Bastiat’s Bastions

As you may have heard, Sirius Satellite Radio and XM Satellite Radio are working on a merger, and some expect them to walk down the aisle to take their vows before the end of this year, as is reported in this story in Reuters (and I heard this on NPR’s “All Things Considered” from Jim Zarroli the afternoon after I posted this article–click on the “Listen” button to hear Zarroli’s radio report).

However, there are two serious roadblocks ahead of them:  two government agencies are sure to speak up to express problems with this union.  The less serious, but more immediate roadblock is the FCC which established rules prohibiting the two satellite radio licenses to be held by the same person or company, as a merger would surely put those licenses in the same hands.  The other objector is sure to be the Anti-trust Division of the Department of Justice, who must give their stamp of approval for any merger, supposedly to protect the public against monopoly power.  Certainly, a merger between XM and Sirius would create a monopoly in Satellite Radio.  Or would it?

The question of whether this combination would amount to a monopoly depends on how the market is defined.  The market could be defined rather narrowly as the market for satellite radio.  It could be defined a bit more widely as the market for high quality music recordings and live performances, in which case, iPods (and podcasts and iTune) and other ways of distributing high quality music recordings and live performances would surely compete with satellite radio.  One of the problems of satellite radio is that its growth and the growth of the CD music market has been constrained by iPods and other MP3 type devices.  Of course, the high price of satellite radio has also restricted the amount of activity in this market, but note that price does not restrict demand, but rather restricts quantity demanded (note that the high current price for satellite radio could be because of market power already in the market).

Because of the high fixed costs of launching satellites and the high fixed costs of some programming, such as the Howard Stern Show, there are huge economies of scale in satellite radio.  When demand is small and there are some economies of scale in the market, there is what has been termed a “natural barrier to entry.”  If demand is small in the neighborhood of declining average costs, or small relative to minimum efficient scale (MES), no more than one firm can survive in the market, as reducing the output of a single firm below the MES level would only serve to increase average costs, and the price that must be obtained for more than one firm to survive—one firm could, in this case, price below the other and force the other out of the market.  In other words, competition can increase prices to consumers if demand is small relative to MES.

There is also the real question about whether or not strict government regulation of this market might not be contributing to monopoly tendencies in this market, or more specifically, to economies of scale.  Regulation requires the firm to face compliance costs.  These costs, as a percent of output, usually fall as output rises.  In other words, a smaller firm faces almost the same regulatory compliance costs as a much larger firm, contributing to economies of scale and the natural barriers to entry in the satellite radio market.

If the Anti-trust Division of the Department of Justice finds that there are significant economies of scale involved so that one firm could achieve small per unit costs than could be achieved with two firms in the market, they might allow Sirius and XM to merge.  Surely, though, they would require the merged firm to relinquish one of the two licenses, so that, should demand rise sufficiently for another firm to enter at some future date, entry would not be stopped by licensing.

One possibility that should be examined is whether or not there are “economies of SCOPE” with some other industry, such as with a satellite/cable TV, so that a merger with, between say VHI and Sirius, and Telemundo and XM, might provide the lower costs so that each might be able to survive and compete.  There could even be economies of scope with some other product or industry, such as retailing.       

Personally, I would rather like to see a merger between Sirius and Toys R Us.  The new company could be called “Sirius R Us–and Us Mean It.”

MC

This entry was posted on Tuesday, February 20th, 2007 at 11:59 am and is filed under General, Political Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.