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Blockbuster vs. the FTC (Keeping Future Competition Safe?)

Mises Daily: Wednesday, June 30, 2010 by

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Five years ago, Federal Trade Commission staff lawyers threw a public temper tantrum, kicking and screaming until video store chain Blockbuster, Inc., abandoned its plans to purchase rival Hollywood Video. The FTC ran to a federal judge and complained that Blockbuster failed to provide enough information about the company's internal operations — in a merger "review," all a company's documents can be seized by FTC agents, as the Fourth Amendment magically disappears — and the agency needed more time to decide whether the proposed Blockbuster-Hollywood combination violated the antitrust laws. Blockbuster capitulated on that issue and ultimately abandoned the merger.

The FTC claimed victory on behalf of consumers — after all, if Blockbuster had purchased its top rival, it would have enjoyed "monopoly power" in the video-rental market and been able to raise prices and reduce services at will. Only strong antitrust regulation can protect competition in such vital markets. At least that's what the FTC said.

In defining a market as narrow as video-rental stores, the FTC excluded online rental services like Netflix and even larger retailers like Walmart. Antitrust requires static markets with a few easily identified competitors. Complexity is too messy for mediocre talents like government attorneys to manage. By defining the market as, say, three firms and only three firms, the regulators can apply simple mathematical tricks to prove the existence of "monopoly power," even if the true marketplace is heterogeneous and incapable of such rigid analysis.

It also helps when the third firm actively lobbies for regulatory intervention. In the Blockbuster-Hollywood case, Movie Gallery, Inc., colluded with the FTC to stop the merger. Not coincidentally, Movie Gallery ended up buying Hollywood itself — with the FTC's blessing — for a lower purchase price then Hollywood previously accepted from Blockbuster. It was a win-win scenario: Movie Gallery acquired a competitor for a below-market price and the FTC protected competition.

Then reality set in. Even in 2005, the video-rental store business was dying. Adam Thierer, president of the Progress & Freedom Foundation, noted in August 2005 that the signs of collapse were everywhere:

I warned that efforts by the Federal Trade Commission (FTC) to block the proposed acquisition of video rental firm Hollywood Video by Blockbuster Inc. would likely lead to the demise of both companies in the long run. Well, excuse me while I toot my own horn for a moment, but it appears that I was likely right, and sooner than I expected.

Joe Flint and Kate Kelly report in today's Wall Street Journal ("New Signs of Strain for Blockbuster" p. B5) that "Blockbuster Inc. is facing new pressures as signs increase that a sharp decline in the video-rental market is putting a strain on the company's finances." The company's stock prices fell by 9.7% on Friday, hitting a 52-week low of $4.60 per share. This came on news that Movie Gallery Inc., the industry's #2 firm, was reporting that sales at many of its stores were expected to drop by 8-10% this quarter.

What's happening is clear: technological and market evolution are finally catching up with this old business and is about to wipe it from the face of the Earth. With all the new sources of competition out there — Netflix and cheap DVDs at WalMart, online movie download services, cable and satellite movie channels plus video-on-demand, telco entry into the video business, all sorts of handheld mobile media gadgets like the PlayStation Portable, and so on — it's no wonder that Blockbuster and others in this sector are struggling.

Fast forward to 2010. In May, Movie Gallery failed to win approval for a bankruptcy reorganization plan, forcing the closure and liquidation of all Movie Gallery and Hollywood video stores. Alas, Movie Gallery's political ties to the FTC proved useless in actual market competition.

Blockbuster isn't faring much better, at least in terms of video stores. On June 11, the Wall Street Journal reported the company is on the verge of bankruptcy itself, seeking private investors to bail out Blockbuster's $900 million in debt. Blockbuster is shedding retail stores worldwide and shifting towards online rentals and standalone rental kiosks.

The Antitrust Quantum Leap

Adam Thierer said in 2005 that he hoped the FTC's inane meddling in the dying video-store market would be "a cautionary tale for future antitrust analysis of high-technology and media markets." Sadly, it wasn't. The FTC loves dying industries — witness FTC Chairman Jon Leibowitz's ongoing crusade to save traditional newspapers through a host of new government subsidies.

The flaw is not in the individual decision makers but in the regulatory model. Antitrust requires constantly looking over one's shoulder to the immediate past. In treating competition as a measurable, almost tangible item, the FTC must start from some baseline; and that's usually the point in time when the FTC suddenly takes an interest in the market.

Consider the disturbing trend of postmerger cases. While most antitrust intervention occurs before a merger takes place — and as Blockbuster demonstrated, most companies run away at the sight of FTC lawyers — there's no legal prohibition on undoing a completed merger, irrespective of how much time has elapsed.

In February 2001, Chicago Bridge & Iron (CB&I) acquired two divisions of Pitt-Des Moines, Inc. (PDM). PDM was selling assets in an attempt to raise its stock price. CB&I and PDM competed in the sale of certain types of chemical storage tanks. The deal closed even while the FTC continued its review.

Eight months after the merger closed, the FTC claimed it illegally reduced competition in four "markets" for specific types of storage tanks. CB&I was unwilling to undo a completed transaction, so the FTC litigated — for the next seven years. CB&I lost at every stage: before the commission-appointed administrative-law judge, before the FTC itself, and finally before a federal appellate court. In November 2008, CB&I sold the former PDM assets to an FTC-approved buyer.

During the lengthy appeals process, CB&I complained the FTC ignored evidence of changes to the marketplace after the 2001 merger. Indeed, the initial decision in the case ignored all such evidence and relied on the FTC's speculation about how the market would progress absent government intervention. The FTC's final decision made some allowance for postmerger evidence, but ultimately the commission said the market was not moving quickly enough to restore the competition "lost" by the merger. Throughout seven years of litigation, the FTC remained fixated on the market as it existed in February 2001. It's as if FTC lawyers see themselves as time travelers leaping from market to market in an effort to "put right what once went wrong."

The Hidden Costs

Merger "review" may be the most illogical form of government intervention ever conceived. It's predicated on the notion that lawyers with no experience in the marketplace can correctly guess the exact right level of "competition" the market needs today, tomorrow, and indefinitely into the future.

Ignorant quasi-central planning doesn't come cheap, either. In the current fiscal year, the FTC spent over $106 million on "actions against anticompetitive mergers and practices." The FTC requested an additional $8 million-plus for next year. This pays for nearly 500 full-time staff, the bulk of whom "review" mergers. Yet for all that spending, the FTC only challenged 19 mergers in the last fiscal year (and 11 in the current fiscal year, which ends in September).

In fact, only 1.3% of the mergers reported to the FTC in fiscal year 2008 resulted in any type of formal investigation. Yet over 1,700 transactions still required formal premerger notifications, which entail thousands of billable hours for antitrust attorneys. And even unreported transactions may be subject to FTC scrutiny. So every company needs some sort of antitrust counsel to protect them from the threat of investigation.

As Blockbuster and CB&I's plights demonstrate, there's not much recourse if the FTC decides to target you. The FTC doesn't respond to logic or economic principles. It doesn't matter that one can't predict the future of a given business, much less an entire industry; there's a bureaucracy to feed.