ON THE HOT SEAT

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Washington-America Online Inc. and Time Warner Inc. spent five hours last week defending their merger before the Federal Communications Commission against the likes of The Walt Disney Co., BellSouth Corp. consumer groups, Internet competitors and small cable operators.

Although FCC officials said they expect to vote on the merger by the end of October, none of them indicated that the agency was prepared to impose some of the drastic conditions Disney wants, such as splitting the company in two to separate content control from cable-system ownership.

AOL chairman and CEO Steve Case and Time Warner chairman and CEO Gerald Levin disputed every contention that the company would shut out competitors, seize control of the Internet and pocket monopoly profits at the expense of innovation and consumer choice in the now-robust Internet arena.

"People who make that claim don't understand what's happening with the Internet," Case said. "This notion that people are restricting choice is kind of silly."

Levin said the companies would allow any competing Internet-service provider onto Time Warner Cable systems and promised an affiliation pact with an unnamed third party would be announced soon.

He said Time Warner hoped to unwind its exclusive contract with Road Runner-the company's partly owned high-speed ISP, with nearly 1 million subscribers-by the end of the year.

"I am quite confident that we can make that happen faster than anyone in the industry," Levin said, although neither he nor Case could pinpoint an exact date.

The AOL-Time Warner combination would be one of the largest mergers in U.S. corporate history, an all-stock deal between the second-largest cable operator, with 12 million subscribers, and the world's largest ISP, with 23 million subscribers.

Time Warner has bellwether cable networks such as Cable News Network, Home Box Office and Cartoon Network. AOL has a near monopoly on instant-messaging users, it controls about 40 percent of the U.S. Internet-access market and it possesses an almost unbeatable inventory of content contracts for an online service that also is a gateway to the Internet.

For the FCC and the Federal Trade Commission-which is also reviewing the deal, but in a much less visible manner than the FCC-the merger involves a lot of novel issues that have come to the fore with the Internet explosion and the dawn of interactive television in just the past few years.

Opponents of the deal want to see AOL-Time Warner comply with a host of conditions designed to prevent the company from unfairly capturing customers through all sorts of business practices they deem anti-competitive.

BellSouth, among other things, wants the FCC to ensure that any programming Time Warner supplies to AOL is available on equal terms to other ISPs.

Mark Cooper, research director of the Consumer Federation of America, said he thought the merger should be blocked until AOL-Time Warner has open-access policies in place that are working.

Ross Bagully, CEO of Tribal Voice, an IM company that can't send traffic to AOL, wants regulators to break down the barriers AOL has erected.

Steven Weed, vice chairman of the American Cable Association, the small-cable-operator lobbying organization, refused to support the merger unless AOL-Time Warner agreed not to require small cable operators to deploy AOL broadband as a condition for access to Time Warner's cable networks.

At the hearing, Time Warner officials agreed to Weed's condition, and the ACA later backed the merger.

Disney's demands were by far the most elaborate. The owner of the ABC TV network, 10 TV stations, a suite of ESPN cable networks, Disney Channel and a block of Web sites tied to the company's global brand, Disney wants AOL-Time Warner split into two companies along content and distribution lines.

Short of that, Disney said it needs guarantees that its interactive-TV services won't be blocked and that any consumer can use AOL-Time Warner's broadband service without being steered to AOL-Time Warner's content through the manipulation of on-screen icons, varying return-path speeds, or navigation devices that bury Disney's content.

Disney executive vice president of government relations Preston Padden said the manifold possibilities of abuse by AOL-Time Warner represented "a deadly combination for consumer choice, and that's why we are here."

Padden said AOL-Time Warner was pursuing a walled-garden marketing strategy designed to corral customers within its Internet sphere and to not let them escape to enjoy the products of competitors.

As an example, Padden said, AOL-Time Warner could use routers and software to disable ABC Inc.'s interactive services, including enhanced advertisements that require icon selection to buy a product or to obtain more information about a product or service.

Insisting that Disney did not oppose the merger merely to gain leverage in negotiations, Padden said Disney's over-arching goal all along has been to secure equal treatment.

"We are not asking for any preferential anything," he said, adding that Disney's new retransmission-consent agreement bars ABC any access to Time Warner's broadband return path.

Time Warner president Richard Parsons challenged that claim. He said Disney's complaints were business disputes "dressed up" as public-policy concerns.

In negotiations over cable carriage of Disney networks, Parsons said Disney has insisted that if its demands were not met, Disney would "splash cold water all over [our] merger."

Time Warner officials have said Disney's willingness to use merger opposition as leverage contributed to an ugly retransmission-consent dispute, in which Time Warner Cable pulled Disney-owned ABC-station signals from cable systems in New York, Los Angeles and elsewhere for two days in May before the two sides called a truce.

Parsons called Disney's dire predictions baseless because "no one really knows how these interactive services.will roll out," and Time Warner's lone interactive-TV deal is with Wink Communications Inc., which is unaffiliated with Time Warner.

As for proposals to segment the company, Parsons said vertical integration-joint ownership of content and distribution-has caused the cable industry to blossom, has expanded consumer choice to reach beyond broadcasting and has led to a vast expansion in program diversity.

"Why would this commission want to reverse that?" Parsons asked.

In their questioning, the five FCC commissioners explored all of the hot topics, but mostly in a nonthreatening manner.

Although the IM dispute came up often, FCC chairman William Kennard kicked off the session with an appeal for an open cable Internet platform, but he said the debate should be about "means, and not ends," and it should examine whether government has to step in or rely on market forces.

"It is my belief that until we see an open-access platform in cable broadband implemented-where people can actually see, touch and feel it, and the ISP community can get confidence that they'll have access to it-there will continue to be a lot of skepticism on this issue, for good reason," Kennard said.

In response, Case said that because Time Warner Cable's systems serve 12 percent of U.S. households, AOL-Time Warner would have a powerful economic incentive in seeing that other platforms are open so that it can reach the rest of the country.

"It would be silly for us to focus on the 12 percent," Case added.

After making so many promises of open access, Case said AOL-Time Warner had to come through if it wanted to protect its credibility with regulators and consumers. "We need to demonstrate this quickly, and we will demonstrate this quickly," he added.

Levin said open access by AOL-Time Warner would happen whether or not market forces drove its decision making, although he added that the company expects plenty of competition from local phone companies with digital-subscriber-line service and from MCI WorldCom Inc. and Sprint Corp. with wireless services.

"There is intense DSL activity," Levin said. "It is clear that there are going to be multiple broadband providers."

The flap over IM was held up as an example of AOL's abuse of market power. AOL-which controls about 90 percent of the IM market-blocks some incoming IMs to protect its users from invasions of privacy and spamming, Case said.

Case added that AOL distributes its IM technology free-of-charge. He said concerns about protecting AOL customers were legitimate and were being addressed by the appropriate standard-setting organization.

"I think our company has been a model for taking a technology and opening it up. That's not something Microsoft [Corp.] has done with Windows," Case said, alluding to a company the government wants to split up.

Barry Schuler, president of AOL's Interactive Services Group, said it would take at least one year for AOL to deploy "server-to-server" technology to open the IM market in a manner consistent with AOL's needs to safeguard its members' interests.

But Bagully called AOL's IM policies "bad behavior." He said AOL had to "break down the wall" between its IM customers and the customers of IM competitors.

On some of the issues raised by Disney, Schuler said AOL would shoot itself in the foot if it deliberately slowed down Disney's broadband Web content by playing caching games with unaffiliated content.

"From our point of view, we can't discriminate. It make absolutely no business sense," Schuler said. "If we did, [AOL customers] would complain to us."

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