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Report to the Chairman, Committee on Commerce, Science, and
Transportation, U.S. Senate:
United States General Accounting Office:
GAO:
October 2003:
Telecommunications:
Issues Related to Competition and Subscriber Rates in the Cable
Television Industry:
GAO-04-8:
GAO Highlights:
Highlights of GAO-04-8, a report to Senator John McCain, Chairman,
Committee on Commerce, Science, and Transportation, U.S. Senate
Why GAO Did This Study:
Over 70 million American households receive television service from a
cable television operator. 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 Commission’s (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.
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.
FCC’s 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 FCC’s survey in a consistent manner, primarily because the
survey lacked clear guidance. In particular, GAO found that 84 of the
100 franchises it surveyed did not provide a complete or accurate
accounting of their cost changes for the year. Also, GAO found that
FCC does not initiate updates or revisions to its classification of
competitive and noncompetitive areas. Thus, FCC’s 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 à la carte approach would facilitate more subscriber
choice but require additional technology and customer service.
Additionally, cable networks could loose 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.
Policies to bring about lower cable rates could have other effects
that would need to be considered.
What GAO Recommends:
GAO recommends that the Chairman of the FCC
* take immediate steps to im-prove the cable rate survey and
* review the commission’s process for maintaining the status of
effective competition.
In commenting on GAO’s 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 status of effective
competition up to date. GAO believes that FCC should examine whether
cost-effective alternative processes could help provide the Congress
with more accurate information.
www.gao.gov/cgi-bin/getrpt?GAO-04-8.
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]
Contents:
Letter:
Results in Brief:
Background:
Competition Leads to Lower Cable Rates and Improved Quality and Service
among Cable Operators:
Concerns Exist about the Reliability of FCC's Data for Cable Operator
Cost Factors and Effective Competition:
A Variety of Factors Contribute to Cable Rate Increases:
Some View Ownership Affiliations as an Important Indirect Influence on
Cable Rates:
Several Factors Generally Lead Cable Operators to Offer Large Tiers of
Networks Instead of Providing À La Carte or Minitier Service:
Industry Participants Have Cited Certain Options That May Address
Factors Contributing to Rising Cable Rates:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: GAO Survey of Cable Franchises:
Appendix III: GAO's Modifications to FCC's Competition Classification:
Appendix IV: Cable-Satellite Model:
Definitions and Sources for Variables:
Estimation Methodology and Results:
Appendix V: Cable Network Carriage Model:
Set-up of Our Cable Network Carriage Model:
Data Sources and Descriptive Statistics:
Estimation Methodology and Results:
Alternative Specification:
Appendix VI: Comments from the Federal Communications Commission:
GAO Comments:
Appendix VII: Comments from Industry Participants:
American Cable Association:
Consumer Federation of America:
Consumers Union:
National Association of Broadcasters:
National Association of Telecommunications Officers and Advisors:
National Broadcasting Company:
National Cable and Telecommunications Association:
News Corporation:
Satellite Broadcasting and Communications Association:
Viacom:
Walt Disney Company:
Appendix VIII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Tables:
Table 1: Definition and Source for Variables:
Table 2: Descriptive Statistics:
Table 3: Three-Stage Least Squares Model Results:
Table 4: Definitions and Sources of Variables:
Table 5: Descriptive Statistics:
Table 6: Logistic Model Results:
Table 7: Logistic Model Results:
Figures:
Figure 1: Section of FCC's 2002 Cable Rate Survey Covering Cable
Franchises' Rate and Cost Changes:
Figure 2: Change in the General and Cable Television Consumer Price
Indexes, 1997 - 2002:
Figure 3: Average Monthly License Fees per Subscriber--Sports
Programming Networks v. Nonsports Networks, 1999 - 2002:
Figure 4: Expenditures by 79 Cable Networks to Produce Programming,
1999 - 2002:
Figure 5: Cable Industry Infrastructure Expenditures, 1996 - 2002:
Figure 6: Ownership Affiliation of the 90 Most Carried Cable Networks:
Figure 7: Percentage of Cable Network Advertising Revenue Compared with
License Fee Revenues for 79 Cable Networks, 1999 - 2002:
Abbreviations:
ACA: American Cable Association:
BLS: Bureau of Labor Statistics:
CPI: consumer price index:
DBS: direct broadcast satellite:
FCC: Federal Communications Commission:
LEC: local exchange carrier:
MMDS: multichannel multipoint distribution service:
MSA: metropolitan statistical area:
MSO: multiple system operator:
NATOA: National Association of Telecommunications
Officers and Advisors
NBCNational Broadcasting Company
NCTANational
Cable and Telecommunications Association
YESYankees Entertainment and
Sports Network:
United States General Accounting Office:
Washington, DC 20548:
October 24, 2003:
The Honorable John McCain
Chairman, Committee on Commerce, Science, and Transportation
United States Senate:
Dear Mr. Chairman:
In recent years, cable television has become a major component of the
American entertainment industry--today more than 70 million households
receive their television service through a subscription to 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 (such as
DIRECTV and EchoStar)--which did not exist a decade ago--has emerged
and grown rapidly in recent years. Nevertheless, cable rates continue
to increase at a faster pace than the general rate of inflation.
You asked us to review several issues related to recent increases in
cable rates and the competitiveness of the subscription video industry-
-an industry that includes cable television, satellite service
(including DBS operators), and other technologies that deliver video
services to customers' homes. We agreed to (1) examine the impact of
competition in the subscription video industry on cable rates and
service; (2) assess 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) examine the causes of recent cable rate increases; (4)
assess 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)
discuss 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) discuss options to address factors that
could be contributing to cable rate increases.
To respond to the first objective on the impact of competition on cable
rates and service, we used an empirical model (our cable-satellite
model) that we previously developed that examines the effect of
competition on cable rates and service.[Footnote 1] Using data from
2001, 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 DBS penetration rates for areas
throughout the United States. We further developed the model to more
explicitly examine whether varied forms of competition have
differential effects on cable rates. We also discussed the degree and
impact of competition in the subscription video industry with an array
of industry stakeholders and experts (see below).
