Time Warner Memo Four
Government Regulation in Economics
By Kallie Kiger

A memo from the President of the Network Television Division at Time Warner to the Vice President of Global Strategy suggests that Time Warner acquire Fox News (Baye, 570). Time Warner owns CNN, which is the largest cable news service in the US, and has had great success. Recent growth in revenue at Fox News, plus the potential for synergies between the news stations makes acquisition seem profitable.

Background on Time Warner’s Media Ownership

Warner Communications and Time, Inc. merged in 1990 to form Time Warner, Inc. (Baye, 547). In 2000, Time Warner, Inc. merged with AOL to form AOL Time Warner. AOL Time Warner is the largest media company in the world (Baye, 548). Acquisitions and media consolidations have allowed them to grow rapidly.

Time Warner’s network division focuses on cable programming (Baye, 558). Their network lineup includes TNT, TBS, CNN, Cartoon Network, and HBO. Time Warner competes heavily with Disney, Viacom, and NBC-Universal.

History of Media Regulation

Since the beginning of the twentieth century, there have been many changes in the media industry. The rapid changes in technology have led to many government regulations. Politicians, economists, media owners, and the general public have different views on the best way to regulate the growing industry.

The Federal Communications Commission is the U.S. regulatory agency that oversees mass media. Since the 1940s, the FCC has been restricting station ownership (Barrett, 2). In 1953, the FCC adopted the rule of seven. The rule of seven was implemented with the intention of increasing diversity. It stated that no single owner could own more than seven AM stations, seven FM stations and five television stations. The number of television stations was also increased to seven in 1954.

In 1984, the FCC increased the rule of seven to the rule of 12 (Horwitz, 188). This was in response to the dramatic changes in technology that happened over three decades (Barrett, 2). By 1992, the FCC raised the radio ownership laws to 30 AM stations and 30 FM stations (Horwitz, 188).

With the rise of the Internet, and ease of distributing other forms of mass media, the Telecommunications Act of 1996 changed many earlier rules implemented by the FCC. A single entity could not have “an attributable interest in cable systems reaching more than 30-percent of cable homes nationwide” (188). The act also stated that a cable company could not own more than 40-percent of its programming.

The most important outcome of the Telecommunications Act of 1996 is that it requires the FCC to review each ownership rule every two years (189). This allows them to ensure that rules support the public’s interest and competition. The act directs the commission to change any rule that they determine inconsistent with the public interest.

Economic Measures of Market Ownership

In order to better understand an industry, the market structure must be examined. Baye describes market structure as factors that affect managerial decisions (236). These factors can include the number of firms in a market, the relative size of the firms, technology and cost of technology in the market, demand for product in the market, and ease of entry and exit to the market.

Industry concentration is an important economic measurement of the Time Warner acquisition of Fox News. The four-firm concentration ratio shows the fraction of the total industry sales generated by the four largest firms (239). A less concentrated industry will have a ratio close to zero, and a more concentrated industry will have a ratio closer to one. To calculate this you take the sum of the revenues generated by the largest four firms and divide by the total industry revenues.

The four largest firms in the cable network market and their revenues for 2003 are:

NBC-Universal

$164,191,667
Time Warner
$302,283,333
Disney/Hearst
$339,266,667
Viacom
$339,575,000
The total revenues for the industry are $1,908,766,666.

Using these numbers, the four firm concentration ratio is 60 percent. This ratio shows that the market is more than 50 percent concentrated.

To understand the change in concentration after the proposed acquisitions, I calculated the four firm concentration ratio with Fox News revenues added to Time Warner’s revenues and subtracted from News Corps Revenues. The ratio increased to 61.82 percent. This is a very small change in the concentration ratio.

A second measure often used is the Herfindahl-Hirschman index (HHI). While this is a very crude measurement, it can provide some insight to the size structure of an industry (240). The HHI lies between zero and 10,000. A number close to zero represents an industry with many small firms, and a number close to 10,000 represents only one firm in the industry.

In 2000, a study by Benjamin Compaine uncovered that even after mass mergers in media, the HHI was virtually unchanged (Horwitz, 185). The overall media industry had an HHI of 268, which is very unconcentrated.

In the cable network industry, there is an HHI of 1102 before the acquisition of Fox News by Time Warner, and an HHI of 1147 after the acquisition. Like the four firm concentration ratio, this shows an increase in concentration, but a very small one. A merger or acquisition must cause an HHI increase of at least 100 points before the Federal Trade Commission will challenge it.

Government Regulation of Proposed Acquisition

During their biennial reevaluation of mass media regulation in 2003, the FCC questioned the current mass media regulations (Shelanski, 372). The FCC relaxed rules that regulated market concentration and ownership in the media industry (375). The new rules were not designed to increase the media mergers, but instead allowed the mergers to be controlled by general antitrust laws, instead of industry specific regulations.

The 2003 biennial review led to the proposal of the diversity index (Hearn, 36). The diversity index was introduced as a way to measure concentration of media-ownership in a market. The diversity index, which works similarly to the HHI, assigns numerical values to various components of ownership. The index was designed to work as an objective analytical tool to decide whether or not a media merger should take place.

