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Testimony:

Before the Committee on Commerce, Science, and Transportation, U.S. 
Senate:

United States General Accounting Office:

GAO:

For Release on Delivery Expected at 9:30 a.m. EST:

Thursday, March 25, 2004:

Telecommunications:

Subscriber Rates and Competition in the Cable Television Industry:

Statement of Mark L. Goldstein, Director, Physical Infrastructure 
Issues:

GAO-04-262T:

GAO Highlights:

Highlights of GAO-04-262T, a testimony before the Committee on 
Commerce, Science, and Transportation, U.S. Senate 

Why GAO Did This Study:

In recent years, rates for cable service have increased at a faster 
pace than the general rate of inflation. GAO agreed to (1) examine 
the impact of competition on cable rates and service, (2) assess the 
reliability of information contained in the Federal Communications 
Commissions (FCC) annual cable rate report, (3) examine the causes of 
recent cable rate increases, (4) assess the impact of ownership 
affiliations in the cable industry, (5) discuss why cable operators 
group networks into tiers, and (6) discuss options to address factors 
that could be contributing to cable rate increases.

GAO issued its findings and recommendations in a report entitled 
Telecommunications: Issues Related to Competition and Subscriber Rates 
in the Cable Television Industry (GAO-04-8). In that report, GAO 
recommended that the Chairman of FCC take steps to improve the 
reliability, consistency, and relevance of information on cable rates 
and competition in the subscription video industry. In commenting on 
GAOs report, FCC agreed to make changes to its annual cable rate 
survey, but FCC questioned, on a cost/benefit basis, the utility of 
revising its process to keep the classification of effective 
competition up to date. GAO believes that FCC should examine whether 
cost-effective alternative processes could help provide more accurate 
information. This testimony is based on that report.


What GAO Found:

Competition leads to lower cable rates and improved quality. 
Competition from a wire-based company is limited to very few markets. 
However, where available, cable rates are substantially lower (by 15 
percent) than in markets without this competition. Competition from 
direct broadcast satellite (DBS) companies is available nationwide, 
and the recent ability of these companies to provide local broadcast 
stations has enabled them to gain more customers. In markets where DBS 
companies provide local broadcast stations, cable operators improve 
the quality of their service.

FCCs cable rate report does not appear to provide a reliable source 
of information on the cost factors underlying cable rate increases or 
on the effects of competition. GAO found that cable operators did not 
complete FCCs survey in a consistent manner, primarily because the 
survey lacked clear guidance. Also, GAO found that FCC does not 
initiate updates or revisions to its classification of competitive and 
noncompetitive areas. Thus, FCCs classifications might not reflect 
current conditions.

A variety of factors contribute to increasing cable rates. During the 
past 3 years, the cost of programming has increased considerably (at 
least 34 percent), driven by the high cost of original programming, 
among other things. Additionally, cable operators have invested large 
sums in upgraded infrastructures, which generally permit additional 
channels, digital service, and broadband Internet access. 

Some concerns exist that ownership affiliations might indirectly 
influence cable rates. Broadcasters and cable operators own many cable 
networks. GAO found that cable networks affiliated with these 
companies are more likely to be carried by cable operators than 
nonaffiliated networks. However, cable networks affiliated with 
broadcasters or cable operators do not receive higher license fees, 
which are payments from cable operators to networks, than 
nonaffiliated networks. 

Technological, economic, and contractual factors explain the practice 
of grouping networks into tiers, thereby limiting the flexibility that 
subscribers have to choose only the networks that they want to 
receive. An  la carte approach would facilitate more subscriber 
choice but require additional technology and customer service. 
Additionally, cable networks could lose advertising revenue. As a 
result, some subscribers bills might decline but others might 
increase.

Certain options for addressing cable rates have been put forth. 
Although reregulation of cable rates is one option, promoting 
competition could influence cable rates through the market process. 
While industry participants have suggested several options for 
addressing increasing cable rates, these options could have other 
unintended effects that would need to be considered in conjunction 
with the benefits of lower rates.

www.gao.gov/cgi-bin/getrpt?GAO-04-262T.

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact Mark Goldstein at 
(202) 512-2834 or goldsteinm@gao.gov.

[End of section]

Mr. Chairman and Members of the Committee:

I am pleased to be here today to report on our work on cable rates and 
competition in the cable television industry. In recent years, cable 
television has become a major component of the American entertainment 
industry, with more than 70 million households receiving television 
service from a cable television operator. As the industry has 
developed, it has been affected by regulatory and economic changes. 
Since 1992, the industry has undergone rate reregulation and then in 
1999, partial deregulation. Additionally, competition to cable 
operators has emerged erratically. Companies emerged in some areas to 
challenge cable operators, only to halt expansion or discontinue 
service altogether. Conversely, competition from direct broadcast 
satellite (DBS) operators has emerged and grown rapidly in recent 
years. Nevertheless, cable rates continue to increase at a faster pace 
than the general rate of inflation. As you know, on October 24, 2003, 
we issued a report to you on these issues, and issued a subsequent 
report to the Senate Judiciary Subcommittee on Antitrust, Competition 
Policy and Consumer Rights on similar issues.[Footnote 1] My statement 
today will summarize the major findings from our October 2003 report, 
and additional findings from our February 2004 report.