For the second objective on the reliability of data in FCC's annual
cable rate report, we randomly sampled 100 of approximately 750 cable
franchises that responded to FCC's 2002 cable rate survey.[Footnote 2]
We designed this sample to be representative of the universe of
franchises that responded to FCC's survey. Using a telephone survey
(our cable franchise survey), we 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 (see app.
II). We also examined FCC's process for classifying cable franchises
regarding whether they face effective competition, a term defined by
statute (see app. III).
For the third, fourth, fifth, and sixth objectives addressing the
causes of recent cable rate increases, the impact of ownership
affiliations, why cable operators group networks into tiers, and
possible options for addressing factors that may be contributing to
rate increases, we interviewed officials and obtained documents and
data from FCC and the Bureau of Labor Statistics. We also interviewed
officials from several trade associations and other organizations: the
National Cable and Telecommunications Association (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, three
major sports leagues, and the Cable Television Advertising Bureau. We
also conducted semistructured interviews with a variety of companies:
11 cable operators, one DBS operator, four broadcast networks (such as
ABC and NBC), 15 cable networks (such as CNN and ESPN), and
representatives of five financial analysis firms. Furthermore, we used
data on cable network revenues and programming expenses that we
acquired from Kagan World Media, which is a private communications
research firm that specializes in cable industry data. We used these
data to develop models that examine whether ownership of cable networks
by broadcasters or by cable operators influences (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).
We conducted our review from December 2002 through September 2003 in
accordance with generally accepted government auditing standards. For
additional information on our scope and methodology, see appendix I.
Results in Brief:
Competition from wire-based and DBS operators 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, such as a second cable operator, a local telephone
company, or an electric utility--is limited to very few markets.
However, in those markets where this competition is present, cable
rates are significantly lower--by about 15 percent--than cable rates in
similar markets without wire-based competition. Since 1999, when DBS
operators acquired the legal right to provide local broadcast stations
(such as affiliates of ABC, CBS, Fox, and NBC), these companies have
emerged as important competitors to cable operators. In particular, in
areas where subscribers can receive local broadcast stations from both
primary DBS operators, the DBS penetration rate--that is, the
percentage of households that subscribe to satellite service--is
approximately 40 percent higher than in areas where subscribers cannot
receive local broadcast stations from both primary DBS operators. In
addition, the DBS provision of local broadcast stations has induced
cable operators to improve the quality of their service by providing
their subscribers with approximately 5 percent additional cable
networks.
FCC's cable rate report may not provide reliable information on the
factors underlying recent cable rate increases or on the effect of
competition. In particular, 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; 73 of 100 cable franchises whom we spoke with
said that the instructions included with FCC's survey were
insufficient. These inconsistencies may have led to unreliable
information in FCC's report on the relative importance of factors
underlying recent cable rate increases. For example, we spoke with 83
franchises that reported zero for infrastructure investment to FCC, 33
of these franchises told us that they had incurred costs for such
investments, thereby implying that they understated the contribution of
infrastructure investment to their 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.
Regarding the effect of competition, because FCC's process does not
provide for updates or revisions to the competitive classification of
cable franchises unless specifically requested to do so, FCC's
classifications of cable franchises as having (or not having) effective
competition on the basis of the statutory definition do not always
accurately reflect current competitive conditions. In our analysis of
the impact of wire-based competition, we checked the current status of
competition in each franchise. The changes we made as a result of this
process 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 issues, such as media consolidation,
also necessitates reliable information in FCC's report. To improve the
quality and usefulness of the data FCC collects annually on cable
television rates and competition in the subscription video industry, 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.
Several key factors--including programming costs and infrastructure
investments--are putting upward pressure on cable rates. Programming
costs incurred by cable operators have risen considerably--on average
by as much as 34 percent--in the last 3 years, and, in particular,
programming costs associated with cable networks showing sporting
events have risen even more--on average by 59 percent--during the same
time frame. The cable industry has also spent billions of dollars in
upgrading its infrastructure to enable new services, such as digital
channels and broadband Internet access. While these upgrades benefit
cable subscribers by expanding the number of cable networks available
and improving picture quality, some of this benefit accrues to
subscribers who purchase new, advanced services, such as broadband
Internet access. Additionally, cable operators have increased spending
on customer service, which typically is now available 24 hours a day, 7
days a week. For the 9 cable operators[Footnote 3] that provided
financial information to us, we found that programming expenses and
infrastructure investment appear to be the primary cost factors that
have been increasing in recent years.[Footnote 4]
Several industry representatives whom we spoke with believe that
certain factors related to the nature of ownership affiliations may
also indirectly influence cable rates through their influence on cable
operators' choice of which cable networks to carry and the cost to the
cable operator for the right to carry the networks. 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 the level of 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 the likelihood that
a cable operator would carry a cable network. Holding constant certain
other factors that might influence the likelihood of a cable network
being carried by a cable operator--such as the popularity of the
network or the type of programming the network carries--we found that
operators were more likely to carry cable networks that were majority-
owned by either cable operators or by broadcasters than to carry other
cable networks. Moreover, cable operators were substantially more
likely to carry cable networks that they directly own than to carry
cable networks owned by other cable operators, broadcasters, or others.
