ICE Bought NYSE: Profiting from the Rules?

Tell me what the rules are, and I’ll make money with them.” This statement, made by Jeffrey Sprecher of Intercontinental Exchange, captures well the attitude that business practitioners should have toward government regulation in a republic. That is to say, businesses should be regulation-takers rather than makers. For the regulatees to make regulation to which they themselves would be subject is an oxymoron, or contradiction in terms. At the very least, it involves a conflict of interest. At the macro level, business as “regulation-maker” effectively turns a democracy into a plutocracy. Accordingly, the strategic use of regulation should pertain to the use side, rather than the regulating side. Crafting regulations—essentially dictating them to legislators or regulators—in order to make money from them takes the strategic use of regulation too far.

 Jeffrey Sprecher of ICE.  Making money playing by the rules.  (nypost)

Sprecher began by working at electric companies. He picked up on the need of those companies to hedge energy contracts so he bought a small exchange and built it up around derivative trading. Eventually, he did away with the exchange’s trading floor—preferring 24 hour computer trading. In 2010, the passage of the Dodd-Frank Act of financial reform requires that derivative trading be done through a clearinghouse. Sprecher’s company stood in a position to take advantage of the new rule. In fact, the intent of the new regulation being that regulators could have a better idea of the volume of derivatives “out there,” Sprecher created a derivatives database in his company. In other words, he anticipated in a way that meant more profits, and he did so without trying to manipulate legislators or regulators with a huge lobbying effort. Rather, he anticipated weaknesses in the market and devised company-based solutions that would be profitable. It is no surprise that the Dodd-Frank Act essentially adopted his business model regarding derivatives—effectively forcing it on the industry as a whole.

In fact, observing the heightened scrutiny of swap contracts under Dodd-Frank, Sprecher decided to convert them to futures contracts. Here again, profit was also in the mix. “The reality is that there are incentives to convert swaps into futures, where there’s less competition,” according to Richard McVey of MarketAxess. “There’s no requirement for [Sprecher’s company] to open [its] futures clearinghouse to other exchanges.” This restriction of competition to increase profit is ironic for ICE because in late 2012 came the announcement that the company would purchase the New York Stock Exchange, which had capitalized on monopolizing the trades of its members. Ironically, Sprecher’s actions had undercut this monopolization and here he was exacting his own version in turning “insurance” swaps into garden-variety futures contracts. Business skill can be regarded as the art of knowing when to ride a wave—and which wave to ride.

It should be noted that both the computer-trading and derivative-trading trends furthered by Sprecher’s very company enabled it to buy the vaunted New York Stock Exchange for $8.2 billion rather than something much higher. According to the New York Times in late 2012, the “transformation of the New York Stock Exchange from its position at the apex of the world financial system to an asset to be bought and sold like any other—and one that is not deemed to be worth as much as it would be if it traded more modern derivative securities rather than old-fashioned stocks—has been going on for decades, but has accelerated in recent years.” Essentially, Sprecher took advantage of this trend by making the purchase, and he would capitalize on owning the “temple of commerce” through intra-company synergies even while committing to keep the NYSE floor up and running.

In short, business acumen has no need of being sidetracked into manipulating lawmakers and regulators into formulating rules favorable to one’s particular company. The strategic use of regulation is most profitably accomplished over the long run on the use side. Take the rules as given and make money with them. This is entirely consistent with business in a viable republic. An implication of this thesis is that it’s the bad—both in terms of business intuition and moral disapprobation concerning manipulating public policy for private gain—manager who represents the plutocric threat to a republic.  The business practitioners knocking on Congressional doors are not the brightest guys in the room as regards innate business skill, and they are not the most forthright concerning getting what they want, whether by money or even information. Unfortunately, turning opportunities into profit is instinctive only for some practitioners, while it is forced or contrived in many others, who therefore feel compelled to circumnavigate business by pressuring public officials. It is significant—and telling—that ICE did not have a substantial lobbying presence in Washington, as Sprecher and his subordinates undoubtedly “kept to the knitting,” being good at it, and thus they did well in profiting from gaps in the market and the related regulatory changes.