At the request of this committee, we have (1) examined the impact of 
competition on cable rates and service; (2) assessed the reliability of 
the information contained in the Federal Communications Commission's 
(FCC) annual cable rate report on the cost factors underlying cable 
rate increases, FCC's current classification of cable franchises 
regarding whether they face effective competition, and FCC's related 
findings on the effect of competition; (3) examined the causes of 
recent cable rate increases; (4) assessed whether ownership of cable 
networks (such as CNN and ESPN) may indirectly affect cable rates 
through such ownership's influence on cable network license fees or the 
carriage of cable networks; (5) discussed why cable operators group 
networks into tiers, rather than package networks so that customers can 
purchase only those networks they wish to receive; and (6) discussed 
options to address factors that could be contributing to cable rate 
increases.

To address these issues, we developed an empirical model (our cable-
satellite model) that examined the effect of competition on cable rates 
and service using data from 2001;[Footnote 2] conducted a telephone 
survey with 100 randomly sampled cable franchises that responded to 
FCC's 2002 cable rate survey, and asked these franchises a series of 
questions about how they completed a portion of FCC's survey that 
addresses cost factors underlying annual cable rate changes; 
interviewed representatives of the cable operator, cable network, and 
broadcast industries; and developed empirical models that examined 
whether ownership of cable networks by broadcasters or by cable 
operators influenced (1) the level of license fee (our cable license 
fee model) or (2) the likelihood that the network will be carried (our 
cable network carriage model) based on data from 2002. For a more 
detailed description of our scope and methodology, see appendix I.

This testimony is based on our report issued October 24, 2003, for 
which we did our work from December 2002 through September 2003. We 
provide additional information based on our report issued February 2, 
2004, for which we did our work from May 2003 to December 2003. We 
preformed our work for both assignments in accordance with generally 
accepted government auditing standards.

My statement will make the following points:

* Wire-based competition is limited to very few markets; according to 
FCC, cable subscribers in about 2 percent of all markets have the 
opportunity to choose between two or more wire-based operators. 
However, in those markets where this competition is present, cable 
rates are about 15 percent lower than cable rates in similar markets 
without wire-based competition in 2001. In our February 2004 report, we 
examined 6 markets with wire-based competition in depth and found that 
cable rates in 5 of these 6 markets were 15 to 41 percent lower than 
similar markets without wire-based competition in 2003. DBS operators 
have emerged as a nationwide competitor to cable operators, which has 
been facilitated by the opportunity to provide local broadcast 
stations. Competition from DBS operators has induced cable operators to 
lower cable rates slightly, and DBS provision of local broadcast 
stations has induced cable operators to improve the quality of their 
service.

* As we mentioned in our May 6, 2003, testimony before this Committee, 
certain issues undermine the reliability of information in FCC's cable 
rate report, which provides information on cable rates and competition 
in the subscription video industry.[Footnote 3] Because the Congress 
and FCC use this information in their monitoring and oversight of the 
cable industry, the lack of reliable information in FCC's cable rate 
report may compromise the ability of the Congress and FCC to fulfill 
these roles. To improve the quality and usefulness of the data FCC 
collects annually, we recommend that the Chairman of FCC take steps to 
improve the reliability, consistency, and relevance of information on 
rates and competition in the subscription video industry:

* We found that a number of factors contributed to the increase in 
cable rates. On the basis of data from 9 cable operators, programming 
expenses and infrastructure investment appear to be the primary cost 
factors that have been increasing in recent years. During the past 3 
years, the cost of programming has increased at least 34 percent. Also, 
since 1996, the cable industry has spent over $75 billion to upgrade 
its infrastructure.

* Some industry representatives believe that certain factors related to 
the nature of ownership affiliations may also indirectly influence 
cable rates. We did not find that ownership affiliations between cable 
networks (such as CNN and ESPN) and broadcasters (such as NBC and CBS) 
or between cable networks and cable operators (such as Time Warner and 
Cablevision) are associated with higher license fees--that is, the fees 
cable operators pay to carry cable networks. However, we did find that 
both forms of ownership affiliations are associated with a greater 
likelihood that a cable operator would carry a cable network.

* Today, subscribers have little choice regarding the specific networks 
they receive with cable television service. Adopting an  la carte 
approach, where subscribers could choose to pay for only those networks 
they desire, would provide consumers with more individual choice, but 
could require additional technology and could alter the current 
business model of the cable network industry wherein cable networks 
obtain roughly half of their overall revenues from advertising. A move 
to an  la carte approach could result in reduced advertising revenues 
and might result in higher per-channel rates and less diversity in 
program choice. A variety of factors--such as the pricing of  la carte 
service, consumers' purchasing patterns, and whether certain niche 
networks would cease to exist with  la carte service--make it 
difficult to ascertain how many consumers would be better off and how 
many would be worse off under an  la carte approach.

* Certain options for addressing factors that may be contributing to 
cable rate increases have been put forth. Some consumer groups have 
suggested that reregulation of cable rates needs to be considered, 
although others have noted problems with past efforts at regulation. 
Other options put forth include reviewing whether modifications to the 
program access rules would be beneficial, promoting wireless 
competition, and reviewing whether changes to the retransmission 
consent process should be considered. Any options designed to help 
bring down cable rates could have other unintended effects that would 
need to be considered in conjunction with the benefits of lower rates. 
We are not making any specific recommendations regarding the adoption 
of these options.