Currently, technological, contractual, and economic factors lead cable
operators to sell large numbers of networks on tiers. On average, a
basic tier of service includes about 25 channels, including local
broadcast stations, and the next tier provides, on average, 36
additional channels, including such popular cable networks as CNN and
ESPN. 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. Greater subscriber choice might
be provided if cable operators used an à la carte system, wherein
subscribers would receive and pay for only the networks they want to
watch. But, an à la carte system could impose additional costs on
subscribers in the near term because additional equipment--which many
subscribers do not currently have--will be required on every television
attached to the cable system to unscramble networks the subscriber is
authorized to receive. Moreover, an à la carte system could alter the
current economics of the cable network industry, wherein cable networks
derive significant revenues from advertising. In particular, cable
networks experiencing a falloff in subscribers could also see an
associated decline in advertising revenues, since the amount that
companies are willing to pay for advertising spots is based on the
number of potential viewers. Although cable networks may take steps to
reduce their production costs to compensate for the decline in
advertising revenue, cable networks may also raise the license fees
charged to cable operators for the right to carry the networks. If
license fees rise, some of the increase is likely to be passed on to
subscribers. Because of the reliance on advertising revenues by the
cable network industry, most cable networks require that cable
operators place their networks on widely distributed tiers. A variety
of factors--such as the pricing of à la carte service, consumers'
purchasing patterns, and whether certain niche networks would cease to
exist with à la carte service--make it difficult to ascertain how many
consumers would be better off and how many would be made worse off
under an à la carte approach. Creating a separate tier for sports
channels may be viable because this genre of programming has a loyal
base of customers. However, sports leagues may be reluctant to have
sporting events appear on cable networks that are placed on a separate
sports tier because the programming would not be widely available.
Certain options for addressing factors that may be contributing to
cable rate increases have been put forth. Although reregulation of
cable rates stands as a possible option, taking steps to promote
competition would help to reduce cable rates by leveraging the normal
workings of the marketplace. Specific options 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 the lower rates. We are not making any specific
recommendations regarding the adoption of any of these options.
FCC provided comments on a draft of this report in which they stated
that the agency is taking steps to redesign their survey questionnaire
in an attempt to obtain more accurate information. However, FCC
questioned, on a cost/benefit basis, the utility of adopting a revised
process to keep the status of effective competition in franchises up to
date. We believe that providing the Congress with reliable information
on cable rates and competition is important, and that more accurate
effective competition designations would help to accomplish this.
Therefore, we believe that FCC should examine whether cost-effective
alternative processes exist to enhance the accuracy of its effective
competition designations. FCC's comments are contained in appendix VI,
along with our responses to those comments. We also provided a draft of
this report to several industry participants and other experts for
their review and comment. The comments we received covered a broad
range of issues and each groups' comments are summarized in appendix
VII.
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 (introduced in 1972), Showtime
(introduced in 1976), and ESPN (introduced in 1979). 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 township or county.[Footnote 5] During cable's early years,
franchising authorities regulated many aspects of cable television
service, including franchise terms and conditions and subscriber rates.
In 1984, the Congress passed the Cable Communications Policy Act, which
imposed some limitations on franchising authorities' regulation of
rates.[Footnote 6] 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 7] 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 8]
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:
Today, wire-based competition--that is, competition from a provider
using a wire technology, such as a local telephone company or an
electric utility--is limited to very few markets, with cable
subscribers in about 2 percent of markets having the opportunity to
choose between two or more wire-based video operators. However, in
those markets where this competition is present, cable rates are
significantly lower--by about 15 percent--than cable rates in similar
markets without wire-based competition, according to our analysis of
rates in 2001. DBS operators have emerged as a nationwide competitor to
cable operators. This competition 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 channels has induced cable
operators to improve the quality of their service.
Wire-Based Competition Is Limited but, Where Available, Has a Downward
Impact on Cable Rates:
Although the Telecommunications Act of 1996 sought to increase wire-
based competition, few customers have a choice among companies
providing video service via wire-based facilities. 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 9] Our interviews with 11 cable operators and five
financial analysis firms yielded a similar finding--wire-based
competition is limited. Local telephone companies are not providing
widespread competition to cable, and FCC also reported in their 2002
video competition report that the four largest local telephone
companies have largely exited the cable market. Also, electric and gas
utilities--which can use their networks and rights of way to provide
video services--are only providing competition to cable operators in
scattered localities. Broadband service providers--a relatively new
kind of entrant, such as Knology and WideOpenWest--are building new,
advanced networks to provide a bundle of services (video, voice, and
high-speed Internet access) and compete with cable operators as well as
with telephone companies. However, the three largest broadband service
providers only serve approximately 940,000 subscribers.
Although wire-based competition is limited, in those markets where it
exists, this competition has a measurable impact. According to our
cable-satellite model (see app. IV), in 2001, cable rates were
approximately 15 percent lower in areas where a wire-based competitor
was present.[Footnote 10] 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 example, 1 cable operator
told us that it stopped raising rates 3 years ago in one market where a
wire-based competitor had entered.[Footnote 11]
DBS Has Become an Important Competitor to Cable Operators Nationwide:
In recent years, DBS has become the primary competitor to cable
operators in the subscription video industry. As of June 2002, about 18
million households--roughly 20 percent of the total video subscribers-
-were served by DBS. Most cable operators that we interviewed described
competition from DBS as substantial. 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--that is,
to offer the signals of over-the-air broadcast stations, such as
affiliates of ABC, CBS, Fox, and NBC--via satellite to their
customers.[Footnote 12] 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--
that is, the percentage of housing units that have satellite service--
is approximately 40 percent higher than in areas where subscribers
cannot receive these stations from the DBS operators. In a recent
report, FCC noted that in 62 of the 210 television markets in the
United States, at least one DBS operator offered local broadcast
stations.[Footnote 13] Both EchoStar and DIRECTV continue to roll out
the provision of local broadcast stations in more markets.
DBS competition is associated with a slight reduction in cable rates as
well as improved quality and service. 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.[Footnote 14] 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. These results
indicate that cable operators are responding to DBS competition and the
provision of local broadcast stations by lowering rates slightly and
improving their quality. 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:
Responses to our cable franchise survey suggest that 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. In particular, we found that respondents
did not fill out FCC's survey on factors underlying cable rate
increases in a consistent manner. Additionally, FCC's designations of
franchise areas as having (or not having) effective competition do not
always accurately reflect current competitive conditions. For
determinations of effective competition that are based on DBS service,
local franchising authorities have raised concerns about the industry
data used to substantiate these filings. 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. Additionally, the potential for this information to be used in
debates on important policy decisions, such as media consolidation,
also necessitates reliable information in FCC's report.