Sources:

Ben Protess and Nathaniel Popper, “Exchange Sale Reflects New Realities of Trading,” The New York Times, December 21, 2012.

Floyd Norris, “A Temple of Commerce that Failedto Keep Up with Change,” The New York Times, December 21, 2012.

Michael J.de la Merced, “At the Big Board, Seeking Rejuvenation in Consolidation,” The New York Times, December 21, 2012.

Strategic Thinking beyond the Business Plan

“When smart people came up with ideas for well-conceived business opportunities, we said go for it. As always, organizational charts, management consultants, and business plans played virtually no role in any of this. My own strategic thinking I did mostly while showering or shaving.”

—Alan C. Greenberg, former Chairman and CEO of Bear Stearns

Similarly, when I write an essay, I inevitably pass on first constructing a formal outline and go instead off of what I have worked out in ratiocinating while exercising, in transit, or showering. Freeing the mind up to search for and try out connections between ideas, and working a theory over and over—like kneeding dough or forming a clay pot on a wheel—are inconsistent with too much structure.

The human mind needs its own space to solve abstract or applied problems needing considerable thought. Subjecting the processes of theory-construction and problem-solving (“critical thinking”) to too much structure is simply not in line with the nature of the mind itself. Human reasoning, it turns out, is not a linear process that necessarily fits within the confines of a business plan or consulting diagnostic tool. Particularly if creativity and innovation are to be encouraged, mechanistic structure must succumb to organic process.

For example, I did a consulting project as part of an organizational design senior seminar that I took in college. The professor had developed a structured organizational audit—a diagnostic tool geared to detecting discrepancies between an organization chart and actual communication. As he had developed the instrument, we were naturally to rely on it in making our recommendations to the clients. I used the tool on a computer retail store and proffered recommendations from it. Because the business was family-owned and operated, I could see that the communications were in part a function of the family dynamics, which the professor’s organizational audit failed to pick up. So I asked some additional questions and made some supplemental recommendations, which the business owner/manager found quite useful—unlike those that came from the audit.

Even though the professor graded me lower for adding the recommendations, the client went so far as to call him to urge that an A be given to me for the project. From what the client told me later, the professor was perhaps too attached to his “organizational audit” tool (which he used in his own consulting practice). My orientation as a novice consultant was neither to my grade nor to the tool; rather, I wanted to help the owner/manager by proffering him insight that he could use to solve his problem. Although I cannot be sure at this point, I might have come up with my final recommendation to him on the way to a class, during a run, or even while shaving.

So I can totally understand Alan Greenberg’s aversion to organization charts, business plans and “professional” consultants. A true consultant comes from a perspective of expertise that clients do not have. For example, a consultant could be an academic or a nearly-retired practioner. In either case, the advice should be viewed as supplemental to the client’s focal situs “on the ground”—that is, consulting advice is something for a client to digest and possibly integrate with his or her larger considerations outside the range of the consultant.

Being geared to helping a client, a consultant should be able to let go of his or her “black bag” if the tools therein fall short in diagnosing the organizational dysfunction, or “illness.” I suspect that one's “gut” can come into play, effectively transcending the mechanistic tools, only if the consultant cares, because only then is he or she intrinsically oriented to the client’s situation rather than the consultant’s own bag of tricks as ends in themselves. In the end, consulting is interpersonal—helping others who are suffering from a problem. Such problems typically involving human beings, it should be no surprise if a consultant should approach them from more than one level.

Therefore, both strategic and consulting thinking ought to be accommodated in the sense of giving them some organic free range. Treating business plans, organizational charts, and diagnostic tools as ends in themselves, as if they were rational beings (i.e., Kant's kingdom of ends), is ultimately self-defeating, if not suffocating. Just as managing can sometimes be informed by simply wandering around, so too the strategic mind needs some room to roam.  

