A trade group that represents 850 small cable companies across the United States argues that AT&T's purchase of DirecTV and the Comcast/Time Warner Cable merger will contribute to higher programming costs, causing some of these small cable TV and Internet providers to drop programming or simply go out of business.

AT&T, which has 16.5 million broadband subscribers and 5.9 million pay TV customers, says it needs to buy DirecTV because it isn't big enough to negotiate favorable programming rates or compete effectively against large cable operators. Yet AT&T is a giant compared to small ISPs. The American Cable Association's (ACA) smallest members have fewer than 100 subscribers, and its biggest has more than a million, while about 700 of its members have 5,000 subscribers or less each. In total, the 850 independent providers in the group serve "nearly 7 million consumers in all 50 states," the ACA says.

Some of those would be at greater risk because the largest TV and broadband providers are set to get even bigger by merging with each other, ACA Senior VP of Government Affairs Ross Lieberman argued in testimony before the House Subcommittee on Regulatory Reform, Commercial and Antitrust Law today.

In particular, higher programming costs could drive some small operators out of business, Lieberman said. DirecTV owns or manages the Root Sports networks in Pittsburgh, Denver, and Washington state. At least 120 small cable companies carry one or more of these networks. DirecTV also "has interests in some national programming networks, including the MLB Network and the Game Show Network," Lieberman said. "Most small and medium-sized cable operators purchase some DirecTV-affiliated programming."

FCC found incentives to over-charge rivals

The ACA is concerned about "the combination of AT&T’s distribution assets with DirecTV’s distribution assets because it will incentivize DirecTV-affiliated programmers to charge higher rates to the merged firm’s rivals above and beyond existing incentives," Lieberman continued. In previous reviews, "the FCC found that companies that own programming have an incentive to disadvantage their rivals in the sale of their affiliated programming in proportion to their per-video-subscriber profits. In other words, if the profit margin per video subscriber of a vertically integrated MVPD [multichannel video programming distributor] rises, so does its incentive to harm its rivals by either withholding its programming permanently or temporarily during negotiation impasses, or simply by forcing them to pay higher prices for this programming."

According to the ACA, "small and medium-sized cable operators closed a total of 1,078 small and rural cable systems" that served a total of 50,000 subscribers between 2008 and 2013.

"After these systems closed, consumers in these rural areas saw a reduction in competition as their only choices for video service became DirecTV and Dish Network," Lieberman said. "Given the rise in programming costs, we are likely to see even more system closings in the coming years. Moreover, we’re also likely to see more small cable systems controlling costs by dropping programming, particularly independent programming."

Lieberman urged Congress and the FCC to "examine and find ways to address programmers’ discriminatory pricing practices, which are some of the biggest threats facing smaller operators and will grow more troublesome if the Comcast/TWC/Charter and AT&T/DirecTV deals are approved."

Today's hearing was about AT&T and DirecTV, but US Rep. John Conyers, Jr. (D-MI) noted that Comcast is also trying to buy Time Warner Cable and that Sprint may announce a deal to buy T-Mobile. "Where does this end?" he asked, referring to industry consolidation.

The size of AT&T and DirecTV "could raise content prices for smaller video providers, potentially driving some of them out of business," Conyers said. Comcast and Time Warner Cable also each own programming. For example, Comcast owns NBCUniversal and Time Warner Cable owns two regional sports networks in Los Angeles.

DirecTV CEO: Small cable companies are still tough negotiators

When asked if programming costs would go up for small ISPs after the merger, DirecTV CEO Michael White argued that "in a local market they [small ISPs] are very, very powerful in terms of their coverage, and they negotiate very tough. I don't expect them to want to see their prices increase any higher than they already are."

When Sen. Herb Kohl (D-WI) asked Comcast at a previous hearing whether it would raise its rivals' costs for NBC programming after buying Time Warner Cable, Comcast CEO Brian Roberts responded that "There are robust distributors—DirecTV, Dish Network, Time Warner, Ms. [Colleen] Abdoulah's company [telecom provider WideOpenWest, or WOW]—all negotiating with other programmers. There is a very defined marketplace and a third party to adjudicate whether somebody is playing games." The possibility of overcharging "would not be available... and that is not the intention," he said.

