Understanding Vertical Integrations in the context of the Entertainment Industry
Introduction
Vertical integration is defined as “the merger in one business of two or more phases of production that are traditionally handled by distinct companies.” Vertical integration in the entertainment business means that the major studios dominate the film production, distribution, and exhibition. Entertainment industry players produce, distribute, and market their content, and even own the theaters where they saw the exhibition was the most profitable segment of the film industry. Before television and VCRs, box-office sales were the primary source of revenue for recouping film production costs. The CEOs of the big studios wanted to ensure that their product had a consistent outlet, which led to a series of actions meant to control the business. Today. OTT have become a much better alternative than these traditional platforms since production houses tend to release their works on thse platforms rather than theaters to recoup their costs.
Each studio appears to have a similar vertical integration structure, for example, the 20th Century Fox produces and distributes their television series and movies and licenses them on their affiliated network, Fox Broadcasting Channel and its numerous basic cable channels: FX, FXM, and FXX, as well as online platforms Fox.com, FX.com, and so on. Viacom owns Paramount Pictures as well as other well-known television networks, including BET, CMT, MTV, Nickelodeon, and VH1. Time Warner owns Warner Brothers, HBO, Turner, and The CW, while recent examples of vertical integration include Lionsgate’s acquisition of Starz and Universal’s acquisition of Dreamworks Animation.
Some other forms of vertical integration in the entertainment sector are Epix and Hulu, both of which are partially owned by numerous big studios, which frequently license their film and television assets to them. The Walt Disney Company is arguably the largest vertical integrator, as it owns the companies that create and produce film and television properties, which are then marketed and distributed globally by Disney, a legendary corporation which broadcasts on affiliated networks such as ABC and other channels and platforms such as ABC.com. Buena Vista Home Video, which is owned by Disney, manufactures in-house films, which are frequently transported to Disney retail locations, along with substantial kinds of other consumer products such as toys, games, and so on, and sold directly to customers.
Regarding their in-house content, OTT platforms may be considered the most recent addition or perhaps the most silent member of the vertical integration business. Netflix Originals, Prime Video Mini, and Disney Hotstar exclusives are just a few examples. Vertical integration is exemplified by Netflix, Inc. The company began as a DVD rental service before expanding into online streaming of films and movies from big studios. Then, Netflix executives realized they might increase their profit margins by creating their original material, such as the smash shows Grace & Frankie and Stranger Things. It has made several duds, such as 2016’s The Get Down, which reportedly cost the studio $120 million. Today, Netflix promotes its content alongside programs licensed by studios through its distribution model. Rather than relying solely on the content of others, Netflix used vertical integration to become more involved in the entertainment development process sooner. ESPN is a critical component of Disney’s television activities. Rather than relying on outside production businesses to deliver sports-related talk shows and movies, ESPN established its own production company. ESPN Films was founded in 2001 as a subsidiary of ESPN. Many of ESPN’s most well-known programs, like Around the Horn and Pardon the Interruption, were created by ESPN Films. ESPN can ensure a consistent flow of programs that fulfill its needs by owning its own production company. Disney has explored vertical integration by operating over 300 retail outlets selling products based on Disney characters and films. This allows Disney to profit from sales that would otherwise go to another store. When a Spiderman featured bag is sold through a Disney store, the company makes a little more money than if the same bag was sold by a retailer.
When did the concept of Vertical Integration come into existence with the entertainment industry?
The United States of America Department of Justice brought an antitrust case in 1938, alleging that eight major motion picture firms conspired to control the motion picture industry through their ownership of film distribution and exhibition. Paramount Pictures, Inc., Twentieth Century-Fox Corporation, Loew’s Incorporated (now Metro-Goldwyn-Mayer (“MGM”)), Radio-Keith-Orpheum (dissolved in 1959), Warner Brothers Pictures, Columbia Pictures Corporation, Universal Corporation, and United Artists Corporation were the eight original defendants. Following a trial, the district court determined that the defendants were part of a widespread conspiracy to illegally fix motion picture prices and control both the film distribution and movie theater markets. The Supreme Court upheld such conclusions on appeal. Following that, each of the defendants entered into a consent decree with the Department (the “Paramount Decrees”).