Source:

Alan C. Greenberg, The Rise and Fall of Bear Stearns (NY: Simon & Schuster, 2010)

Occupying Wall Street: A Self-Regulated Protest?

The right to protest as a manifestation of freedom of speech is held societally as sacred the United States, but the question of how far protest goes before it becomes simply living in a park is one of those gray areas that tend to be decided by the judiciary far from the tarps and sleeping bags. The protesters’ premise that living in a public space eventuates in the achievement of their goals is tenuous where the goals are broad. Undergoing a hunger strike to get a certain anti-corruption bill voted on by India’s parliament is far different than camping out in Zuccotti Park in New York City until corporate capitalism is ended in the U.S. In short, the tactics used should be oriented to the sort of objective being sought. Moreover, the tactics and indeed the objectives themselves require a protest group to self-police such that it does not wander too far off course or spread itself too thin. Protest movements may be too prone to die a slow death from self-inflicted wounds without even the slightest recognition of the cause of death. The Occupy Wall Street protest movement had the capacity to self-regulate, but fell well short of that which was necessary for the group to achieve its anti-corporate goals.

To be sure, the movement evinced some capacity to regulate itself. Faced with the prospect of an imminent clean-up of Zuccotti Park—perhaps a salubrious subterfuge actually geared to permanently dislodging the park’s new residents—some of the protesters scurried around “with brooms and trash bags, moving mountains of sleeping bags, backpacks and jackets out of the way,” according to The New York Times. Meanwhile, others gardened. These tasks doubtlessly tapped into the young protesters’ ideal of working toward something larger than themselves, which they tend to label as “community.”  The impetus on the upkeep was geared to forestalling the park’s owner, Brookfield Properties, from clearing the park a third at a time for a “once-over” by a clean-up crew, after which new rules proscribing camping, tents, tarps and sleeping bags would be enforced. But was it even in the group’s interest to allow camping to become a major issue? Secondly, could the energy of self-regulation have been put to better uses than clean up, given the group’s anti-corporate goals?

Taking the first question first, it should be obvious that occupying a park is not occupying Wall Street. If the protesters were serious on their occupation, they would have sat own in streets in New York’s financial district and blockaded the bank entrances with sit-downs—perhaps even occupying bank lobbies akin to the anti-war protest at Columbia University in 1968. This “actual occupation” strategy would have been more likely to involve the police, but the occupation would have been real—at least for a time. This strategy is distinct from protest marches, which as a strategy could have been an alternative or addition to that of actual occupation of the streets and banks. Allowing the issue to be whether camping takes place in a park can thus be seen as a diversion that is not in the protester’s own interest. Indeed, getting sick by living in a crowded park night after night would also enervate the protest (besides justify the public authorities in clearing the park for public health reasons).

Regarding the second question, the self-regulation evinced by the protesters cleaning up on their own volition can be read as supporting the argument that the protest movement could have policed itself regarding delimiting its topic and presenting a positive image for public relations purposes. Protesters could have volunteered, for example, to make the rounds to eliminate any off-topic signs, such as those for the environment and against the war in Afghanistan. Allowing the protest to be a virtual grab-bag of leftist causes deprived the movement of broader support and gave the opposition ammunition with which to relegate the movement. Even in shifting from an anti-big-corporation message to redistribution undercuts the group’s original anti-corporate (but not necessarily redistributive) goals.

Butting up against the movement’s own efforts to regulate itself was the ideology or illusion that the movement had no leaders. “Every action you see here is autonomous,” one protester said as he was filling plastic bags with trash. “Autonomous enough for people not to be doing it,” another protester added, as reported by The New York Times. That protester went on to describe his “autonomous plan” as if that label itself, and his belief in it, rather than a single-minded aim of ridding American society of large corporations were the main point of him being there.

