Mr. Chairman and Ranking Member, it is a real pleasure to be here today, and thank you again for not issuing that formal subpoena you had to threaten in order to compel us to testify.

Let me begin my testimony by taking this opportunity to divert the media’s attention from this hearing by making a series of Google public announcements that our news algorithms predict will bury news of today’s hearing on the second page of most search results.

  • Yesterday, in a contest between the world’s fastest supercomputers, IBM’s “Watson” was defeated by Google’s “Knowitall” at Jeopardy, The Price is Right and the Wheel of Fortune.
  • This week, the number of Google+ users surpassed Facebook as Google added 1.1 billion Google+ users “privately” without their permission in just the last month.
  • Today, as a gesture of goodwill to the European Union, Google has agreed to buy Greece for €7.77 billion.
  • Also today, Google’s “Knowitall” computer network became sentient and automatically renamed itself “Your Majesty.”

Now let me disarm the tension in this room by feigning humility and reciting some focus group-tested cliché mantras that our tracking algorithms tell us will be believed by 93.1459% of people in this relevant targeted audience: Don’t be evil; Google would never do anything to undermine the trust of users; Using Google is a choice; Competition is a click away; Not every website can come out at the top of the page; You can make money without doing evil; Google is not a monopoly; Big is not bad; We are for openness others for closedness; and We understand with success comes scrutiny.

That in a nutshell is our antitrust defense; so please move along, there is nothing to see here.

Before I go, I have been told by my Washington advisors it would be helpful if I feigned more humility and I apologized for what Google has been caught doing red-handed.

First, we are very sorry Google was forced by the DOJ to officially admit to knowingly committing criminal felonies over a period of several years in actively promoting illegal prescription drug imports into the U.S. and to having to pay a near record $500m in criminal fines to settle the matter. Honestly, we never intended to get caught.

Second, we are very very sorry that Federal Judge Chin and the DOJ opposed the Google Book Settlement because we illegally copied fifteen million books without the permission of, or payment to the copyright owners, and also attempted to corner the online market for orphan works. It never occurred to us that stealing was illegal.

Third, we are very, very, very, sorry for being forced to admit to deceptive privacy practices and to be on probation for twenty years in the FTC-Google Buzz privacy settlement. Google has always said one thing and done another, so we had no idea that misrepresentation on the Internet was considered a deceptive business practice. Who could have known that?

Fourth, we are very, very, very, very sorry, for being investigated by the FCC for effectively wiretapping tens of millions of Americans homes in the Google StreetView WiSpy scandal. We always thought that if an average person did not know how to encrypt their private information, passwords and email, they deserved to have their privacy violated.

Fifth, we are very, very, very, very, very sorry the DOJ had to threaten us with a Sherman Act monopolization case to stop us from colluding with Yahoo to corner the online advertising market in the proposed Google-Yahoo Ad Agreement in 2008. Frankly, we were surprised the DOJ could get so huffy about antitrust.

Sixth, we are very, very, very, very, very, very sorry the that discovery in the Viacom vs. Google copyright case showed Google knowingly infringed on hundreds of thousands of videos in order to corner the Internet video distribution market. At Google we call taking whatever content we want without permission “fair use” and “sharing,” not infringing or stealing.

Seventh, we are very, very, very, very, very, very, very sorry that in this difficult job market, the DOJ caught us colluding with five other companies, to restrain competition for highly-skilled employees to limit both the compensation and career opportunity of thousands of our employees. We are happy to report in this instance Google was not the only company caught breaking the law.

In conclusion, Google’s unique mission to organize the world’s information is not monopolistic. Our repeated clashes with law enforcement and the plethora of antitrust, criminal, privacy, property and other investigations of our company are just a big misunderstanding because Google’s ever-flowing innovations are so disruptive. Several years ago, Google’s founders chose a Tyrannosaurus-Rex as Google’s corporate mascot, and prominently installed a life size skeleton of a T-Rex at our Mountain View headquarters as a symbol of Google’s disruptive innovation. Every other dinosaur had to run faster and hide better because of the T-Rex’s constant disruptive innovation. Simply, where others see predation, Google sees innovation.