Background:

Cable television emerged in the late 1940s to fill a need for 
television service in areas with poor over-the-air reception, such as 
mountainous or remote areas. By the late 1970s, cable operators began 
to compete more directly with free over-the-air television by providing 
new cable networks, such as HBO, Showtime, and ESPN. According to FCC, 
cable's penetration rate--as a percentage of television households--
increased from 14 percent in 1975 to 24 percent in 1980 and to 67 
percent today. Cable television is by far the largest segment of the 
subscription video market, a market that includes cable television, 
satellite service (including DBS operators such as DIRECTV and 
EchoStar), and other technologies that deliver video services to 
customers' homes.

To provide programming to their subscribers, cable operators (1) 
acquire the rights to carry cable networks from a variety of sources 
and (2) pay license fees--usually on a per-subscriber basis--for these 
rights. The three primary types of owners of cable networks are large 
media companies that also own major broadcast networks (such as Disney 
and Viacom), large cable operators (such as Time Warner and 
Cablevision), and independent programmers (such as Landmark 
Communications).

At the community level, cable operators obtain a franchise license 
under agreed-upon terms and conditions from a franchising authority, 
such as a local or state government. During cable's early years, 
franchising authorities regulated many aspects of cable television 
service, including subscriber rates. In 1984, the Congress passed the 
Cable Communications Policy Act, which imposed some limitations on 
franchising authorities' regulation of rates.[Footnote 4] However, 8 
years later in response to increasing rates, the Congress passed the 
Cable Television Consumer Protection and Competition Act of 1992. The 
1992 Act required FCC to establish regulations ensuring reasonable 
rates for basic service--the lowest level of cable service, which 
includes the local broadcast stations--unless a cable system has been 
found to be subject to effective competition, which the act 
defined.[Footnote 5] The act also gave FCC the authority to regulate 
any unreasonable rates for upper tiers (often referred to as expanded-
basic service), which include cable programming provided over and above 
that provided on the basic tier.[Footnote 6] Expanded-basic service 
typically includes such popular cable networks as USA Network, ESPN, 
and CNN. In anticipation of growing competition from satellite and 
wire-based operators, the Telecommunications Act of 1996 phased out all 
regulation of expanded-basic service rates by March 31, 1999. However, 
franchising authorities can regulate the basic tier of cable service 
where there is no effective competition.

As required by the 1992 Act, FCC annually reports on average cable 
rates for operators found to be subject to effective competition 
compared with operators not subject to effective competition. To 
fulfill this mandate, FCC annually surveys a sample of cable franchises 
regarding their cable rates. In addition to asking questions that are 
necessary to gather information to provide its mandated reports, FCC 
also typically asks questions to help the agency better understand the 
cable industry. For example, the 2002 survey included questions about a 
range of cable issues, including the cost factors underlying changes in 
cable rates, the percentage of subscribers purchasing other services 
(such as broadband Internet access and telephone service), and the 
specifics of the programming channels offered on each tier.

Some franchise agreements were initially established on an exclusive 
basis, thereby preventing wire-based competition to the initial cable 
operator. In 1992, the Congress prohibited the awarding of exclusive 
franchises, and, in 1996, the Congress took steps to allow telephone 
companies and electric companies to enter the video market. Initially 
unveiled in 1994, DBS served about 18 million American households by 
June 2002. Today, two of the five largest subscription video service 
providers are DIRECTV and EchoStar--the two primary DBS operators.

Competition Leads to Lower Cable Rates and Improved Quality and Service 
among Cable Operators:

Competition from a wire-based provider--that is, a competitor using a 
wire technology--is limited to very few markets, but where available, 
has a downward impact on cable rates. In a recent report, FCC noted 
that very few markets--about 2 percent--have been found to have 
effective competition based on the presence of a wire-based 
competitor.[Footnote 7] Our interviews with cable operators and 
financial analysis firms yielded a similar finding--wire-based 
competition is limited. However, according to our cable-satellite model 
that included over 700 cable franchises throughout the United States in 
2001, cable rates were approximately 15 percent lower in areas where a 
wire-based competitor was present. With an average monthly cable rate 
of approximately $34 that year, this implies that subscribers in areas 
with a wire-based competitor had monthly cable rates about $5 lower, on 
average, than subscribers in similar areas without a wire-based 
competitor. Our interviews with cable operators also revealed that 
these companies generally lower rates and/or improve customer service 
where a wire-based competitor is present.

For our February 2004 report to the Senate Judiciary Subcommittee on 
Antitrust, Competition Policy and Consumer Rights, we developed an 
alterative methodology to examine the relationship between cable rates 
and wire-based competition. In particular, we developed a case-study 
approach that compared 6 cities where a broadband service provider 
(BSP)--new wire-based competitors that generally offer local telephone, 
subscription television, and high-speed Internet services to consumers-
-has been operating for at least 1 year with 6 similar cities that do 
not have such a competitor. We compared the lowest price available for 
cable service in the market with a BSP to the price for cable service 
offered in markets without a BSP.

We found that cable rates were generally lower in the 6 markets we 
examined with a BSP present than in the 6 markets that did not have BSP 
competition. However, the extent to which rates were lower in a BSP 
market compared to its "matched market" varied considerably across 
markets. For example, in 1 BSP market, the monthly rate for cable 
television service was 41 percent lower compared with the matched 
market, and in 2 other BSP locations, cable rates were more than 30 
percent lower when compared with their matched markets. In two other 
BSP markets, rates were lower by 15 and 17 percent, respectively, in 
the BSP market compared to its matched market. On the other hand, in 1 
of the BSP markets, the price for cable television service was 3 
percent higher in the BSP market than it was in the matched market.