In other words, the protesters themselves suffered from a lack of priorities and this hurt the attainment of their original anti-corporate goals. Even though the voluntary clean-up effort demonstrates that the movement was capable of self-regulation to delimit and protect the priority of its original, anti-corporate goals, the refusal to delimit the topics (based on the illusion that there were no leaders) and keep the distracting ideologies at bay undercut the group’s self-regulatory potential and ultimately the group’s realization of its anti-corporate goals. Indeed, their lip-service to the contrary, many of the protesters may not have been sufficiently interested in those goals in the first place.

In a letter to the local police commissioner, the chief executive of the property company that owns Zuccotti Park reported that there had been neighborhood complaints of “lewdness, groping, drinking and drug use.” Without self-policing such behavior, the movement risked undercutting its own legitimacy in the eyes of the wider public. Without legitimacy, the movement would face an uphill battle even to be heard. Furthermore, the behavior could be viewed as having an opportunity cost—that of the foregone focus on how to achieve the anti-corporate aims of the movement. Actions speak louder than words; from my vantage-point, it seems that the protesters could have been more devoted to the cause that presumably brought them to Zuccotti Park.

So while it might be fun for young people to relish their “autonomous plans,” get high and camp out with other like-minded people in the zest of life, the refusal of the group to self-regulate itself may have been the seed of the group’s eventual dissolution without the movement having attained its goals—whatever those happened to be. It is an interesting question whether an aggregate of "autonomous plans" can regulate a movement without even a leader as a spokesperson. But why risk "the cause" to find out?

Every group must necessarily have leaders. Whether centralized or decentralized, leadership is part of any organization. Whether accountable or stealth, leadership is there, and whether as spokespersons or committees, leadership is also there. To eschew mechanisms like majority rule and group decision-making so that every person can feel fully autonomous is not only antithetical to there even being a group, it is also at odds with the realization of the movement’s goals, which presumably are necessary means to the greater autonomy being sought outside of a city park.

In short, the protesters undercut themselves from the get-go by wanting too much both ways. They refused to self-regulate their ideology. They would hate reading this, but I suspect that a crucial error of the movement early-on was to give young people too great a role in, yes, running it. Even forestalling necessary decision-making at the group level constitutes a default-decision. In a way, to eschew any leadership at all evinces a puerile or jejune mentality of stubbornness at the expense of one's goal of reducing the impediments to greater economic liberty. This mentality may also have manifested in the failure of the young in the movement to defer to more seasoned leaders. We can do it better ourselves this time and we want it both ways. We don't want ANY limitations. To this mentality, I echo Burl Ives as the snowman narrator of Rudolf the Red-Nosed Reindeer, where he shakes his white head of snow, smiles, and says almost fatalistically, Ah, youth.

In Homer's story of the Trojan War, Achilles' youthful exuberance defers quite uncomfortably to the experience of King Agamemnon; a war led solely by youthful passion would be a mere series of battles. In Lawrence of Arabia, Alec Guinness as King Faisal tells Peter O'Toole as Lawrence to leave the room so the British and Arab leaders can negotiate on Damascus. Some things must be left to old men, the king teaches the youthful warrior with a credible tone of fatalism at the expense of volition. Successful youth are mature and humble enough to know they can't do it all themselves. Successful leaders can then tap into youthful passion and direct it strategically.

Had the Occupy Wall Street movement self-regulated itself beyond cleaning up the park, the group could have enforced and sustained sufficient focus (and thus energy) on the original anti-corporation goals, wherein corporations no longer own Congress and the largest banks and corporations are broken up because of their systemic risk to the financial system, the economy, and representative democracy. The opportunity cost in broadening the movement is sad, particularly as theTea Party could have readily agreed to protest against big business and the banks. That leftist causes, even that of redistribution, were allowed to join the movement out of sheer ideological convenience and an immature refusal to admit the necessity of leadership demonstrates that the self-regulation evinced in the clean-up of the city park did not go nearly far enough for the movement's own good, and that of the republic for which we stand united for life, liberty and the pursuit of happiness.