***

Google Antitrust Pinocchio Series:
Part IX: Google Locks-in Its One Click Away Defense
Part VIII: Google’s Deceptive One Click Away Defense
Part VII: Two fatal Flaws in Google’s Antitrust Defense
Part VI: Fact-Checking Google’s Antitrust Defense
Part V: “Google does not reap the benefits of significant network effects”
Part IV: Stress-Testing Google’s Top Ten Antitrust Defenses
Part III: “Google-AdMob: ‘Its too new to dominate'”
Part II: Google: Antitrust’s Pinocchio?
Part I: What is “One click away?

 

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Netflix’ Uneconomics

September 6, 2011

Netflix’ continues to exhibit serious difficulties grasping basic economics, competition and value.

First, Netflix is lowering its value to customers.

  • Netflix now charges its subscribers’ 60% more in September in return for lots less premium content available for subscribers in February, as Netflix just lost Starz, its top premium content provider, which supplies 22 of Netflix’ top 100 movies.

Second, Netflix is shifting its costs to its customers.

  • Netflix used its abrupt and controversial 60% price hike to force many of its core users away from the DVD model that many prefer and have the viewing technology for (but costs Netflix more), to the streaming model, (which Netflix prefers because it costs them less) even if it costs many of their DVD customers to spend lots more to upgrade their viewing technology to view the streamed content in the way they can currently view DVDs. 

Third, Netflix is chasing away the premium content its subscribers demand.

  • Netflix’ abrupt and careless business model pivot from a value DVD business to streaming, signaled loudly to content providers (on which Netflix depends) that Netflix took them for granted in the wake of the demise of Blockbuster’s store business model.
  • It appears that Netflix imagined its perceived market power could force premium content suppliers, like Starz, into a accepting a new online business model that would profoundly devalue their premium content franchises long term.
  • In effect, Netflix wants its premium content suppliers to acquiesce to its demands that they accept a permanent change from a time-limited usage content model (DVD rental), which enables premium content to extract premium value for its content, to a commoditized unlimitedaccess content model where their content reaps no benefit from being premium and being viewed repeatedly.
  • Starz wisely told NetFlix: “No.”
    • Starz and other premium content providers understand that Netflix will not be the only online game in town for their premium content, as Amazon, Apple, WalMart, Dish/Blockbuster, Google-YouTube, and others increasingly compete for premium content with premium content-friendly deals that can be more transaction-based and more remunerative for premium content.
    • Netflix apparently does not grasp that, as essentially a cloud-based video streamer, they face lots of new entrant competition from deeper-pocketed competitors who are likely to be more willing and able to pay more for premium content to provide content differentiation to their online streaming customers — than Netflix.
    • In a nutshell, Netflix has exhibited broad uneconomic hubris, and over time competitive forces will teach Netflix lessons about economics, competition and value. 

Finally, Netflix is claiming entitlement to regulatory subsidies from its main suppliers.

As previous pieces in this Netflix series have documented (see links below), Netflix imagines that the FCC’s net neutrality policy, embodied in its December Open Internet order, should entitle Netflix to operate in a competitive environment where its actual or potential competitors cannot charge competitive usage-based pricing, for competitive bandwidth services.

  • Netflix continues to forum shop for corporate welfare from regulators when the FCC’s December order supports usage-based pricing and both the FCC and FTCChairmen have publicly endorsed usage-based pricing for bandwidth to ensure the nation’s broadband infrastructure remains economic and sound from an operational and investment perspective.
  • As the single largest bandwidth cost-causer in streaming more video than any entity, Netflix needs to become a better steward of Internet usage and invest in much more network management and content caching closer to its customers — as Google-YouTube responsibly did before them when faced with this legitimate bandwidth hogging criticism.
  • Netflix’ naive uneconomic approach to its business seeks to have regulators force its suppliers to subsidize Netflix with uneconomic flat rate unlimited bandwidth, at the same time:
    • Netflix’ competitors are adapting competitively by managing their networks much more efficiently; and
    • Netflix is cost-shifting to its customers and trying to cost shift to its content suppliers.