This case and the subsequent decisions affected the structure of the motion picture business dramatically. First, the Supreme Court order supplemented with the Paramount Decrees required segregation of film distribution and exhibition by ordering the five defendants who held movie theaters at the time to divest either their distribution business or their theaters. Following that, the orders barred the defendants from both distributing films and owning theaters without prior court clearance. Second, the Supreme Court and the decrees prohibited a variety of motion picture distribution practices, including block booking (bundling multiple films into a single theater license), circuit dealing (entering into a single license that covered all theaters in a theater circuit), resale price maintenance (setting minimum prices on movie tickets), and granting broad clearances.
Current Scenario of the Paramount Decrees
On Monday, November 20, 2019, the United States of America’s Assistant Attorney General Makan Delrahim announced an unexpected policy shift for the Justice Department’s antitrust division: the repeal of the 1948 Paramount Decree. This judgment comes in the wake of broader public worries about monopolies, following the mergers of AT&T and Time Warner, as well as Disney and 21st Century Fox. It also follows the now-constant drumbeat for the government to split up huge corporations such as Amazon, Netflix, and other big corporations. The judgment allowed movie theater companies to do more than just buy them; it would allow them to use them in unexpected ways, perhaps exacerbating industry concerns about competition and market share. The termination of the Paramount Decree comes at a time when streaming is the most popular way of viewing, while changes to the theatrical exhibition will affect all modes of consuming entertainment content.
The motion picture industry has changed dramatically since the district court issued the Paramount Decrees. None of the defendants in the Paramount case owns a considerable number of movie theaters. Furthermore, unlike seventy years ago, most urban locations now have many movie theaters. The first-run movie palaces of the 1930s and 1940s, which had one screen and showed just one movie at a time, have been replaced by multiplex cinemas, which have numerous screens and show movies from many distributors at the same time. Finally, people are no longer constrained to watching movies in theaters. New technology has given rise to a plethora of new distribution and viewing platforms that did not exist when the decrees were enacted.
Why is Vertical Integration preferred in the entertainment industry?
Vertical integration is preferred by players in the entertainment industry since it allows them to profit at every stage of the film production and distribution process without paying excessive fees to other parties. Since they control diverse sections of the production chain, they can earn profit at each stage. Rather than paying a premium at various stages of the manufacturing process. Increasing the scope of the company’s operations. The fact that the distributor’s product will cross paths with these businesses and brands permits them to thrive. Vertical integration enables businesses to minimize overhead costs, enhance manufacturing and distribution efficiencies, and eliminate third-party expenditures to lower overall expenses while reducing turnaround times to take advantage of economies of scale.
Legal aspects of vertical Integration in India
The term ‘integration’ or ‘agreement’ has been broadly defined under the Indian Competition Act 2002 (Act) to include any arrangement, understanding, or concerted action, whether formal, in writing, or intended to be enforced through legal processes (Section 2(c) of the Act). Vertical agreements are characterized as arrangements between companies that operate at different levels of the production or distribution chain. Vertical agreements, in contrast to horizontal accords, do not contain a fusion of market power. However, vertical agreements influence market competition only when the firms applying vertical restraint have a substantial degree of market dominance. Furthermore, rivalry from other firms’ products (intra-brand competition) is low in such circumstances. In contrast, if the firm imposing vertical constraint lacks significant market power or there is adequate intra-brand rivalry, the prohibition on competition between distributors and retailers selling the same brand may not affect market competition. As a result, while considering cases of vertical agreements, the aspect of market power must be carefully considered.
