it from making the transition to another business model. And because pure distribution and pure content companies typically appeal to different kinds of shareholders, AOL Time Warner's stock was neither fish nor fowl to many investors. Add in the combined company's lack of dominance in either content or distribution, the fact that the resentful employees of Time Warner resisted helping their new AOL bosses, and AOL's own slowness to develop a new strategy, and you had a recipe for inertia and, ultimately, failure.
It took almost a decade, though, for the AOL Time Warner leadership to realize its mistake. In late 2009 Levin admitted his responsibility for the failure to convince Time Warner divisions to execute on the grand vision he and Case had articulated: “I'm really very sorry about the pain and suffering and loss that was caused. I take responsibility. It wasn't Steve Case's fault. It was taking this magnificent concept and not being able to meld it into a missionary zeal. It was not a supermarket, it was a mall.” As Case put it, “vision without execution is hallucination.”57
Bewkes, installed as CEO of Time Warner in 2007, subsequently spun off the Time Warner Cable operations in March 2009—and AOL as well. From Bewkes's perspective, both the capital-intensive needs of the cable-distribution business and AOL's inability to settle on a new business model distracted from Time Warner's content operations. By the time AOL was finally separated from Time Warner, in December 2009, the company's stock had declined 77 percent since the merger—triple the decline in Standard & Poor's 500-stock index over the same period.58
The regulatory conditions so painstakingly imposed on the AOL–Time Warner merger are seen today as failures. In Gerald Levin's view, the company had a “tough time with the regulatory process. They imposed conditions that are basically chimeras—I mean they don't really exist.”59 EarthLink managed to thrive as an independent actor, enlisting 445,000 new customers because of the AOL–Time Warner agreement, even as it moved from dial-up to broadband. But after the merger went through, no other ISP was able to get terms from Time Warner that would allow it to compete successfully. From a competition point of view, then, the regulations were hardly a success. (Earthlink asked the regulators to impose the same condition as part of the Comcast-NBCU merger to no avail.)
The FTC had done its best to open competition to ISPs and had hired a highly respected FCC engineer, Dale Hatfield, to oversee the ISP open-access (common-carriage) elements of the AOL–Time Warner deal.60 But the merged company's obligations were not precisely clear, and the FTC had not had adequate technical advice in setting up the requirements. AOL Time Warner was plainly uninterested in providing the kind of access to competitive ISPs at a sufficiently fundamental technical level to allow the competitor to add value through quicker or better service; the competitor was in essence relegated to reselling the service that AOL Time Warner offered, without differentiation. (When sharing telephone wires for DSL Internet access, by contrast, a company with access to the copper wire that also had better technology on its side could do things the incumbent could not. Common-carriage requirements initially imposed on the telephone companies had made the provision of high-speed Internet access a respectably competitive business.)
But the biggest problem for potential competitors was the price squeeze: there just wasn't enough of a margin to make it worthwhile to share the pipe. Fixing this issue would have required somehow allocating AOL Time Warner's costs on a fair basis among competitors—and that, in turn, would have required major staff attention from the FTC. No one seemed to have the stomach to impose such a regime. Finally, without the ability to differentiate its services technically or charge a lot less (given the nonexistent margins), the ISP would have to prove that its service was nonetheless somehow “better” for consumers. With more and more services provided by online applications, there was little an ISP could do to stand out from the crowd. Any condition short of requiring a separation between content and distribution (something the Nixon White House had wanted, John Malone had feared, and Disney had sought in the context of the AOL–Time Warner merger) seemed to doom the future of independent ISPs.
The conditions placed on AOL Time Warner's Instant Messaging services seemed especially fanciful. The FCC had felt that AOL's IM service, with its 100 percent market share at the time, would crush the competition once it was combined with Time Warner's cable lines and content; the agency imagined a world in which IM would be the place for gaming and video, and AOL Time Warner would have an unmatchable subscription list and content library. So it required that AOL Time Warner not provide any new buddy-list video services for IM unless its subscription list were interoperable with that of another provider.61 This quickly proved overly restrictive. By 2003, AOL was rapidly losing market share in the IM market to Microsoft and Yahoo!, which both offered attractive services, and the company pleaded with the FCC to be relieved of the interoperability requirement. FCC chairman Michael Powell lifted the condition, remarking that he had never agreed with it in the first place.62
Just like Comcast and NBC Universal, AOL Time Warner had had online video in mind. On January 10, 2000, the day the merger was announced, Jim Ledbetter of the now-defunct Industry Standard magazine zeroed in on this goal: “One of the things the two companies talked today about is streaming video through your computer … [but] these kinds of applications … right now are very difficult to do at the access speeds that most consumers have to the Internet. Time Warner, with its Road Runner service, potentially has the ability to deliver that.”63
Arguably, AOL Time Warner was simply ahead of its time and short on some key assets that would have made the video story work out better: a stronger transition of AOL's dial-up customer base to broadband, and a stronger position in cable distribution from Time Warner, together with a willingness on Time Warner's part to tie its content fortunes to some exclusivity or priority over the AOL service. And management expertise.