Weaknesses in FCC's Survey May Lead to Inaccuracies in the Relative
Importance of Cost Factors:
Results of our cable franchise survey indicated considerable variation
in how cable franchises completed the section of FCC's 2002 cable rate
survey on which they provide information about the factors underlying
recent cable rate increases. Figure 1 shows the actual section of FCC's
survey that franchises completed to provide their cost change
information; see also appendix II for our cable franchise survey. We
identified two key problems with FCC's survey, as follows: a lack of
guidance on how the survey was to be completed, and the requirement
that the sum of the cost and noncost factors equal the change in cable
rates.
Figure 1: Section of FCC's 2002 Cable Rate Survey Covering Cable
Franchises' Rate and Cost Changes:
[See PDF for image]
[End of figure]
Our telephone survey with 100 cable franchises indicated that a lack of
specific guidance regarding this cost change section of the survey
caused considerable confusion about how to complete the form.[Footnote
15] Every franchise that we surveyed said it was unclear what FCC
expected for at least one of the six factors (five cost factors plus a
noncost factor) listed in figure 1 above, and 73 of the 100 franchises
said that the instructions were insufficient. In particular, several
cable representatives we surveyed noted that there were no instructions
or examples to show how to calculate investment, what types of cost
elements should go into the "other cost" category, and what FCC meant
by "non-cost-related factors." This lack of guidance created
considerable variation in the approaches taken to develop the cost
factors. For example, although 76 of the franchises left the noncost
factors answer blank, other franchises included a number to reflect a
change in profit margin or the need to establish uniform rates across
franchises.
Our cable franchise survey also indicated that another source of
confusion for respondents was the requirement that the sum of the
underlying cost and noncost factors (see fig. 1, lines 52-57) equal the
change in the franchise's cable rates (see fig. 1, line 51). Because
the expanded-basic service was deregulated in 1999, it is no longer
necessary that the cost factors equal the yearly change in cable
rates.[Footnote 16] FCC officials told us that, cable operators could
use the noncost factor element to adjust the sum of the factors to
ensure that they equal the change in annual rates. That is, FCC
officials suggested that after accounting for all cost factors, any
difference between the sum of these costs and the rate change--whether
positive or negative--could be accounted for by the noncost factor.
However, it appears that this information may not have been clearly
communicated to the cable franchises. We found that only 10 of the 100
franchises that we surveyed took this approach and instead, most
franchises told us that they chose to change their estimate of one or
more of the cost factors in order to achieve the rate-cost balance. In
most cases, cable representatives told us that this meant reducing
other cost factors because most franchises told us that their actual
annual cost increases for the year covered by the 2002 survey exceeded
their rate change for expanded basic service.[Footnote 17] In fact,
most franchises--84 of the 100 franchises we surveyed--did not provide
a complete or accurate accounting of their cost changes for the
year.[Footnote 18]
According to FCC's 2002 cable rate report, cable franchises attributed
65 percent of their rate increases last year to the changes in the cost
of new and existing programming. Comparatively, investment and other
cost changes had a lesser role in the rate increases. However, our
findings regarding how cable franchises responded to FCC's survey on
these issues indicated that the survey findings may not accurately
reflect the relative importance of these cost factors. In particular,
we found that most franchises used real cost data to calculate the
change in new or existing programming costs. However, franchises often
understated their estimates for investments and other costs. For
example, 33 of the 83 respondents who entered zero for infrastructure
investment, noted in our survey discussions with them that there had
been costs for such investments that year. Similarly, we found that 64
franchises entered a zero for the other cost category, even though half
of these respondents told us during our survey that there were costs in
that category during that year. Moreover, the investment and other cost
factors were often used to adjust overall costs to equal the rate
change for the year--these adjustments most often required downward
adjustments in these cost factors. 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 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. FCC reported that on July 1, 2001, competitive operators were
charging an average monthly rate of $34.93, while noncompetitive
operators were charging $37.13--a 6.3 percent differential for the
combined basic and expanded-basic tiers of service and
equipment.[Footnote 19] In another analysis, FCC looked at a subset of
those areas that had been found to have effective competition--that is,
areas in which effective competition had been granted on the basis of
the existence of a wire-based competitor. Using a regression model, FCC
found that cable rates were nearly 7 percent lower when such a
competitor existed. Conversely, as previously mentioned, we found a
greater impact of wire-based competition using a similar model, that
is, rates were lower by 15 percent in locations where a wire-based
competitor was operating, according to our cable-satellite model.
One possible explanation for the difference between FCC's results and
those of our cable-satellite model may be the differences in the
criteria used to classify the status of competition. When reporting on
differences between average rates for locations with and without
effective competition, FCC is mandated to include in the group defined
to have effective competition only those franchise areas that have had
a finding by FCC that is based on the statutory definition of effective
competition.[Footnote 20] However, FCC's process for implementing this
mandate may lead to situations in which the effective competition
designation does not reflect the actual state of competition in the
current time frame. In particular, key aspects of FCC's process are as
follows:
* As set forth in FCC's rules, cable franchises are presumed not to
face effective competition.
* Cable operators can petition FCC for a finding of effective
competition, which would prohibit the franchising authority from
regulating the rates for basic-tier service.[Footnote 21] If the cable
franchise can show that at least one of the statutory criteria for
effective competition is met, FCC classifies the cable franchise as
facing effective competition.
* A franchising authority can file a petition for recertification to
regulate rates for basic-tier service, if it believes that the
conditions under which effective competition was granted no longer
exist. If recertification is granted, the franchise will no longer be
considered to have effective competition.