The provision against anti-competitive vertical agreements is found in Section 3(4) of the Act. This section states that any agreement between enterprises or individuals at different stages or levels of the production chain in different markets regarding production, supply, distribution, storage, sale or price of, or trade in goods or provision of services, including tie-in arrangements, exclusive supply agreements, exclusive distribution agreements, refusal to deal and/or resale price determination, is a violation of Section 3, sub-section 1 of the Act.
In turn, section 19(3) of the Act enunciates upon Appreciable Adverse Effect on Competition (hereafter, AAEC) by noting that the Commission shall, while determining whether an agreement has an appreciable adverse effect on competition. Vertical Integration (or Vertical Agreements as called in India and referred to as hereafter) in India are assessed by the Competition Commission of India (CCI) under the ‘rule of reason’ framework – i.e., vertical restraints are prohibited only if the CCI, upon an inquiry, concludes that they cause, or are likely to cause, an AAEC in India. The vertical agreements are not per se anti-competitive but are considered to be anti-competitive if these agreements cause or are likely to cause AAEC in India. An assessment of AAEC involves considering the net impact of certain procompetitive and anticompetitive factors. The anticompetitive harms that the CCI is required to examine are the creation of barriers to new entrants in the market; driving existing competitors out of the market, and the foreclosure of competition by hindering entry into the market
Vertical Integration in the entertainment industry from an Indian law perspective
Vertical integration is addressed in the Act’s relevant provisions through exclusive distribution and exclusive supply agreements.
Any agreement to limit, restrict, or withhold the output or supply of any goods, or to allocate any area or market for the disposal or sale of the commodities, is considered an exclusive distribution agreement. From the standpoint of the entertainment industry, entertainment entities such as OTT platforms and even production houses can retain the right to exclusively distribute the content to which they own or have purchased the rights, as seen in exclusively available content such as Netflix’s Sacred Game, Prime Video’s Mirzapur, MX Player’s Ashram, and many others. It will be interesting to see whether production companies/producers opt to sell rights to exclusive cinema hall chains like PVR or Carnival in the future by entering into a deal with them.
Any arrangement that restricts the purchaser in any way from obtaining or otherwise dealing in goods other than those of the seller or another person is considered an exclusive supply agreement. From the standpoint of the entertainment industry, entertainment content consumers have no choice but to “legally” consume content from sole-right owners such as OTT platforms or other content-right owners.
The exclusivity factor may not always be present as a contractual condition between stakeholders in the entertainment sector, and this can be shown in the way stakeholders conduct themselves. Exclusivity is a severe concern in the case of dominating firms and their suppliers because an exclusive supply agreement entered into by a dominant enterprise can suddenly lead to market foreclosure to competitors. Thus, in the presence of substantial and sufficient market power, exclusive agreements can be a source of dominance abuse.
Conclusion
The recent rise of streaming services currently benefits customers by providing high-quality material for free or at a reasonable cost. However, when these corporations’ market strength grows through vertical integration, present competition regulations may be insufficient to protect consumers from potential long-term damages such as higher pricing, decreased content quality and diversity, or erosion of data privacy.
To protect both competition and customers, it is critical to determine if streaming services engage in anticompetitive business activities. Though streaming businesses are not in violation of existing competition laws since consumers are not already harmed, they are engaging in aggressive business activities that have the potential to ill-affect consumers. The oligopolistic streaming market is characterized by high entry hurdles, predatory pricing, imperfect price discrimination, bundling, disfavoring competitors on their platforms, massive talent buyouts, and opaque use of user data. Today’s business models, in which consumers have a myriad of options for watching movies, do not necessitate monitoring of studio licensing activities concerning the exhibitors. Some would argue that technology has made the free market even more approachable and open for distributing entertainment content. Others think that the hazards and risks that led to the Paramount Consent Decrees in the United States of America like monopolization and trade restraint are prevalent in the Indian market as well, despite technological developments. Although vertical integration is not a well prevalent factor in the Indian entertainment industry due to the absence of scaling opportunities it would be interesting to see what the future holds for Indian regulatory authorities if the situation changes.
LAWBEES 