In recent years, DBS has become the primary competitor to cable 
operators. The ability of DBS operators to compete against cable 
operators was bolstered in 1999 when they acquired the legal right to 
provide local broadcast stations--such as over-the-air affiliates of 
ABC, CBS, Fox, and NBC--via satellite to their customers.[Footnote 8] 
On the basis of our cable-satellite model, we found that in areas where 
subscribers can receive local broadcast stations from both primary DBS 
operators, the DBS penetration rate is approximately 40 percent higher 
than in areas where subscribers cannot receive these stations from the 
DBS operators. In terms of rates, we found that a 10 percent higher DBS 
penetration rate in a franchise area is associated with a slight rate 
reduction--about 15 cents per month. Also, in areas where both primary 
DBS operators provide local broadcast stations, we found that the cable 
operators offer subscribers approximately 5 percent more cable networks 
than cable operators in areas where this is not the case. During our 
interviews with cable operators, most operators told us that they 
responded to DBS competition through one or more of the following 
strategies: focusing on customer service, providing bundles of services 
to subscribers, and lowering prices and providing discounts.

Concerns Exist about the Reliability of FCC's Data for Cable Operator 
Cost Factors and Effective Competition:

As we mentioned in our May 6, 2003, testimony before this Committee, 
weaknesses in FCC's survey of cable franchises may lead to inaccuracies 
in the relative importance of cost factors reported by FCC. Cable 
franchises responding to FCC's 2002 survey did not complete in a 
consistent manner the section pertaining to the factors underlying 
cable rate increases primarily because of a lack of clear guidance. 
These inconsistencies may have led to unreliable information in FCC's 
report on the relative importance of factors underlying recent cable 
rate increases. Overall, we found that 84 of the 100 franchises we 
surveyed did not provide a complete or accurate accounting of their 
cost changes for the year. As such, an overall accurate picture of the 
relative importance of various cost factors, which may be important for 
FCC and congressional oversight, may not be reflected in FCC's data.

FCC's cable rate report also does not appear to provide a reliable 
source of information on the effect of competition. FCC is required by 
statute to produce an annual report on the differences between average 
cable rates in areas that FCC has found to have effective competition 
compared with those that have not had such a finding. However, FCC's 
process for implementing this mandate may lead to situations in which 
the effective competition designation may not reflect the actual state 
of competition in the current time frame. In particular, FCC relies 
exclusively on external parties to file for changes in the designation. 
Using data from FCC's 2002 survey, we conducted several tests to 
determine whether information contained in franchises' survey 
information--which was filed with FCC in mid-2002--was consistent with 
the designation of effective competition for the franchise in FCC's 
records. We found some discrepancies. These discrepancies may explain, 
in part, the differential findings regarding the impact of wire-based 
competition reported by FCC, which found a nearly 7 percent reduction 
in cable rates, and our finding of a 15 percent reduction in cable 
rates.

Because the Congress and FCC use this information in their monitoring 
and oversight of the cable industry, the lack of reliable information 
in FCC's report on these two issues--factors underlying cable rate 
increases and the effect of competition--may compromise the ability of 
the Congress and FCC to fulfill these roles. Additionally, the 
potential for this information to be used in debate regarding important 
policy decisions, such as media consolidation, also necessitates 
reliable information in FCC's report. As a result, we recommended that 
the Chairman of FCC improve the reliability, consistency, and relevance 
of information on cable rates and competition in the subscription video 
industry by (1) taking immediate steps to improve its cable rate survey 
and (2) reviewing the commission's process for maintaining the 
classification of effective competition.[Footnote 9] In commenting on 
our report, FCC agreed to make changes to its annual cable rate survey 
in an attempt to obtain more accurate information, but questioned, on a 
cost/benefit basis, the utility of revising its process to keep the 
classification of effective competition in franchises up to date. We 
recognize that there are costs associated with FCC's cable rate survey, 
and we recommend that FCC examine whether cost-effective alternative 
processes exist that would enhance the accuracy of its effective 
competition designations.

A Variety of Factors Contribute to Cable Rate Increases:

Increases in expenditures on cable programming contribute to higher 
cable rates. A majority of cable operators and cable networks, and all 
financial analysts that we interviewed told us that high programming 
costs contributed to rising cable rates. On the basis of financial data 
supplied to us by 9 cable operators, we found that these operators' 
yearly programming expenses, on a per-subscriber basis, increased from 
$122 in 1999 to $180 in 2002--a 48 percent increase.[Footnote 10] 
Almost all of the cable operators we interviewed cited sports 
programming as a major contributor to higher programming costs. On the 
basis of our analysis of Kagan World Media data, the average license 
fees for a cable network that shows almost exclusively sports-related 
programming increased by 59 percent, compared to approximately 26 
percent for 72 nonsports networks, in the 3 years between 1999 and 
2002.[Footnote 11] Further, the average license fees for the sports 
networks were substantially higher than the average for the nonsports 
networks (see fig. 1).