Our analysis of FCC's classification of cable franchises regarding
effective competition revealed that FCC's process for maintaining this
classification--namely, their reliance on external parties to file for
changes in the classification--may lead to some classifications of the
competitive status of franchises that do not reflect current
conditions. Using data from FCC's 2002 cable rate 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 classification of effective competition for the
franchise in FCC's records. We found some discrepancies. We
subsequently interviewed officials from local franchising authorities
in a number of areas with seemingly inconsistent information to further
investigate the nature of the discrepancies.
Of 86 franchises in FCC's 2002 survey classified as satisfying the low-
penetration test[Footnote 22] for effective competition, we found that
48 franchises reported current information to FCC that indicate, on the
basis of our calculations, the penetration rate exceeded the 30 percent
threshold.[Footnote 23] We spoke with officials from three local
franchising authorities in areas having a low-penetration
classification and found the following: a Maryland franchise with a
current penetration rate of 75 percent, a Virginia franchise with a
penetration rate of 76 percent, and a California franchise with a
penetration rate of 97 percent. In the aforementioned franchise areas,
the local officials told us that they did not know why the franchise
was classified as low penetration. However, our review of FCC filings
found that the cable operators in those franchise areas had filed for
and received an effective competition finding that was based on the
low-penetration test in the years between 1994 and 1997. Because there
had never been a petition by the franchise authority to be recertified
to regulate basic cable rates, the franchise area remained designated
as having low penetration.
Under the statute, local franchising authorities do not have the
authority to regulate cable rates in franchises found to have effective
competition. Therefore, a franchise should not simultaneously be listed
as facing effective competition and having regulation of basic rates.
Of 262 franchises in FCC's survey classified as facing effective
competition, 40 also reported that the franchising authority regulated
their basic service rates. For example, FCC survey data include one
franchise each in three states--New Jersey, Kentucky, and California--
that were identified as facing effective competition and also as
subject to rate regulation. Officials from the franchising authorities
in New Jersey and Kentucky told us that they indeed regulate the basic
service tier, and that no competitor was present. The official in
Kentucky said that the discrepancy could be the result of a wire-based
competitor that was granted a franchise but has yet to enter the market
due to a lawsuit filed by the incumbent cable operator attempting to
block the competitor's entry. The official in New Jersey said there is
no competition in the area and the discrepancy may be attributed to the
fact that two cable operators hold franchise agreements in the
community, but do not compete against each other because each serves a
different area of the community. According to an official in the
California franchise, the franchise is not regulated--implying that the
cable operator incorrectly answered FCC's question. However, the
official also told us that there is no competition in the area--that
is, while two cable operators hold franchise agreements, they do not
compete against each other. We also found one franchise each in two
states--Texas and Illinois--that were identified as facing effective
competition and also reporting that they are subject to rate
regulation. The official in the Texas franchise said that the
discrepancy may be attributed to the fact that the incumbent cable
operator filed for a finding of effective competition, but a finding
has not yet been granted. According to a local franchising authority
official in the Illinois franchise, the discrepancy could be a result
of a wire-based competitor that expressed an interest in entering the
market, but never did.
When the information contained in FCC's database on effective
competition conflicts with a cable operator's response on the annual
survey, FCC uses the information in their database for the purpose of
its analysis of the differences in prices in areas with and without
effective competition. We found that the survey responses on effective
competition were not in accord with FCC's files for 24 percent of all
franchises--or 165 franchises--in its 2002 survey.
DBS Subscriber Information Used in Effective Competition Filings Has
Not Been Independently Validated:
In the last several years, there have been dozens of petitions for a
determination of effective competition based on DBS competition.
However, the data on subscriber counts by zip code, which are used to
make these petitions, are considered proprietary business information
by DBS companies. DBS providers EchoStar and DIRECTV, as well as big
dish satellite provider Motorola, have agreed to make their individual
market data available to SkyTRENDS--a market research and reporting
firm for the satellite industry--which aggregates the information
across the providers.[Footnote 24] SkyTRENDS subsequently makes the
aggregated data available to cable operators for the purpose of making
filings for effective competition to FCC. Although FCC has not verified
the SkyTRENDS data or the method used by SkyTRENDS (and by cable
operators) to calculate penetration levels at the franchise level, it
nonetheless accepts SkyTRENDS data for these petitions.
The SkyTRENDS data used to make effective competition petitions that
are based on DBS competition are generally not available to government
regulators. According to government regulators and a SkyTRENDS
official, SkyTRENDS will not provide local franchising authorities with
the underlying data used to support these filings, unless (in
accordance with agreements with the satellite providers) the cable
operator authorizes that dissemination. However, franchising
authorities do have access to the data provided by cable franchises in
their submissions for effective competition to FCC. According to FCC
officials, the agency has not obtained detailed SkyTRENDS data since
1999. Some local franchise authorities have questioned the accuracy and
validity of the DBS data and methods used by SkyTRENDS and cable
operators for developing DBS penetration levels used to support
effective competition determinations. Nevertheless, FCC has reiterated
that it finds the SkyTRENDS data reliable for purposes of effective
competition determinations, and that these data are the only available
source for determining DBS penetration.
The Lack of Reliable Information May Compromise Monitoring and
Oversight of the Cable Industry:
FCC's annual cable rate report provides an important source of
information about the cable industry. This report provides an extensive
analysis of the cable industry, including such important factors as
cable rates, factors underlying changes in cable rates, and provision
of advanced services (such as cable modem Internet access). FCC's
findings provide the Congress with information relevant to important
policy decisions, including the regulation of cable rates and/or
services and media consolidation and the convergence of video, voice,
and data services. The lack of reliable information in FCC's cable rate
report may compromise the ability of the Congress to make these
important policy decisions and of FCC to monitor and provide oversight
of the cable industry. As such, it is important for FCC's report to
provide accurate, current, and relevant information about the cable
industry.
A Variety of Factors Contribute to Cable Rate Increases:
During the preceding 5 years, cable rates have increased approximately
40 percent--well in excess of the approximately 12 percent increase in
the general rate of inflation. We found that a number of factors
contributed to the increase in cable rates. These factors include
increased expenditures on programming, infrastructure investments, and
costs associated with customer service. 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.