Conclusion

Netflix, in myopically focusing on subscriber growth, and largely ignoring competitive economics and competitive value creation, has exposed enormous competitive weaknesses long-term.

  • In their its-all-about-Netflix world, Netflix has taken most everything for granted: its customers, its value proposition, its suppliers (content & bandwidth), and its potential regulators.

As I pointed out several months ago at the beginning of this research series, Netflix’ nosebleed stock price growth would not last forever.

  • Given that Netflix is 28% off it high in July, it should answer this wake up call, and stop behaving like a hubristic hot dot.com “it” stock.
  • Netflix should start competing in the real world of focusing on the customer, providing differentiated content, paying competitive prices for competitive inputs, and competing in the free market that is only going to get a lot more competitive with the ramp-up of other cloud-based video-streamers: Apple, Amazon, Walmart, Dish-Blockbuster, Google-YouTube, Microsoft-Skype, etc.

At core, Netflix’ fits of uneconomic behavior are a blinking warning sign that Netflix could have much deeper business problems than the company is letting on. 

***

Previous Netflix posts:

The DOJ lawsuit against the AT&T – T-Mobile merger has many serious flaws that will make it difficult for the DOJ to meet its burden of proof in court that this merger is anti-competitive.

  • Court cases are precedent, fact, and merit driven, and DOJ’s case is much weaker in those critical dimensions than most appreciate or reports indicate.
  • (See DOJ’s release here and the DOJ’s complaint here.)

Importantly, if the DOJ ultimately cannot prove this merger is anti-competitive in a court of law, that official legal decision would make it legally difficult for the FCC to block the merger on competition grounds under the FCC’s public interest standard, especially given that the merger would bring more broadband speed more quickly to more Americans, and create jobs, which the FCC’s claims are their top public interest priorities.

  • Simply, the precedents, facts, and merits are friends of the proposed AT&T-T-Mobile deal.

I.   Summary of Top Ten Flaws in DOJ’s Case

  1. The DOJ’s own facts don’t support its national relevant market definition.
  2. The DOJ arbitrarily gerrymandered its market definition to exclude real and relevant market competition in a large geographic segment of the nation.
  3. The DOJ’s arbitrary nationalmarket definition completely ignores ~10% of their supposed “national” market.
  4. Implying #4 T-Mobile is the only important “maverick” competitor, essentially ignores how #3 Sprint also has many “maverick” attributes and capabilities that would survive the merger.
  5. The DOJ is arbitrarily ignoring its own longstanding precedent of defining the wireless market locally without any justification for this fundamental change.
  6. The DOJ is also trying to move the goalpost on what is an acceptable level of market concentration.
  7. The FCC’s competitive facts do not support the DOJ’s market definition or conclusion.
  8. The DOJ ignores and dismisses obvious market efficiencies.
  9. The DOJ’s charge the merger will substantially lessen competition in “product variety and innovation” completely ignores the plethora of facts from the handset, mobile OS and App markets to the contrary.
  10. Maybe most importantly, the DOJ complaint ignores the explosion of market facts that show how dynamic and fast-changing the mobile marketplace has become.

II. The Top Ten Serious Flaws in DOJ’s Case

First, the DOJ’s own facts don’t support its national relevant market definition.

The DOJ’s entire case rests on DOJ’s factually unsupported and contrived assertion that the relevant market is a national mobile wireless telecommunications services market when most of the market data/evidence the DOJ presents in its own complaint is local market based.