Source:

Anemona Hartocollis, “Tidying UP, Pre-emptively, But Showdown May Loom,” The New York Times, October 14, 2011. 

See related essays: "Occupying Wall Street" and "Political Protest 101" and "Police Against Protesters: Sadism or Politics"

Did Pandora's IPO Eclipse Fiscal Gravity?

Pandora, an internet-based radio company oriented to music, sold its initial public offering at $16 per share late on June 14, 2011. The shares opened the next day at $20 and rose as high as $26, only to fall into the teens before market close. At $26, the company had a market value of $4.2 billion, more than the value of AOL at the time. Just two weeks earlier, Pandora’s management had been looking at the $7 to $9 range.  Despite offering only 9 percent of its shares to the public, the company raised twice as much money as it had expected.

Astonishingly, Pandora had not made a profit in its 11 year history. On June 15^th  when the share price was over $20,  Pandora’s CEO, Joe Kennedy, refused to say whether the company would make a profit in the next five years. Instead, he pointed to the operating margin and cash flow, and to the business model, as reasons to invest long-term in the company. "Our focus has always been to build a great company. That’s our dream, that’s our passion, that’s our focus," he said, according to CNBC. It can be asked whether investors were engaging in irrational exuberance or on the rational expectation that it can take time for a company to begin showing profits.  

With all the attention typically paid to quarterly earnings, it is refreshing to hear a CEO stress the long-term nature of investing in his company. It would be nice if Pandora’s owners also had had a passion in Pandora as a going concern pushing along the technological wave by providing music tailored to individual listeners’ tastes. Such long-term investment would have bode well for corporate governance as owners take more of an interest in holding their management accountable through directors and stockholder referendums.

At the same time, Pandora’s reliance on advertising revenue even as an increasing proportion of use on smart phones may suggest a flawed business model. For internet companies in general (as well as bloggers!), it is difficult to turn non-paying users into subscribers. At the time of its IPO, Pandora had 94 million registered users, most of which were non-paying customers. "The excitement for Pandora is driven by people's usage of the service and the enjoyment of the service," said Richard Greenfield, an analyst with BTIG Research. "But in order to justify a high valuation, they need to get far more advertising, and they need to get more people paying for the service." But this can be difficult in a marketplace where users can simply switch to a free service. While a nice set-up for us users, I’m not sure the business model is viable, given how much internet advertisers pay for clicks of their ads (which in turn is a reflection of users being able to ignore ads).

My understanding is that the phenomenon wherein a very high proportion of customers can use a product for free is pretty much limited to the internet. Tangentially, free wifi at coffee shops and even some restaurants (e.g., McDonalds) has given rise to customers “camping out” for hours to use the free service long after finishing their drink.  Incidentally, as I write this essay, I’m using Starbucks’ wifi long after my ice tea and slice of coffee cake. I’m watching the 100-minute full lunar eclipse live (just showed the video feed to the store’s manager and another customer—both of whom are amazed) as I contemplate Pandora’s business plan relative to fiscal gravity here on earth. It is just such amazement at the marvels of technology that a long-term investor in a company like Pandora can have while participating in the innovation; but lest we lose too much perspective, it is well to observe that a business model is trite, artificial and even profane next to the translucent liminality of the eclipsed rock otherwise known as our moon.

If Pandora’s advertising revenue is not sufficient to pay for the rights to the music the station plays, then not being allowed by the market to charge most users can mean eventual financial ruin for the company, especially given the extent of the competition facing the company. According to Msnbc.com, “Pandora is going up against traditional radio companies, satellite radio provider Sirius XM, music services such as Rhapsody, not to mention services from Apple, Google and Amazon that allow users to access music from anywhere.” The internet platform itself can mean not only relatively low advertising rates, but also low barriers to entry for future competitors.