Rates for Cable Service Have Increased Rapidly, Far Outpacing the
General Rate of Inflation:
FCC data indicate that the average monthly rate subscribers are charged
for the combined basic and expanded-basic tiers of service rose from
$26.06 in 1997 to $36.47 in 2002--a 40 percent increase over the 5
years. This rate of increase is much greater than the general rate of
inflation, as measured by the Consumer Price Index (CPI), which rose 12
percent over the same period. The CPI cable television subcategory
index also shows cable rates increasing much faster than inflation,
although the rise is somewhat less than the rise in rates as reported
by FCC, likely because the Bureau of Labor Statistics (BLS) calculates
this index in a way that takes into account the increasing number of
channels offered over time. As figure 2 shows, the CPI cable television
subcategory index rose just under 30 percent in the same 5-year time
frame.
Several cable industry officials told us that the general rate of
inflation is not an appropriate gauge for evaluating cable rates. In
particular, these officials told us that a more appropriate comparison
against which to evaluate the price increases for cable television
would be other services that have the same kind of cost factors, such
as other forms of entertainment media and services, which have also
experienced significant price increases in recent years. Moreover,
several cable industry representatives told us that on a per-channel
basis, the increase in cable rates has not been as dramatic because
cable operators are providing additional cable networks.[Footnote 25]
However, it is not clear how meaningful cable rates reported on a per-
channel basis are since subscribers cannot purchase cable service on a
per-channel basis. Alternatively, in a recent analysis, a researcher
found that because the number of hours subscribers view cable networks
has increased, cable rates, adjusted for this additional viewing, have
actually declined.[Footnote 26]
Figure 2: Change in the General and Cable Television Consumer Price
Indexes, 1997 - 2002:
[See PDF for image]
[End of figure]
Increases in Expenditures on Cable Programming Contribute to Higher
Cable Rates:
As discussed in the previous section, one important factor contributing
to higher cable rates is cable operators' increased costs to purchase
programming from cable networks. Ten of the 11 cable operators, 8 of
the 15 cable networks, and all of the financial analysts we interviewed
told us that higher programming costs contribute 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. 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.[Footnote
27] Although these estimated increases are somewhat different--which
probably occurs because the data underlying these analyses are from
different sources--both methods appear to reflect a substantial rise in
programming expenses over the past few years.
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 in the 3 years between 1999 and
2002.[Footnote 28] Conversely, for the 72 nonsports networks, the
average increase in license fees for the same period was approximately
26 percent. Further, the average license fees for the sports networks
were substantially higher than the average for other networks. See
figure 3 for a comparison of the average license fees for sports
programming networks compared with nonsports networks from 1999 to
2002.
Figure 3: Average Monthly License Fees per Subscriber--Sports
Programming 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. Also, some
executives cited the increased cost of sports rights[Footnote 29] and
increased competition among networks for the broadcast rights of
existing programming (such as syndicated situation comedies). As figure
4 shows, data from Kagan World Media indicate that of 79 cable networks
we analyzed, expenditures by these networks to produce programming
increased from $6.47 billion in 1999 to $8.90 billion in 2002, or by
about 38 percent.[Footnote 30]
Figure 4: Expenditures by 79 Cable Networks to Produce Programming,
1999 - 2002:
[See PDF for image]
[End of figure]
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. In fact, 3 cable networks with whom we spoke said that they
believe at least half of the license fees cable operators pay to carry
their networks are recouped through the sale of the local advertising
time that cable networks allow the cable operators to sell, which
typically amounts to 2 minutes per hour. According to industry data,
cable operators received over $3 billion from the sale of local
advertising time in recent years. 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 31] However, we were told
that only the larger cable operators gain significant revenues from the
sale of advertising, and that smaller cable operators generally do not
sell as much local advertising because it is not always cost-effective
for them to do so. In fact, even the larger cable operators do not sell
all of the local advertising time that is available to them because
there are significant costs of selling television ads.
Several Other Factors Appear to Contribute to Higher Rates for Cable
Service:
In addition to higher programming costs, the cable industry has
incurred other increased costs. For example, according to industry
sources, the cable industry spent over $75 billion between 1996 and
2002 to upgrade its infrastructure by replacing degraded coaxial cable
with fiber optics and adding digital capabilities (see fig. 5). 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 32] Five of the 11 cable operators, 9 of the 15 cable
networks, and three of the five financial analysts we interviewed said
investments in system upgrades contributed to increases in consumer
cable rates. For example, one network with whom we spoke said that the
major cause of recent cable rate increases is the cable industry's
capital improvements. Although these upgrades benefit cable subscribers
by expanding the number of cable networks available and improving
picture quality, much of the benefit of infrastructure improvements
accrue to subscribers who purchase new, advanced services, such as
broadband Internet access. One expert who commented on our report noted
that there is no need for cable operators to pass on costs associated
with infrastructure upgrades to subscribers purchasing basic and
expanded-basic service because, by his calculations, these costs are
almost fully offset by increases in revenues for digital tier and
advanced (e.g., cable modem) services.
Figure 5: Cable Industry Infrastructure Expenditures, 1996 - 2002:
[See PDF for image]
[End of figure]
Another factor contributing to higher cable rates is cable operators'
increased expenditures on customer service. NCTA said that the industry
is paying more in labor costs because it has sought better-educated and
more highly trained employees to provide customer support for the new
services that the cable operators are offering. Additionally, customer
service is now typically available to cable subscribers 24 hours a day,
7 days a week. Three of the five financial analysts we interviewed
agreed that increased customer service costs contributed to increases
in cable rates, while 5 of the 11 cable operators we interviewed said
increases in customer service, labor costs, or both contributed to
higher cable rates.