Members of the FCC debated over the index’s complicated formula and its actual purpose. Many FCC members wanted to keep the rules around the media industry simple and feared the diversity index would create complicated mathematical rules. Other members hoped that the index would simply create a guideline to help make decision-making simpler.

While the diversity index was not adopted in 2003, it did lead to discussion that caused the FCC to increase the limits for broadcast ownership from 25 percent to 30 percent (Shelanski, 378). Before acquisition of Fox News, Time Warner held 15.84 percent of the market. The acquisition would increase their market share to 17.65 percent. This is below either threshold, which means there is no legal reason to object to the acquisition.

Additional Problems with Proposed Acquisition

While there are no legal problems with Time Warner’s acquisition of Fox News, there are some ethical issues involved. A debate forms around the possible problems associated with few companies owning too much media. In this case, Time Warner plans on acquiring Fox News. This would mean that they would have control over both CNN and Fox News, which are two of the largest news stations. Time Warner would potentially have the power to add bias to the news without the two stations keeping one another in check.

Columnist William Safire said that the deregulation in 2003 could be attributed to a powerful broadcast lobby, and “policymakers who have confused deregulation with sound economics” (Shelanski, 376). Media organization want the ability to merge, grow, and increase profits. Looser ownership restrictions would allow consolidation that could reduce costs (Duke, 4). The desire to loosen these restrictions could cause media companies to hire experienced lobbyists who could influence policymakers in less than ethical ways.

Duke argues, however, that looser ownership restrictions may actually cause an increase in diversity. Because media companies today are publicly traded companies, owned by investors, their main objective is to “maximize its audience to attract advertising revenue” (5). This will cause them to diversify their programming to reach as many individuals as possible, instead of only one large segment.

Duke continues to say that as long as Americans demand alternative perspective, that media companies will provide them, and the Internet will keep them in check.

Conclusion

I recommend that Time Warner acquire Fox News with the intention of keeping the programming conservative in nature. By providing a variety of viewpoints between CNN and Fox News, Time Warner will increase their overall viewers. To avoid the appearance of bias, Time Warner may keep the stations independent of one another.

Questions

1. What is the formula to calculate HHI?
a. (S1 + S2 + S3 + S4)/ST
b. ∑w2
c. 10000∑w2
d. 10000S/ST
2. Who are Time Warner’s biggest competitors?
a. Disney, Viacom, and NBC-Universal
b. Disney, Comcast, News Corp
c. Viacom, NBC-Universal, News Corp
d. Comcast, Viacom, Disney
3. When did the FCC adopt the rule of seven?
a. 1984
b. 1954
c. 1996
d. 1953
4. According the four firm concentration ratio, the cable network industry is _.
a. Unconcentrated
b. Under 50 percent concentrated
c. Over 50 percent concentrated
d. Very concentrated
5. Since the Telecommunications Act of 1996, how often does the FCC review media ownership regulations?
a. Every year
b. Every two years
c. Twice a year
d. Every five years


Answers
1. c. 10000∑ w2
The Herfindal-Herschman Index is the sum the squared market shares of firms in a given industry. The HHI is a very crude measure of the size structure of an industry. The closer the HHI is to 0, the more small firms there are in an organization. An HHI close to 10,000 represents an industry with only a few large firms.

2. a. Disney, Viacom, and NBC-Universal
Disney, Viacom, NBC-Universal, and Time Warner are the four largest firms in the cable network industry. These four firm’s revenues create a four firm concentration ratio of 60 percent.

3. d. 1953
The rule of seven was adopted in 1953, and said that no one firm could own more than seven AM stations, seven FM stations and five television stations.
In 1954, the number of television stations increased from five to seven.
In 1984, the rule of twelve was adopted which allowed 12 of each AM stations, FM stations, and television stations.
The Telecommunications Act of 1996 adopted the rule that said the FCC should review media ownership regulations every two years.

4. c. Over 50 percent concentrated
The four firm concentration ratio of the cable television network industry is 60 percent. This is just over 50 percent concentrated.

5. b. Every two years
The FFC reviews media ownership biennial, or once every two years.


Works Cited

Barrett, M. (2005, January). The FCC's Media Ownership Rules and the Implications for the Network-Affiliate Relation. Journal of Media Economics, 18(1), 1-19.

Baye, Michael. (2006) Managerial Economics and Business Strategy. McGraw-Hill, Boston.

Dukes, A. (2004, Winter2004). The FCC and Media Regulation. Phi Kappa Phi Forum, 84(1), 4-5.

Hearn, T. (2003, April 21). New Divider: 'Diversity Index'. Multichannel News, 24(16), 36.

Horwitz, R. (2005, July). On Media Concentration and the Diversity Question. Information Society, 21(3), 181-204.

Shelanski, H. (2006, March). Antitrust Law as Mass Media Regulation: Can Merger Standards Protect the Public Interest?. California Law Review, 94(2), 371-421.