Fox, Time Warner, and the Perils of Vertical Integration

The news broke this week about a possible Fox takeover of Time Warner.   As you read these reports, you may have noticed many of the key arguments for why this deal would make sense, i.e. powerful synergies exist between the two media/entertainment companies.  However, yesterday's Wall Street Journal featured a terrific article examining the perils of vertical integration with respect to this  deal.   Note that Time Warner is a major producer of television shows, which it sells to various broadcast networks.    Fox, of course, owns a major television network (and a variety of cable channels).  Warner Brothers is one of the only major TV studios not connected to a major broadcast network (Sony is another).  In the article,  Time Warner CEO Jeff Bewkes says, " Being the leading independent supplier to all the broadcast networks makes us the preferred home to the top writers and producers on TV which, in turn, makes us indispensable to those networks."  Lee Dinstman, a partner at the Agency for the Performing Arts, explained, "The fact that [Warner] has the freedom to take a creative idea to the proper home, instead of just selling to a captive network, can be incredibly attractive." 

What happens if the two firms merge?  Will the loss of independence hurt the Warner production studios?  Put yourself in the position of a programming chief at one of the other major broadcast networks.  When Warner Brothers studios comes pitching a new TV show, what will you think?  You might wonder:  "If it's such a great show, why is it now being broadcast on Fox?"   You may conclude that Warner Brothers is trying to push lower quality shows out to your network.  Note that many firms are vertically integrated in the industry.   Many of the in-house studios at other firms place most of their shows on their own networks. For instance, the article notes that Fox studios has 18 shows on major networks at this time; 14 of them are on the Fox network, while only 4 have been sold to other networks.   Is that because it's the most profitable decision, or is it because other networks are reluctant to buy from the competition?   That, in a nutshell, is one of the perils of vertical integration.  A firm such as Warner Brothers ends up competing with its own customers, creating some challenging conflicts of interest.