According to The New York Times, Pandora had just 3 percent of the market at the time of the company’s IPO and had lost $92 million cumulatively since it began. In 2010, revenue of $137.8 million was more than double from the previous year, but the company’s 2010 loss was at $1.8 million. Most significantly, the company had never earned a profit and yet investors were rushing to invest in the company’s IPO. "I think it's heavily overvalued," Anupam Palit, an analyst with GreenCrest Capital, said according to Msnbc.com. "It's a great company but what we're seeing right now is incredible investor demand for Internet IPOs and a lot of dollars chasing very little supply." In rushing to invest, investors may have been ignoring a fundamentally flawed business model—in effect defying fiscal gravity.

An unsustainable imbalance between relying on on-line advertising revenue rather than subscribers and having to pay labels substantial fees for content mean that Pandora may never earn a profit. According to The New York Times, “the fees [Pandora] pays to record labels for songs remain its largest expense. The cost to acquire content more than doubled last year to $69.4 million. ‘As the volume of music we stream to listeners increases, our content acquisition expense will also increase, regardless of whether we are able to generate more revenue,’ the company warned.” According to The Wall Street Journal, “The company faces hefty payments to music labels and publishers, similar to traditional radio companies, and has yet to offset such expenses with advertising revenues and user fees.” It would seem that the labels and publishers were not making a sufficient allowance for the discounted nature of internet-advertising revenue relative to that of brick-and-mortar radio stations.

I would be remiss if this business analysis did not place Pandora in historical context. In the closing years of the twentieth century and during the first decade of the twenty-first century, managers of “dot.coms” grasped at how to monetize the internet wherein the norm was free content. That norm had such gravitas and the internet itself was so new that business practitioners had trouble simply grasping how to get a handle on the platform. Indeed, the internet itself was changing—prodded along by the likes of companies such as The New York Times that led the way to confining their internet-users to a subscription-basis. At the time, no one knew whether the momentum would shift to this basis across the internet; no one knew whether the free access to stuff on the internet would continue unabated or suffer a decline.

Theoretically, a movement toward “subscription-only” access could pass a threshold-point beyond which businesses (and bloggers) could discount the impact of alternative free vendors and the monetization trend would be irreversible. The more traditional, more financially-solid business model could then be applied by internet companies. By the end of the first decade of the twenty-first century, internet-company managers could not even be sure that such a threshold would be crossed. At the same time, relying on advertising revenue seemed to be an insufficient basis for sustained profitability.

In other words, the uncertainty in the air at the time of Pandora’s IPO was not limited to the company. Fundamentally, the world was still grappling with how to make money using a completely new platform. It takes years for such novelty to be understood and thus ably used, even if in hindsight it seems simple. The human mind is indeed quite finite, particularly as it struggles to make sense of a new environment.

 Those people willing to invest in Pandora in its IPO on the ides of June 2011 were indeed taking a risk, and the CEO was correct to stress the long-term (which is the best perspective for stock-ownership anyway). Unless or until the monetization threshold point is hit on the internet as a whole, Pandora’s management (and investors) ought to have been taking seriously the possibility that the company’s business model was not in balance. Content should be in balance with ad revenue, and negotiating with labels and publishers ought to reflect such a balance as even the suppliers cannot earn money from defunct distributors such as Pandora. A viable business model is indeed possible for internet companies before the threshold point unless they face an overwhelming amount of free-content by competitors and ad revenue is tiny (e.g., blogging). The question at the time of Pandora's IPO was whether the company would go down this route or be able to adjust its business model even without the internet itself reaching a monetization threshold-point. 

Sources:

Margo D. Beller, “Pandora Soars, Then Falls in Market Debut,” CNBC, June 15, 2011.

“Pandora Shares Surge at Their Debut,” msnbc.com, June 15, 2011.

Lynn Cowan and Don Clark, “Pandora IPO Is High Note,” The Wall Street Journal, June 15, 2011.