Figure 1: Average Monthly License Fees per Subscriber--Sports Networks 
v. Nonsports Networks, 1999-2002:

[See PDF for image]

[End of figure]

The cable network executives we interviewed cited several reasons for 
increasing programming costs. We were told that competition among 
networks to produce and show content that will attract viewers has 
become more intense. This competition, we were told, has bid up the 
cost of key inputs (such as talented writers and producers) and has 
sparked more investment in programming. Most notably, these executives 
told us that networks today are increasing the amount of original 
content and improving the quality of programming generally.

Although programming is a major expense for cable operators, several 
cable network executives we interviewed also pointed out that cable 
operators offset some of the cost of programming through advertising 
revenues. Local advertising dollars account for about 7 percent of the 
total revenues in the 1999 to 2002 time frame for the 9 cable operators 
that supplied us with financial data. For these 9 cable operators, 
gross local advertising revenues--before adjusting for the cost of 
inserting and selling advertising--amounted to about $55 per subscriber 
in 2002 and offset approximately 31 percent of their total programming 
expenses.[Footnote 12]

In addition to higher programming costs, the cable industry has spent 
over $75 billion between 1996 and 2002 to upgrade its infrastructure by 
replacing degraded coaxial cable with fiber optics and adding digital 
capabilities. As a result of these expenditures, FCC reported that 
there have been increases in channel capacity; the deployment of 
digital transmissions; and nonvideo services, such as Internet access 
and telephone service.[Footnote 13] Many cable operators, cable 
networks, and financial analysts we interviewed said investments in 
system upgrades contributed to increases in consumer cable rates.

Programming expenses and infrastructure investment appear to be the 
primary cost factors that have been increasing in recent years. On the 
basis of financial data from 9 cable operators, we found that annual 
subscriber video-based revenues increased approximately $79 per 
subscriber from 1999 to 2002. During this same period, programming 
expenses increased approximately $57 per subscriber. Depreciation 
expenses on cable-based property, plant, and equipment--an indicator of 
expenses related to infrastructure investment--increased approximately 
$80 per subscriber during the same period. However, because these 
infrastructure-related expenses are associated with more than one 
service, it is unclear how much of this cost should be attributed to 
video-based services. Moreover, cable operators are enjoying increased 
revenues from nonvideo sources. For example, revenues from Internet-
based services increased approximately $74 per subscriber during the 
same period.

Some View Ownership Affiliations as an Important Indirect Influence on 
Cable Rates:

Several industry representatives and experts we interviewed told us 
that they believe ownership affiliation may also influence the cost of 
programming and thus, indirectly, the rates for cable service. Of the 
90 cable networks that are carried most frequently on cable operators' 
basic or expanded-basic tiers, we found that approximately 19 percent 
were majority-owned (i.e., at least 50 percent owned) by a cable 
operator, approximately 43 percent were majority-owned by a 
broadcaster, and the remaining 38 percent of the networks are not 
majority-owned by broadcasters or cable operators (see fig. 2).

Figure 2: Ownership Affiliation of the 90 Most Carried Cable Networks:

[See PDF for image]

Note: Cable networks were assumed affiliated if the ownership interest 
was 50 percent or greater.

[End of figure]

Despite the view held by some industry representatives with whom we 
spoke that license fees for cable networks owned by either cable 
operators or broadcasters tend to be higher than fees for other cable 
networks, we did not find this to be the case. We found that cable 
networks that have an ownership affiliation with a broadcaster did not 
have, on average, higher license fees (i.e., the fee the cable operator 
pays to the cable network) than cable networks that were not majority-
owned by broadcasters or cable operators. We did find that license fees 
were statistically higher for cable networks owned by cable operators 
than was the case for cable networks that were not majority-owned by 
broadcasters or cable operators. However, when using a regression 
analysis (our cable license fee model) to hold constant other factors 
that could influence the level of the license fee, we found that 
ownership affiliations--with broadcasters or with cable operators--had 
no influence on cable networks' license fees.[Footnote 14] We did find 
that networks with higher advertising revenues per subscriber (a proxy 
for popularity) and sports networks received higher license fees.

Industry representatives we interviewed also told us that cable 
networks owned by cable operators or broadcasters are more likely to be 
carried by cable operators than other cable networks. On the basis of 
our cable network carriage model--a model designed to examine the 
likelihood of a cable network being carried--we found that cable 
networks affiliated with broadcasters or with cable operators are more 
likely to be carried than other cable networks. In particular, we found 
that networks owned by a broadcaster or by a cable operator were 46 
percent and 31 percent, respectively, more likely to be carried than a 
network without majority ownership by either of these types of 
companies. Additionally, we found that cable operators were much more 
likely to carry networks that they themselves own. A cable operator is 
64 percent more likely to carry a cable network it owns than to carry a 
network with any other ownership affiliation.

Several Factors Generally Lead Cable Operators to Offer Large Tiers of 
Networks Instead of Providing  La Carte or Minitier Service:

Using data from FCC's 2002 cable rate survey, we found that with basic 
tier service, subscribers receive, on average, approximately 25 
channels, which include the local broadcast stations. The expanded-
basic tier provides, on average, an additional 36 channels. In general, 
to have access to the most widely distributed cable networks--such as 
ESPN, TNT, and CNN--most subscribers must purchase the expanded-basic 
tier of service. Because subscribers must buy all of the networks 
offered on a tier that they choose to purchase, they have little choice 
regarding the individual networks they receive.