Yet programming costs are so high that even AT&T says it's too small to get a better deal, making it necessary to buy DirecTV.

"Today, 60 cents of every video dollar we earn goes straight to programmers, before we spend a penny to market our service, install a set-top box, send a bill, or answer a customer’s call," AT&T CEO Randall Stephenson told members of Congress. "As a result, our video product is, on its own, unprofitable. More than 97 percent of our video customers purchase video along with another AT&T product… The addition of a profitable video product to AT&T’s portfolio is a game-changer in the economics of deploying broadband. This transaction will allow us to lower content costs for AT&T video subscribers by 20 percent or more, and we project total cost synergies to exceed $1.6 billion annually within three years after closing."

If a company with $128.8 billion in annual revenue such as AT&T can't strike a better deal for programming, how can companies with just hundreds of subscribers compete? Groups like the National Cable Television Cooperative negotiate on behalf of small cable operators, but small operators still pay higher rates than the big companies, the ACA said.

Lieberman argued that regulators should impose a condition on the AT&T/DirecTV merger that prevents programmers "from disadvantaging the merged firm’s rivals in the prices it charges."

"Up until recently, rival MVPDs that reached an impasse in their negotiations with DirecTV for its RSNs [regional sports networks] had a right to take DirecTV to arbitration pursuant to a voluntary commitment with the FCC agreed to by DirecTV when Liberty Media acquired DirecTV," he said. "However, this condition, which was in place for more than six years, expired on February 27, 2014." Lieberman wants stronger rules than the previous one, because arbitration is too expensive and difficult for many small cable companies, he said.

AT&T’s broadband promises

Stephenson argued that the acquisition will increase competition because AT&T promises it will use its improved financial position to bring fixed wireless service to 13 million more Americans and fiber-to-the-home to two million more Americans.

The promise of fiber seems to be enough to sway Rep. Hank Johnson (D-GA), though AT&T has so far only said that it would consider building in his home district of Atlanta. "Deploying an all-fiber network in Atlanta would immeasurably benefit many existing local startups, as well as untold entrepreneurs, app developers, and other innovators still emerging," Johnson said. "As a former county commissioner who understands the power of big ideas, I stand ready to work with both AT&T and local government to make this happen."

Rural areas will get the wireless broadband product, which is expected to "perform as well as wireline broadband services advertised today at 15-20 Mbps," Stephenson said. "Rural customers will be able to purchase this new broadband service, DirecTV, and IP telephone service with advanced features and larger calling areas as an integrated package or, if they prefer, on a standalone basis. This is big news for rural America. We estimate that nearly 20 percent of these rural consumers today have no access to a high-speed wireline broadband service and that another 27 percent are hostage to only one provider."

Stephenson argued that AT&T and DirecTV "do not compete at all" in the vast majority of the US.

It's true that the companies don't compete for broadband customers, because DirecTV doesn't offer Internet service. But they do compete for TV customers in the areas where AT&T offers TV service, Senior Staff Attorney John Bergmayer of consumer advocacy group Public Knowledge said.

"AT&T, a pay TV company, wants to remove DirecTV, another pay TV company, from the marketplace. This is a classic horizontal merger, and it would harm consumers," Bergmayer said. "By reducing the number of pay TV competitors in each market where AT&T currently offers video service, this proposed merger would reduce consumer choice and violate the law. Free Press’ Derek Turner has noted, in 64 local TV markets, the level of market concentration would exceed the Department of Justice’s merger guidelines. This concentration would harm consumers in numerous ways. Less competition would lead to higher prices, worse service, and reduced access to diverse content. Even AT&T admits that this merger could exert upward pressure on 'the prices of standalone video or broadband,' suggesting only that this could be offset by cheaper bundles (though it is not committing to offering cheaper bundles)."

AT&T has said the merger would put "significant downward pressure on the prices of the new integrated bundles of AT&T broadband and DirecTV video," but it hasn't said whether prices would be lower than previous bundles.

Stephenson further argued today that AT&T buying DirecTV "will put downward pricing pressure on all cable products—cable bundles, cable video, and cable broadband."