Evelyn M. Rusli, “Pandora Prices Its I.P.O. at $16 a Share,” The New York Times, June 15, 2011.

Hedge Fund Set to Hack Nestlé Up: A Case of Sensationalistic Over-Kill

Does the fact that an earnings-per-share figure has not meaningfully improved over, say, five years justify an overhaul pushed by a hedge-fund activist investor?  Put another way, is a steady earnings-per-share tantamount to failure? Especially for an established company, steady numbers do not evince bad performance. An airline would only foolishly fire a pilot for not climbing once having attained a cruising altitude. Maintaining such an altitude during a flight is hardly a reason to turn a plane around or set it in a radically different direction.

With 40 million shares, which amounts to about $3.5 billion, in Nestlé, Third Point hedge fund urged the company’s management in June of 2017 to “sell its stake on L’Oréal and sell off nonessential operations as part of a broad shake-up.”[1] The conglomerate’s shares had appreciated nearly 15% over the preceding 12 months—behind Unilever but better than Mondelez and Kraft Heinz. So why a shake-up? 

Dan Loeb of Third Point.  Relax, Dan, Nestle is not on a nose-dive. 

To be sure, the conglomerate structure is itself arguably too much of a strain on the extant science of management, especially in the United States given the penchant for specialization over “big-picture” management. Selling L’Oréal thus may make sense so the management can concentrate on food. It was not as if such a focus would leave corporate managers with nothing to do.

In May, Nestlé announced a joint-operation with Amazon to offer a cooking companion with recipe instructions and other help for customers. At the same time, Nestlé set to work eliminating unpopular ingredients to its Maggi line. The company had been working to remove preservatives from its ice creams. Lastly, the company announced in June that it was the lead investor in a $77 million in Freshly, a subscription meal service. Such adaption to changing consumer tastes and changes in the industry is a solid means by which an established company improves its profitability. Slogans like “a bold strategy” and a “broad shake-up” make for good press, but they do not fit with a company that has achieved cruising altitude. In other words, severing arms and legs should only be attempted in the more dire of cases, rather than as business as usual.

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[1] Michael Merced, “Third Point, a Hedge Fund, Sets Its Activist Sights on Nestlé,” The New York Times, June 26, 2017.

AT&T Buys Time Warner: An Expansive Strategy Amid Industry Uncertainty

After Comcast’s $30 billion takeover of NBCUniversal and Verizon’s acquisitions of the Huffington Post and Yahoo, AT&T agreed on October 22, 2016 to buy Time Warner for $85.4 billion. The ability to produce content and deliver it to millions of viewers “with wireless phones, broadband subscriptions and satellite TV connections was not lost on either board.[i] At the time, AT&T sold “wireless service in a saturated market, while Time Warner [was] a content company whose primary assets, networks like CNN and HBO, [faced] tougher times in a cord-cutting world.”[ii] Although AT&T’s board could be accused of empire-building, the stabilizing impact of combining wireless service and content could hardly be ignored in a business-environment so full of change and uncertainty. In other words, with the traditional television industry facing such dire threats to its revenue-structure due to the proliferation of high-tech substitutes, having the wherewithal to formulate and experiment with different distribution means and even content was at the time a fitting strategy.

Due to the internet and the smartphone, the way people paid for TV, the kinds of programming, and the devices to watch it on were “all undergoing transformational change.”[iii] Accordingly, consumer behavior was “neither settled nor predictable.”[iv] One thing was clear: the ability to avoid having to watch commercials was something that viewers prized, and this meant that the traditional television industry would very likely be transformed. “I think we’re all trying to figure this out — how technology and the consumer is going to change, and who are the winners and losers in this future,” said Walter Piecyk, who studies the telecommunications industry at the research firm BTIG. The best argument for the merger, he said, is that AT&T would be diversified in that the company would have both programming content and distribution channels, rather than just one or the other. When you face an uncertain future, diversity can be an asset. “If it turns out that in the future, content becomes more valuable than distribution, the new AT&T will have that; if the opposite happens, it’s covered there, too.”[v]