If cable operators were to offer all networks on an  la carte basis--
that is, if consumers could select the individual networks they wish to 
purchase--additional technology upgrades would be necessary in the near 
term. In particular, subscribers would need to have an addressable 
converter box on every television set attached to the cable system to 
unscramble the signals of the networks that the subscriber has agreed 
to purchase. According to FCC's 2002 survey data, the average monthly 
rental price for an addressable converter box is approximately $4.39. 
Although cable operators have been placing addressable converter boxes 
in the homes of customers who subscribe to scrambled networks, many 
homes do not currently have addressable converter boxes or do not have 
them on all of the television sets attached to the cable system. Since 
cable operators may move toward having a greater portion of their 
networks provided on a digital tier in the future, these boxes will 
need to be deployed in greater numbers, although it is unclear of the 
time frame over which this will occur. Also, consumer electronic 
manufactures have recently submitted plans to FCC regarding 
specifications for new television sets that will effectively have the 
functionality of an addressable converter box within the television 
set. Once most customers have addressable converter boxes or these new 
televisions in place, the technical difficulties of an  la carte 
approach would be mitigated.

If cable subscribers were allowed to choose networks on an  la carte 
basis, the economics of the cable network industry could be altered. If 
this were to occur, it is possible that cable rates could actually 
increase for some consumers. In particular, we found that cable 
networks earn much of their revenue from the sale of advertising that 
airs during their programming. Our analysis of information on 79 
networks from Kagan World Media indicates that these cable networks 
received nearly half of their revenue from advertising in 2002; the 
majority of the remaining revenue is derived from the license fees that 
cable operators pay networks for the right to carry their signal (see 
fig. 3).

Figure 3: Percentage of Cable Network Advertising Revenue Compared with 
License Fee Revenues for 79 Cable Networks, 1999 - 2002:

[See PDF for image]

Note: Although cable networks have other sources of revenues, 
advertising and license fee revenues comprise the vast majority of 
cable network revenues.

[End of figure]

To receive the maximum revenue possible from advertisers, cable 
networks strive to be on cable operators' most widely distributed tiers 
because advertisers will pay more to place an advertisement on a 
network that will be viewed, or have the potential to be viewed, by the 
greatest number of people.[Footnote 15] According to cable network 
representatives we interviewed, any movement of networks from the most 
widely distributed tiers to an  la carte format could result in a 
reduced amount that advertisers are willing to pay for advertising 
time. To compensate for any decline in advertising revenue, network 
representatives contend that cable networks would likely increase the 
license fees they charge to cable operators. Because increased license 
fees, to the extent that they occur, are likely to be passed on to 
subscribers, it appears that subscribers' monthly cable bills would not 
necessarily decline under an  la carte system. Moreover, most cable 
networks we interviewed also believe that programming diversity would 
suffer under an  la carte system because some cable networks, 
especially small and independent networks, would not be able to gain 
enough subscribers to support the network.

The manner in which an  la carte approach might impact advertising 
revenues, and ultimately the cost of cable service, rests on 
assumptions regarding customer choice and pricing mechanisms. In 
particular, the cable operators and cable networks that discussed these 
issues with us appeared to assume that many customers, if faced with an 
 la carte selection of networks, would choose to receive only a 
limited number of networks, which is consistent with the data on 
viewing habits. In fact, some industry representatives had different 
views on the degree to which consumers place value on networks they do 
not typically watch. While two experts suggested that it is not clear 
whether more networks are a benefit to subscribers, others noted that 
subscribers place value in having the opportunity to occasionally watch 
networks they typically do not watch. Additionally, the number of cable 
networks that customers choose to purchase will also be influenced by 
the manner in which cable operators price services under an  la carte 
scenario. Thus, there are a variety of factors that make it difficult 
to ascertain how many consumers would be made better off and how many 
would be made worse off under an  la carte approach. These factors 
include how cable operators would price their services under an  la 
carte system; the distribution of consumers' purchasing patterns; 
whether niche networks would cease to exist, and, if so, how many would 
exit the industry; and consumers' true valuation of networks they 
typically do not watch.

Industry Participants Have Cited Certain Options That May Address 
Factors Contributing to Rising Cable Rates:

Industry participants have suggested the following options for 
addressing the cable rate issue. This discussion is an overview, and we 
are not making any specific recommendations regarding the adoption of 
any of these options.

* Some consumer groups have pointed to the lack of competition as 
evidence that reregulation needs to be considered because it might be 
the only alternative to mitigate increasing cable rates and cable 
operators' market power. However, some experts expressed concerns about 
cable regulation after the 1992 Act, including lowering of the quality 
of programming, discouragement of investment in new facilities, and 
imposition of administrative burdens on the industry and regulators.

* The 1992 Act included provisions to ensure that cable networks that 
have ownership relationships with cable operators (i.e., vertically 
integrated cable operators) generally make their satellite-delivered 
programming available to competitors. Some have expressed concern that 
the law is too narrow because it applies only to the satellite-
delivered programming of vertically integrated cable operators and it 
does not prohibit exclusive contracts between a cable operator and an 
independent cable network. Given these concerns, some have suggested 
that changes in the statutory program access provisions might enhance 
the ability of other providers to compete with the incumbent cable 
operators while others have noted that altering these provisions could 
reduce the incentive for companies to develop innovative programming.