Indeed, AOL had one thing at the time of the merger that has remained extraordinarily valuable in the world of online video: its reputation for simplicity. Steve Case, after all, had started by offering his service via Commodore 64s, cheap toylike devices with built-in modems, which would connect subscribers to an online bulletin board. At the time, very few people were online and very few PCs had modems installed. Simplicity was key: if you subscribed to AOL, you got access, content, and communications, all in one safe, walled-off area. AOL had hoped to use the Time Warner merger to bring that simplicity and ease of use to a faster-moving broadband world.
Today, similarly, Comcast–NBC Universal aims to make “online” experiences as accessible as possible—as long as consumers play by its rules.
The Comcast-NBCU deal suggests that Case was right but a decade too early. AOL's vision could work today in a way it was unable to
ten years ago; many Americans are once again confused by the vast array of Internet options, particularly video. Limiting and protecting the online experience—making it predictable, branded, pleasant, and easy to access—might make it more appealing to more users.
The key to this walled-garden future is Comcast's embrace of TV Everywhere: allowing users to watch high-quality video from well-known programmers online as long as they are already “authenticated” subscribers to pay-TV service bundles. If you pay for HBO on your television, for example, you can watch HBO on your computer, or on a mobile device inside your house.
Like the pre–Time Warner AOL, TV Everywhere will be popular (because it is easy to use and it simplifies the search for satisfying online video) and successful (because only TV Everywhere will have the distribution leverage to keep licensing costs of popular high-quality content down for online viewing). As Case envisioned for AOL Time Warner, TV Everywhere will be able to take advantage of the libraries of content currently provided by the media conglomerates. Plus new stuff.
TV Everywhere could be what saves the content business, allowing Hollywood to move content safely online in the bundled, channeled, pay-TV format with which the movie industry feels comfortable. (The programmers have been spooked by the music industry's experience with iTunes; they want to make sure they can hang on to bundles and avoid fracturing their content into zillions of cheap bits.) TV Everywhere is easy to understand and access; and it is likely that popular TV programs and sports will be available online only through the TV Everywhere bundled service. Add a deal with Facebook, as Comcast did in 2011, and it becomes a one-stop, community-minded, well-branded, well-organized place. Just like AOL.
But there is a key difference: the TV Everywhere structure is effectively a joint venture among all the major cable distributors and most of the media conglomerates around the country. This time the cable distributors in general—and Comcast in particular—have the downstream market power in distribution that Time Warner lacked in 2001. Since then, Comcast and Time Warner have clustered their operations so that they control the “whole of the market” in which they are the providers of bundled wired-distribution services (video plus data).64 TV Everywhere allows them to move their local physical market power online because customers must subscribe to their pay-TV service to access TV Everywhere.
As Mark Cooper testified at the Senate Antitrust Subcommittee hearing in February 2010, TV Everywhere is “a blatant market division scheme in which the two cable operators [Comcast and Time Warner] who have never overbuilt one another, never competed head to head in physical space, would like to extend that anticompetitive gentleman's agreement into cyberspace.”65
And this time around, unlike the situation in the 1990s, the interests of the concentrated media conglomerates and the cable distributors are clearly aligned: they are all threatened by online video and interested in keeping the tens of billions of dollars in payments flowing among them—affiliate fees, retransmission consent fees, and other fees that the cable distributors kick back to programmers based on subscribership and advertising revenue—intact. All those fees will flow only if distribution of high-priced content can be carefully controlled and charged for by way of a guaranteed distribution channel—the downstream control that Bewkes says is essential for any vertical integration scheme to work. The other media conglomerates needed Comcast's goodwill for the money spigot to stay open. From the cable-distributor's perspective, a programmer was either with it or against it. A media conglomerate that put its programming online outside this framework would risk losing the guaranteed revenue that came from staying with the club. The NBC Universal deal made Comcast into a media programming powerhouse, and thus allowed it to place formidable content assets inside the TV Everywhere umbrella to kick-start efforts to fight the rise of competing online video.66
At the same time, TV Everywhere is a modern-day version of AOL—a safe haven from the wilds of the Internet. As an online writer said in a spring 2010 comment on a blog post:
I don't think that internet video … ever … is really going to make all that much difference. Because the way that these providers [cable distributors] are now packaging their services is so much more convenient. I go to xfinity TV [the rebranded name of Comcast's TV Everywhere product] and click a couple links and now I'm watching my HBO programming. And there's just a vast amount of other content that is part of my package that is now available as well. And best of all … it's all legal as well. I'm not cheating anyone. The quality … is superb. The speeds … awesome. I don't need to be a pirate surfing the open web trying to find what I want. It's all really right there. Nice and convenient. [ellipses in original]67
Another key difference from the AOL Time Warner story was good management. Here's John Malone, talking to the New Yorker’s Ken Auletta in October 2002:
When the AOL merger took place, I think what was lacking was a power base that the C.E.O. had which allowed him to be somewhat dictatorial. … What's very hard is to force behavioral change, where you say, “We just bought AOL. We were into twenty-six million households. The music division needs to create a product that we can bundle with AOL exclusively—not exclusively, who cares, but we need a product that we can sell.” And it didn't happen.68
Brian Roberts and Comcast might succeed where Gerald Levin and Steve Case failed: they had the management ability to turn all of NBC Universal into a smoothly functioning machine in the service of the Comcast brand, and the coordinated power in the programming-distribution market to make the whole thing work.