Programming Expenses and Infrastructure Investment Appear to Be Primary
Contributors to Cable Rate Increases:
On the basis of financial data from 9 cable operators, we found that
annual subscriber video-based revenues--that is, revenues from basic,
expanded-basic, and digital tiers; pay-per-view; installation charges;
and other revenues such as equipment rental--increased approximately
$79 per subscriber from 1999 to 2002. By 2002, revenues per subscriber
averaged $561, or $47 per month. 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. Although this may indicate
that the marginal profits for the video business have been declining--
which is consistent with what we were told during our interviews with
financial analysts--there are two important caveats to this conclusion.
First, depreciation expenses (and therefore infrastructure investment)
represent a joint (or common) expense for both video-based and
Internet-based services. Because these expenses are associated with
more than one service, it is unclear how much of this cost should be
attributed to video-based services. Second, cable operators are
enjoying increased revenues from these nonvideo sources. For example,
revenues from Internet-based services increased approximately $74 per
subscriber during the same period. Thus, even if video profit margins
have been in decline, this does not imply that overall profitability of
cable operators has declined.
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. We found
that there are two primary ownership relationships that some believe
influence the cost of cable programming: relationships between cable
networks and cable operators, and relationships between cable networks
and broadcasters. To understand the nature of these ownership
relationships, we analyzed the ownership of 90 cable networks that are
carried most frequently on cable operators' basic or expanded-basic
tier (see fig. 6). Of these 90 cable networks, we found that
approximately 19 percent were majority-owned (i.e., at least 50 percent
owned) by a cable operator.[Footnote 33] For example, cable operators
have ownership interests of at least 50 percent in such widely
distributed cable networks as TBS, TNT, CNN, AMC, and the Cartoon
Network.[Footnote 34] We also found that approximately 43 percent of
the 90 networks were majority-owned by a broadcaster. For example,
broadcasters have ownership interests of at least 50 percent in such
widely distributed cable networks as ESPN, FX, MSNBC, and MTV. The
remaining 38 percent of the networks are not majority-owned by
broadcasters or cable operators.
Figure 6: 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. In particular, 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.[Footnote 35] 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 36] 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. There was a
particular concern expressed to us regarding retransmission consent
agreements. These agreements often include, as part of the agreement
between cable operators and broadcasters for the right of the cable
operator to carry the broadcast station, a simultaneous agreement to
carry one or more broadcast-owned cable networks. Many representatives
from cable operators and several independent (nonbroadcast) cable
networks told us that because the terms of retransmission consent
agreements often include carriage of broadcast-owned cable networks,
cable operators sometimes carry networks they might otherwise not have
carried, and this practice can make it difficult for independent cable
networks to be carried by cable operators. Alternatively,
representatives of the broadcast networks told us that, to their
knowledge, cable networks had not been dropped nor were independent
cable networks unable to be carried by cable operators because of
retransmission consent agreements. Further, these representatives told
us that they accept cash payment for carriage of the broadcast station,
but that cable operators prefer to carry broadcast-owned cable networks
in lieu of a cash payment.
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. Appendix V provides a
detailed discussion of this model.
Several Factors Generally Lead Cable Operators to Offer Large Tiers of
Networks Instead of Providing À La Carte or Minitier Service:
Most cable operators with whom we spoke provide subscribers with
similar tiers of networks, typically the basic and expanded-basic
tiers, which provide subscribers with little choice regarding the
specific networks they purchase. Adopting an à 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 impose additional costs on both cable
operators and subscribers. Additionally, this approach 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 à la carte approach could result in reduced
advertising revenues and might result in higher per-channel rates and
less diversity in program choice. Because of this reliance on
advertising revenues by cable networks, most cable networks require
cable operators to place their network on widely distributed tiers. A
variety of factors--such as the pricing of à la carte service,
consumers' purchasing patterns, and whether certain niche networks
would cease to exist with à la carte service--make it difficult to
ascertain how many consumers would be better off and how many would be
made worse off under an à la carte approach. Creating a greater number
of smaller tiers could cause many of the same technological and
economic concerns as an à la carte approach.
Most Cable Operators Offer Similar Bundles of Networks:
The 11 cable operators that we interviewed adopt very similar
strategies for bundling networks into tiers of service. These cable
operators offer their subscribers the following tiers of service: basic
tier (11 operators), expanded-basic tier (11 operators), digital tier
(11 operators), and premium services (7 operators). Five of the 11
cable operators offer the same or similar tiers of service to
subscribers in all their franchise areas. The remaining 6 cable
operators offer different tiers of service among their franchise areas;
we were told that these differences are generally the result of the
cable operators acquiring franchises with different tiering strategies.
Using data from FCC's 2002 cable rate survey, we also examined the
networks included in the basic, expanded-basic, and digital tiers of
service. With basic tier service, subscribers receive, on average,
approximately 25 channels, which include the local broadcast
stations.[Footnote 37] The expanded-basic tier provides, on average, an
additional 36 channels. With a digital tier, subscribers receive, on
average, 104 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.
Concerns Exist about a Lack of Subscriber Choice:
The manner in which cable networks are currently packaged has raised
concern among policy makers and consumer advocates about the lack of
consumer choice in selecting the programming they receive. Under the
current approach, it is likely that many subscribers are receiving
cable networks that they do not watch. In fact, a 2000 Nielsen Media
Research Report indicated that households receiving more than 70
networks only watch, on average, about 17 of these networks. The
current approach has sparked calls for more flexibility in the manner
that subscribers receive cable service, including the option of à la
carte service, in which subscribers receive only the networks that they
choose and for which they are willing to pay. Additionally, an
organization representing small cable operators recently released a
report advocating an à la carte approach because they believe it will
mitigate the ability of broadcast networks to gain carriage agreements
for their cable networks through the retransmission consent
process.[Footnote 38]
An À La Carte Network Offering Could Impose Costs on Cable Subscribers
and Operators:
If cable operators were to offer all networks on an à 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.