* DBS operators have stated that they are currently not able to provide 
local broadcast stations in all 210 television markets in the United 
States because they do not have adequate spectrum to do so while still 
providing a wide variety of national networks. As part of the so-called 
carry one, carry all provisions, these companies are required to 
provide all local broadcast stations in markets where they provide any 
of those stations. Some suggest modifying the carry one, carry all 
provisions to promote carriage of local stations in more markets. 
However, any modifications to the DBS carry one, carry all rules would 
need to be examined in the context of why those rules were put into 
place--that is, to ensure that all broadcast stations are available in 
markets where DBS providers choose to provide local stations.

* In the 1992 Act, the Congress created a mechanism, known as 
retransmission consent, through which local broadcast station owners 
(such as local ABC, CBS, Fox, and NBC affiliates) could receive 
compensation from cable operators in return for the right to carry 
their broadcast stations. Today, few retransmission consent agreements 
include cash payment for carriage of the local broadcast station. 
Rather, agreements between some large broadcast groups and cable 
operators generally include provisions for carriage of broadcaster-
owned cable networks. As a result, cable operators sometimes carry 
cable networks they otherwise might not have carried. Alternatively, 
representatives of the broadcast networks told us that they did not 
believe that cable networks had been dropped and that they accept cash 
payment for carriage of the broadcast signal, but that cable operators 
tend to prefer carriage options in lieu of a cash payment. Certain 
industry participants with whom we met advocated the removal of the 
retransmission consent provisions and told us that this may have the 
effect of lowering cable rates, but others have stated that such 
provisions serve to enable television stations to obtain a fair return 
for the retransmitted content they provide and that retransmission 
rules help to ensure the continued availability of free television for 
all Americans.

Mr. Chairman, this concludes my prepared statement. I would be happy to 
respond to any questions you or other Members of the Committee may have 
at this time.

Contact and Acknowledgments:

For questions regarding this testimony, please contact Mark L. 
Goldstein on (202) 512-2834 or goldsteinm@gao.com. Individuals making 
key contributions to this testimony included Amy Abramowitz, Stephen 
Brown, Julie Chao, Michael Clements, Andy Clinton, Keith Cunningham, 
Bert Japikse, Sally Moino, Mindi Weisenbloom, and Carrie Wilks.

[End of section]

Appendix I: Scope and Methodology:

To respond to the first issue--examine the impact of competition on 
cable rates--we used an empirical model (our cable-satellite model) 
that we previously developed that examines the effect of competition on 
cable rates and services.[Footnote 16] Using data from the Federal 
Communications Commission's (FCC) 2001 cable rate survey, the model 
considers the effect of various factors on cable rates, the number of 
cable subscribers, the number of channels that cable operators provide 
to subscribers, and direct broadcast satellite (DBS) penetration rates 
for areas throughout the United States. We further developed the model 
to more explicitly examine whether varied forms of competition--such as 
wire-based, DBS, multipoint multichannel distribution systems (MMDS) 
competition--have differential effects on cable rates. In addition, we 
spoke with an array of industry stakeholders and experts (see below) to 
gain further insights on these issues.

The second issue consists of two parts. To respond to part one--assess 
the reliability of the cost justifications for rate increases provided 
by cable operators to FCC, we conducted a telephone survey (our cable 
franchise survey), from January 2003 through March 2003, of cable 
franchises that responded to FCC's 2002 cable rate survey. We drew a 
random sample of 100 of these cable franchises; the sample design was 
intended to be representative of the 755 cable franchises that 
responded to FCC's survey. We used data from FCC, and conversations 
with company officials, to determine the most appropriate staff person 
at the franchise to complete our survey. To ensure that our survey 
gathered information that addressed this objective, we conducted 
telephone pretests with several cable franchises and made the 
appropriate changes on the basis of the pretests. We asked cable 
franchises a series of open-ended questions regarding how the franchise 
staff calculated cost and noncost factors on FCC's 2002 cable rate 
survey, how well the franchise staff understood what FCC wanted for 
those factors, and franchise staff's suggestions for improving FCC's 
cable rate survey. All 100 franchises participated in our survey, for a 
100 percent response rate. In conducting this survey, we did not 
independently verify the answers that the franchises provided to us.

Additionally, to address part two of the second issue--assess FCC's 
classifications of effective competition--we examined FCC's 
classification of cable franchises regarding whether they face 
effective competition. Using responses to FCC's 2002 cable rate survey, 
we tested whether the responses provided by cable franchises were 
consistent with the various legal definitions of effective competition, 
such as the low-penetration test. Further, we reviewed documents from 
FCC proceedings addressing effective competition filings and contacted 
franchises to determine whether the conditions present at the time of 
the filing remain in effect today.

To address the third, fourth, fifth, and sixth issues (examine reasons 
for recent rate increases, examine whether ownership relationships 
between cable networks and cable operators and/or broadcasters 
influence the level of license fees for the cable networks or the 
likelihood that a cable network will be carried, examine why cable 
operators group networks into tiers rather than sell networks 
individually, and discuss options to address factors that could be 
contributing to cable rate increases), we took several steps, as 
follows:

* We conducted semistructured interviews with a variety of industry 
participants. We interviewed officials and obtained documents from FCC 
and the Bureau of Labor Statistics. We interviewed 15 cable networks--
12 national and 3 regional--from a listing published by the National 
Cable and Telecommunications Association (NCTA), striving for a mixture 
of networks that have a large and small number of subscribers and that 
provide varying content, such as entertainment, sports, music, and 
news. We interviewed 11 cable operators, which included the 10 largest 
publicly traded cable operators and 1 medium-sized, privately held 
cable operator. In addition, we interviewed the four largest broadcast 
networks, one DBS operator, representatives from three major 
professional sports leagues, and five financial analysts that cover the 
cable industry. Finally, we interviewed officials from NCTA, Consumers 
Union, the National Association of Broadcasters, the National 
Association of Telecommunications Officers and Advisors, the American 
Cable Association, the National Cable Television Cooperative, and the 
Cable Television Advertising Bureau.