Randall Stephenson and Jeffrey Bewkes, the chairmen and chief executives of AT&T and Time Warner, argued, “the future of TV will depend on a lot of new ideas that are tested and deployed very quickly. These might include new business models for paying for shows, new ways to distribute and market that content, and new technologies and industrywide standards to make sure it all works.”[vi] Analysts, however, said a lot of these potential products and services could be created from licensing deals. A merger might actually slow down industrywide collaborations, they argued, because it sets up a new giant that others in the industry may not want to work with. “This appears to be about empire sustenance rather than economic efficiency,” said Brian Wieser, an analyst at the Pivotal Research Group.

Expanding a business empire is never without its ethical challenges, not to mention the possible economic hit on market-competition. In the case of the media, a lot of power in a few hands also presents political risks to democracy, especially when the electorate relies on the media for information concerning candidates and policy. In the case of the United States, where the First Amendment of the federal constitution protects media, giving such license to a few rather than many can result in distortions within the democracy. Not only could the few who control the "public airwaves" (an antiquated expression) influence elections and public policy; interlocking corporate board memberships could make it easy for the few private companies that control the media to act in the interest of corporations in other sectors at the expense of the public good. Rather than taking on these "macro" issues here, I want to suggest how the combined merger in this case can be optimized from a business standpoint. 

Moving to the company-level, a possible conflict of interest is involved in this particular merger. Specifically, would AT&T give priority in its distribution channels to its own content from Time Warner? Also, would AT&T restrict Time Warner’s content to the company’s distribution channels? It would not make sense economically “for Time Warner to offer most of its content exclusively to AT&T’s customers. Not only would that destroy its profitability (Comcast’s customers pay a lot for CNN and HBO, so why would Time Warner want to kill that business?), but it would also be out of step with the future. The notion of content tied to specific distribution lines is exactly what consumers [were] moving away from when they [chose] services like Netflix over cable bundles.”[vii] Clearly, maximizing both the types of distribution and the content would be in the combined company’s best interest, especially considering the tremendous uncertainty playing out in the industry after decades of traditional radio and television. 

So in this case, enlightened self-interest can obviate the conflict of interest that is inherent in having content and distribution channels that show others' content as well. Having the wherewithal to put large sums of money into research and development in new means of distribution and how they would impact the type of content is perhaps the foremost strategic advantage in the merger. With the industry changing so much and so quickly, at least as of the time of the merger, being and staying on the forefront both technologically and in terms of content is a prime advantage of this gigantic merger. 

The strategic standpoint at the company- and industry-level is of course not the whole story, particularly as the industry includes the media, which is very important especially in a large republic such as the United States. Weighing the strategic benefit to the firm and industry from the merger against possible costs including not only political ones, but also economic as well (i.e., diminished competition) is especially difficult because different levels are involved (i.e., society, industry, and company), and analysts reside at these various levels. A CEO talking about the case with a U.S. Senator, for instance, will face the problem of talking from one level to another (i.e., company to societal). Ideally, societal actors can work to create and sustain competitive industries and a free and open media, while CEOs still have enough space to situate their respective firms as best as possible strategically. The present case is interesting because the merger has the potential to facilitate the transformation of how content is delivered due to the combined financial wherewithal even as there are major ethical, economic, and political risks or downsides.

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[i] Michael J. de la Merced, “AT&T Pledges $85 Billion To Acquire Time Warner,” The New York Times, October 23, 2016.

[ii] Farhad Manjoo, “AT&T-Time Warner Deal Is a Strike in the Dark,” The New York Times, October 24, 2016.

[iii] Ibid.

[iv] Ibid.

[v] Ibid.

[vi] Ibid.

[vii] Ibid.