As John Malone put it in his interview with Auletta, “The vision [for the AOL–Time Warner merger] was taking unique content and marrying that with the Internet, and, particularly as the Internet transitions to high speed, you convince the world—that is, your dial-up subscribers—that high speed creates a value in content that wasn't there at slow speed. And so you shift AOL from being essentially a transport mechanism to being a way to receive unique content services and pay for it—a subscription-content model, as opposed to a connectivity-payment model, where little value goes to the content.”69 By owning programming and controlling access to it, and by selling “specialized services” like TV Everywhere that felt like the Internet but were treated much more favorably both technically and financially, Comcast could shift its distribution services to the all-subscription-content model, make things simple and friendly for consumers, and forestall the day when its pipes were viewed as transport mechanisms for other companies’ content. In 1996, Steven Levy had scoffed at AOL for serving up a comfortable walled-garden world of content and community; Levy was confident that AOL was about to be destroyed by the advent of the wide-open spaces of the Net, and called it a “dead man walking.”70 Fifteen years later, Comcast's 2011 merger with NBC Universal, taken together with its power over high-speed distribution in its markets, looked to be the implementation of the AOL–Time Warner plan. (The next, inevitable step: in 2012, Comcast announced that its online video flowing through an Xbox would not be subject to usage caps—it would be a “specialized service” with quality guarantees—but that Netflix Internet video would be so subject, even though from the consumer's perspective the two would appear to be exactly the same.)71 The Internet, this time around, seemed like the dead man walking.
The regulators in charge of reviewing the Comcast-NBCU deal were, understandably, haunted by memories of AOL Time Warner. Following enormous public concerns about the deal, the agencies back then had risen to the challenge by trying to make room for new marketplaces in competitive ISPs and Instant Messaging applications. But when the AOL–Time Warner merger turned out to be a fiasco, the regulators looked weak for imposing intrusive conditions that ultimately meant nothing. When the same concerns were raised about Comcast and NBC Universal, the regulators had to be worried that overzealous advocates were crying wolf once more.
Maybe this merger would also fail. Bewkes of Time Warner (now just a content, not a distribution, company) made it clear duri
ng an October 2009 TVWeek Conference that he did not think much of the Comcast-NBCU deal, explicitly comparing it to the AOL–Time Warner disaster. It was not clear to him how Comcast was going to be able to become a more successful business by buying NBC Universal. “Somebody has finally noticed that these things don't work out so well,” he said, adding, “We love to see our competitors taking risks.”72 Other vertical integrations had been unwound; Bewkes split Time Warner Cable from Time Warner Entertainment in 2008–9; News Corp. went after DirecTV in 2003 but then spun it loose in 2006.73
Whether all vertical mergers are benign is an open question. Forty years ago, the economist Oliver Williamson argued that vertical integration had “dubious if not outright antisocial properties.”74 After years of litigation and, crucially, the defection of maverick Howard Hughes from the studio pack, the Supreme Court forced the movie studios to divest their theater chains in the 1948 Paramount case, even though the studios had argued that without control over distribution they would have no incentive to invest in expensive content production. (Much the same argument is made today in support of TV Everywhere models.) Studios had forced theater chains to buy films they did not want as part of packages—“block booking”—and often required them not to show films from competing studios. Independent producers had a great deal of trouble getting their films seen in major movie houses, because the theaters would say—often truthfully—that they had no open time.75 Colleen Abdoulah of WOW! would have recognized these practices.
Before the litigation brought the system to an end, the studios had flourished within their vertically integrated format. Modern economists have asserted that block booking brought efficiency gains and that the studios’ vertical integration into distribution and exhibition provided low-priced entertainment to huge numbers of filmgoers. Schemes the Supreme Court at the time saw as “devices for stifling competition and diverting the cream of the business to the large operators” are now praised by many economists as having reduced the costs of doing business, smoothing the way for high-quality mass entertainment on thousands of well-attended screens across the country.76 The idea that there could be a public interest in decentrali-zation—even at the risk of occasional higher costs to industry—is now out of fashion, as is the notion that an inefficient firm might want to vertically integrate in order to use its market power to foreclose change in a dynamic digital world. As the biggest purchaser of television content and the biggest broadband provider in the country, Comcast arguably had the power to influence how the most popular television programming was distributed over the Internet, and an interest in slowing the rise of online video that might replace Comcast's core transmission services’ revenue stream.
Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age Page 13