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When MFN Clauses Go Bad

· June 18, 2012

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Last week, I touched on some of the strategies cable companies use to hold back the oncoming disruption in the video distribution market, and it turns out that the Department of Justice is probing those very same issues in an extensive investigation.  What is interesting about this investigation is that it appears focused on a much wider range of potential anticompetitive practices than is normal of a typical investigation. According to Multichannel News:

A cable industry source familiar with the information requests confirms that the Justice Department has been contacting cable operators as part of an investigation into whether MSOs are trying to suppress over-the-top video competition through data caps, TV Everywhere “collusion,” contract language — most-favored nation clauses–and more.

According to a cable industry source familiar with the Department of Justice requests, Justice started out focused on TV Everywhere and alleged “collusion” and has extended the investigation to a range of topics. The source said the investigation has been going on for a couple of months.

This laundry list of potential violations of competition law includes both Sherman Act Section 1 violations (collusion surrounding the “authentication” scheme used to ensure that you can only watch TV online if you are a cable subscriber) and Section 2 violations (anticompetitive use of data caps, exclusive contract language and most favored nations clauses).  As this investigation illustrates, this is a highly orchestrated campaign aimed at limiting consumer choice. In response, the cable industry said –‘ oooh, look over there, shiny objects’:

The innovative offerings by cable companies are positive developments for consumers and represent accepted and legitimate business practices as well as sound network management. All the industry’s actions are intended solely to ensure consumers get the highest value for their subscription.  [statement by NCTA’s spokesman, Bryan Dietz.]

The problem isn’t that they are not giving consumers the highest value for their subscription, it’s the problem of the value of the subscription in the first place.  If the subscription model really was “more valuable” to the consumers, then why are cable companies conspiring to prevent the rise of “less valuable” alternatives (like online distribution untethered from cable subscriptions)?

These practices, arising from the fact that consumers have few TV choices, inflate consumer prices.   Cable companies have been able to use “Most Favored Nation” (MFN) clauses (essentially saying, ESPN, we will pay you a ton of money, but you cannot give anyone else a better price… oh, and you can’t make your content available for free online–except to our subscribers).  This is particularly problematic for customers because their cable providers, who face limited competition in the first place, have less incentive to negotiate aggressively, and they then pass on these inflated prices to their consumers.  Consumers are also prevented from switching to a lower price option–because these clauses prevent any other distribution channel from getting better deals.  As the WSJ points out, these contracts are seen as “insurance for poor negotiators.”   Unfortunately, it is consumers who pay the inflated “insurance” premiums.

In the television industry, it has long been seen as insurance for poor negotiators—the use of contractual clauses that guarantee the biggest cable operators the lowest price for TV channels.  Now the clauses, which have drawn the attention of the Justice Department, are affecting where TV programs go online.

Technically known as “most favored nation” clauses, their use in deals between cable operators and TV-channel owners has evolved over the past 25 years. Initially about economic terms, clauses are now being negotiated around digital rights, industry executives say. As a result, the clauses are in some cases limiting how and where channel owners can make their programming available online, industry executives say.

Anticompetitive MFN clauses are also the focus of the DOJ’s antitrust charges against Apple and the major publishing houses, who colluded and agreed to contract terms that prevented the selling of books for cheaper than what they were sold through Apple’s book store.  (Also, MFN clauses prompted one of the complaints against the proposed Google book search settlement and they were also at the heart of the DOJ’s recent charges against Blue Cross Blue Shield.)

“MFN clauses” (so named because of their resemblance to devices in international trade agreements that prevent tariff discrimination against particular countries) can be a good thing when they are written to ensure a company’s ability to compete on price.  However, they can be a problem when they are designed to prevent incumbent companies from having to compete at all.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.