* We solicited the 11 cable operators we interviewed to gather 
financial and operating data and reviewed relevant Securities and 
Exchange Commission filings for these operators. Nine of the 11 cable 
operators provided the financial and operating data we sought for the 
period 1999 to 2002. We also acquired data from Kagan World Media, 
which is a private communications research firm that specializes in the 
cable industry. These data provided us with revenue and programming 
expenses for over 75 cable networks.

* We compared the average license fees among three groups of networks: 
those that are majority-owned by a broadcaster, those that are 
majority-owned by a cable operator, and all others. We preformed t-
tests on the significance of these differences. We also ran a 
regression (our cable license fee model) in which we regressed the 
license fee across 90 cable networks on the age of the network, the 
advertising revenues per subscriber (a measure of network popularity), 
dummy variables for sports and news programming, and a variety of 
factors about each franchise.

* We conducted several empirical tests on the channel lineups of cable 
operators as reported to FCC in its 2002 cable rate survey. We 
developed an empirical model (our cable network carriage model) that 
examined the factors that influence the probability of a cable network 
being carried on a cable franchise, including factors such as ownership 
affiliations and the popularity of the network. Further, we developed 
descriptive statistics on the characteristics of various tiers of 
service and the channels included in the various tiers.

FOOTNOTES

[1] See U.S. General Accounting Office, Telecommunications: Issues 
Related to Competition and Subscriber Rates in the Cable Television 
Industry, GAO-04-8 (Washington, D.C.: Oct. 24, 2003) and U.S. General 
Accounting Office, Telecommunications: Wire-Based Competition 
Benefited Consumers in Selected Markets, GAO-04-241 (Washington, D.C.: 
Feb. 2, 2004).

[2] Our model was based on data from 2001 since this was the most 
recent year for which we were able to acquire the required data on 
cable rates and services and DBS penetration rates when we began our 
analysis.

[3] See U.S. General Accounting Office, Telecommunications: Data 
Gathering Weaknesses In FCC's Survey Of Information on Factors 
Underlying Cable Rate Changes, GAO-03-742T (Washington, D.C.: May 6, 
2003).

[4] Under the 1984 Act and FCC's subsequent rulemaking, over 90 percent 
of all cable systems were not subject to rate regulation.

[5] Under statutory definitions in the 1992 Act, substantially more 
cable operators were subject to rate regulations than had previously 
been the case.

[6] Basic and expanded-basic are the most commonly subscribed to 
service tiers--bundles of networks grouped into a package--offered by 
cable operators. In addition, customers in many areas can purchase 
digital tiers and also premium pay channels, such as HBO and Showtime. 

[7] See Federal Communications Commission, Annual Assessment of the 
Status of Competition in the Market for the Delivery of Video 
Programming, Ninth Annual Report, FCC 02-338 (Washington, D.C.: Dec. 
31, 2002).

[8] In 1999, the Congress passed the Satellite Home Viewer Improvement 
Act, which allows satellite operators to provide local broadcast 
stations to their customers. Prior to this act, satellite operators 
were limited to providing local broadcast stations to unserved areas 
where customers could not receive sufficiently high-quality, over-the-
air signals. This practice had the general effect of preventing 
satellite operators from providing local broadcast stations directly to 
customers in most circumstances.

[9] See U.S. General Accounting Office, Telecommunications: Issues 
Related to Competition and Subscriber Rates in the Cable Television 
Industry, GAO-04-8 (Washington, D.C.: Oct. 24, 2003), page 45 for a 
full discussion of our recommendations.

[10] Using data from Kagan World Media, we found that the average fees 
cable operators must pay to purchase programming (referred to as 
license fees) increased by 34 percent from 1999 to 2002. 

[11] The seven national sports networks that we included in our 
analysis were ESPN, ESPN Classic, ESPN2, FOX Sports Net, The Golf 
Channel, The Outdoor Channel, and the Speed Channel.

[12] Advertising sales revenues net of expenses incurred to insert and 
sell local advertising would offset a lower percentage of cable 
operators' programming expenses.

[13] For example, FCC reported that approximately 74 percent of cable 
systems had system capacity of at least 750 MHz, and that approximately 
70 percent of cable subscribers were offered high-speed Internet access 
by their cable operator in 2002.

[14] In the cable license fee model, we regressed the average monthly 
license fee for 90 cable networks on a series of variables that might 
influence the license fee. See GAO-04-8 for a list of variables 
included in that model.

[15] Most contracts negotiated between cable networks and cable 
operators specify the tier that the network must appear on. We were 
told that cable networks include these provisions in their contracts 
because their business models are developed on the basis of a wide 
distribution of their network.

[16] See U.S. General Accounting Office, Telecommunications: Issues in 
Providing Cable and Satellite Television Services, GAO-03-130 
(Washington, D.C.: Oct. 15, 2002).