  • Moreover, the combined local market shares DOJ presents in the top 100 markets vary wildly by local market, from  a combined low of 17.4% in Toledo to a combined high of 65% in Baton Rouge — an extremely wide range of almost 4 times more from low to high.
    • If the DOJ’s national market conclusion was factually sound, that what really drives this market is the nationalpricing plans of competitors’ offerings, why do the market shares of the top 100 local markets not show any perceptible statistical regression to some sort of national mean?
      • Shouldn’t the data the DOJ chooses to present in order to make its case, at least statistically resemble their proposed conclusion?
  • It will be obvious to the court that competition in these local markets must be driven by local market factors that are completely different from “national pricing plans” that the DOJ claims determine the market’s overall competitive dynamics, e.g. the amounts and types of spectrum available, the market’s population density, its legacy wireline footprints and brand, the number of retail locations, among other local market factors.

Second, the DOJ arbitrarily gerrymandered its market definition to exclude real and relevant market competition in a large geographic segment of the nation.

Equally damning to the DOJ’s case is that as it tries to assert that the market is national, the DOJ is omitting the large part of the Nation that is not in the top 100 markets.

  • It appears that DOJ has excluded this critical evidence and made no mention of this large segment of the Nation in its analysis, because these critical facts strongly undercut the DOJ’s assertion of a national market and their de facto conclusion that the merger would be effectively anti-competitive in all local markets of the nation.

How can the DOJ logically and legitimately claim that this merger threatens rural wireless competitors when it excludes from its analysis any discussion or combined market share data for rural markets?

  • It appears the DOJ has excluded that local market data because it undermines their national market definition assertion, and because the combined shares in smaller markets are generally much smaller than in larger markets because of the competition from regional  and rural competitors.
  • A fair judge will naturally be suspicious of selective market facts that exclude relevant facts that most refute the DOJ’s market definition and anti-competitive conclusion.

Third, the DOJ’s arbitrary nationalmarket definition completely ignores ~10% of their supposed “national” market.  

  • The DOJ will have a hard time proving that value competitors Metro PCS and Leap Wireless, which serve 200 million Americans, and regional competitors like U.S. Cellular and Cellular South with significant local market shares, are irrelevant to this analysis, conclusion and case.
  • And if the DOJ truly believes they are competitively irrelevant, why does the DOJ local market data include them at all? They can’t have it both ways. 

Fourth, implying #4 T-Mobile is the only important “maverick” competitor, essentially ignores how #3 Sprint also has many “maverick” attributes and capabilities that would survive the merger.

DOJ’s case depends in large part on DOJ convincing the court to ignore the competitive existence and capabilities of Sprint, which has: ~50m customers, maverick pricing plans, industry-largest spectrum portfolio, and innovative technology leadership in partnering with ClearWire and LightSquared.

  • To mangle metaphors here, the DOJ has to convince the court that the Sprint “elephant in the room” is really “chopped liver.”

Fifth, the DOJ is arbitrarily ignoring its own longstanding precedent of defining the wireless market locally without any justification for this fundamental change.

The DOJ has reviewed about a score of wireless mergers over the last decade and has evaluated them all on a local by local market basis, not a national market basis.

  • The DOJ complaint is silent on why it has changed this longstanding procedure and precedent.
  • If market conditions somehow have changed sufficiently to make it appropriate to define the market dramatically differently than the DOJ has defined it in repeated consent decrees approved by courts in the many legal and court precedents before this merger, then the DOJ must be able to successfully defend their fundamental change in precedent and procedure before this court.
  • A core element of justice is equal treatment under the law. Without any explanation or justification to date, it appears the DOJ has made an arbitrary and capricious decision to gerrymander a selective ~90% “national” market” to capture this particular merger.
  • A core element of fairness is that players in the game have the certainty that the goalposts won’t move as the player approaches the goal line.
  • DOJ must be able to conclusively prove that it is treating the AT&T/T-Mobile merger no differently than it treats all other mergers the DOJ reviews.

Sixth, the DOJ is also trying to move the goalpost on what is an acceptable level of market concentration.

Context matters for fairness and equal treatment under the law.

The DOJ complaint effectively gerrymandered a selective market definition to arrive at the claim that this would be a 4-to-3 merger when in most large local markets it would be a 6-to-5 or 5-to-4 merger.

  • This could be another arbitrary and capricious problem for the DOJ because the DOJ is silent on why the DOJ would approve an ostensible 2-to-1 satellite radio merger of XM-Sirius, or a 3-2 consolidation of search engines in Microsoft-Yahoo as competitive, but conclude definitively that somehow an ostensible 4-3 AT&T – T-Mobile is so anti-competitive that it did not even consider remedies to cure it that DOJ has successfully employed in many previous wireless mergers?
  • Moreover, the court will probably want to know why this merger should be treated differently and more harshly than the alleged 3-to-2 Oracle-Peoplesoft merger that was approved by Federal Court.

Seventh, the FCC’s competitive facts do not support the DOJ’s market definition or conclusion.

The FCC’s latest wireless competition report shows that ~90% of Americans have a choice of five wireless competitors.

  • How can the DOJ credibly claim that this is a 4-to-3 merger for ~90% of the national market when the U.S. Government’s most recent official data shows that it would be a 5-to-4 merger for 90% of the country?

Eighth, DOJ ignores and dismisses obvious market efficiencies.

The DOJ complaint’s entire treatment of efficiencies constituted only one sentence: 

  • The defendants cannot demonstrate merger-specific, cognizable efficiencies sufficient to reverse the acquisition’s anticompetitive effects.” 

The companies should have a field day in court “demonstrat[ing] merger-specific cognizable efficiencies” of this merger:

  • Bringing 4G LTE broadband to 55 million Americans who otherwise would not get it;
  • Upgrading T-Mobile’s 33m customers to 4G service that T-mobile would not have been able to provide on its own;
  • Combining compatible GSM networks that can be integrated easily, seamlessly and cost-effectively;
  • Creating scale and scope that financially justifies investment neither company could do alone;
  • Correcting inefficient spectrum deficits in key markets; and
  • Providing a host of other cognizable efficiencies. 

In court, DOJ will not get away with asserting “because we say so” that there are no cognizable efficiencies.

  • The DOJ will have the burden of proof to justify why the court should ignore all the efficiencies the companies can easily present and enumerate.
  • Facts matter.

Ninth, DOJ’s charge the merger will substantially lessen competition in “product variety and innovation” completely ignores the plethora of competitive facts from the handset, mobile OS and App markets to the contrary.

Americans have more handset choice than most anywhere in the world — over 600 handset choices.

OS providers (Apple, Google-Android, RIM, Symbian) manufacturers (Apple, Samsung, LG, Nokia, Motorola, etc. are driving fantastic product variety and innovation in handsets.

  • It is a huge reach for DOJ to prove that this merger will substantially lessen competition in product variety or innovation, because that dynamic has long not been practically controlled or driven by wireless providers.

Tenth, and maybe most importantly, the DOJ complaint ignores the explosion of market facts that show how dynamic and fast-changing the mobile marketplace has become.

The reality of technological convergence is that new competitive pressures are coming from virtually every direction: customer demand; integrated platform ecosystems: Apple, Google, Facebook, Microsoft-Skype, Amazon; device, hardware and accessory suppliers; applications providers and developers; cloud computing models; big box stores; etc.

At core, DOJ will be trying to convince the court that this is their father’s wireless market; it is not. 

  • If the companies can get the court to understand how dynamic, fluid, ever-changing, innovative, and vibrant the overall mobile ecosystem really is, it will be very difficult for the DOJ to prove, based on the preponderance of the evidence, that this 5-to-4 merger will substantially lessen competition. 

III.  Conclusion

In sum, the DOJ has the burden of proof to prove the AT&T-Mobile merger is anti-competitive.

  • The DOJ has not helped its case by arbitrarily gerrymandering its market definition in direct contradiction to longstanding precedent, with no justification, and by ignoring important and relevant competitive facts.

Public assertions and lawsuits may persuade some merging parties to fold on their own, but being on the right side of precedent, facts and the merits will be required to win in court here.

Advantage to AT&T – T-Mobile in court.