Today, the networks included on the basic and expanded-basic tiers are
usually transmitted throughout the cable system in an unscrambled
fashion. Because most televisions in operation today are cable ready, a
cable wire can usually be connected directly into the television and
the subscriber can view all of the networks on those tiers. An
addressable converter box--which serves to unscramble any scrambled
networks--is only needed if the subscriber chooses to purchase networks
that the cable operator transmits in a scrambled fashion, as is usually
the case for networks placed on digital tiers, certain premium movie
channels, and pay-per-view channels.[Footnote 39]
If all networks were offered on an à la carte basis, cable operators
would need to scramble all of the networks they transmit to ensure that
subscribers are unable to view networks they are not paying to receive.
Under such a scenario, addressable converter boxes, which enable the
operator to send messages from the cable facility to the box to
indicate which networks the subscriber is purchasing and thus allowed
to watch, would need to be connected to all television sets attached to
the cable system. The addressable converter box would unscramble the
signals of the networks that the subscriber has agreed to purchase. The
need for an addressable converter box deployment could be costly.
According to FCC's 2002 survey data, of the franchises that responded
to the survey and provided cost data on addressable converter boxes,
the average monthly rental price for a box is approximately $4.39. For
homes that have multiple television sets, the expense for these boxes
could add up--the extra cost for a home that needs to add three
addressable converter boxes would be about $13.17 a month at current
prices.
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. For
example, a representative of 1 cable operator we interviewed indicated
that most of its subscribers do not have addressable converter boxes. A
representative of another cable operator stated that only 40 percent of
its subscribers have addressable converter boxes. Conversely, 1
operator told us that nearly three out of four of its subscribers do
have at least one addressable converter box in place, and that the
number of homes with a box will only continue to increase. Addressable
converter boxes are becoming more commonly deployed as more customers
subscribe to digital tiers. 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.
Moreover, consumer electronic manufacturers have recently submitted
plans to FCC regarding specifications for new television sets that will
effectively have the functionality of an addressable box within the
television set. Once most customers have addressable converter boxes or
these new televisions in place, the technical difficulties of an à la
carte approach would be mitigated. Several experts that we spoke with
offered a wide divergence of views on how long it would be before
addressable converter boxes and/or new televisions with built-in boxes
are fully deployed in all American homes.
In addition to the subscriber costs of converter boxes, cable operators
also would incur costs to monitor and manage an à la carte approach.
Cable operators likely would have to add additional customer service
and technical staff to deal with the increased number of transactions
that would occur under an à la carte regime. One cable network
representative we interviewed indicated that an à la carte regime would
be a substantial undertaking for the cable operators. For example, this
network representative told us that a cable operator offering 150
channels of à la carte programming could have its subscribers choosing
all different numbers of networks, which would mean that subscribers
would be spending much longer periods of times on the telephone with
customer service staff.
Cable Networks Often Specify Placement on the Basic or Expanded-Basic
Tier:
Even if cable operators desired to offer customers a wider variety of
bundles of services or even à la carte service, most contracts
negotiated between cable networks and cable operators prohibit these
alternatives. All 11 cable operators and four of five financial
analysts that we interviewed told us that program contracts generally
specify the tier that the network must appear on, or the contract
establishes a threshold percentage of subscribers that must be able to
see a network--which effectively requires the same tier placements. For
example, one individual responsible for negotiating program contracts
for cable operators noted that all of the top 40 to 50 networks specify
that their networks appear on either the basic or expanded-basic tier.
We also reviewed sample contracts for 2 cable networks, one contract
specified that the network appear on the basic or expanded-basic tier
and the other contract specified "the most widely subscribed level of
service." 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.
Economic Characteristics of the Cable Network Market Are a Constraint
to an À La Carte Approach:
If cable subscribers were allowed to choose networks on an à la carte
basis, the economics of the cable network industry could be altered,
and, 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. For example, 3 of the 15 cable
network representatives we interviewed indicated that they receive
approximately 60 percent of their revenue from advertising. 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 to networks for the
right to carry their signals. Figure 7 provides a breakdown of the
relationship in recent years between advertising revenues and license
fee revenues on the basis of data from Kagan.
Figure 7: 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. In other words, 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. According to cable
network representatives we interviewed, any movement of networks from
the most widely distributed tiers to an à la carte format could result
in a reduced amount that advertisers are willing to pay for advertising
time because there would be a reduction in the number of viewers
available to watch the networks. 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. In particular, we were told by many cable networks that
under an à la carte system, the cost burden of cable television would
become less reliant on advertising revenues and much more reliant on
license fees that would likely be passed on to consumers. For example,
one cable network representative estimated that to compensate for the
loss of advertising revenue in an à la carte scenario, the network
would have to raise its monthly license fee from the current monthly
rate of $0.25 per subscriber to a level several fold higher--possibly
as much as a few dollars per subscriber per month. Additionally, four
of the five financial analysts we interviewed also stated that license
fees would increase under an à la carte approach. At the same time, if
cable networks see advertising revenues decline, they will also likely
take steps to reduce production costs, because cable operators might be
unwilling to accept increases in license fees to fully offset the
decline in adverting revenues. As such, it is not clear whether license
fees would need to completely offset any declines in advertising
revenues.
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 à la carte
system. The cable networks that we interviewed generally told us that
they believe that an à la carte approach would not reduce cable rates
for most subscribers. In fact, representatives of 7 cable networks
noted that costs to subscribers could actually increase under an à la
carte system, while 6 networks said that subscribers might pay about
the same monthly bill but would likely receive far fewer channels.
Conversely, for subscribers who purchase only a few cable networks,
rates would likely decline under this approach because they would only
have to pay for the limited number of networks that they choose to
purchase. Thus, an à la carte approach would provide consumers with
greater control over their cable choices, even if, on average, consumer
bills did not decline.
Most of the cable networks we interviewed also believe that programming
diversity would suffer under an à la carte system because some cable
networks, especially small and independent networks, would not be able
to gain enough subscribers to support the network. For example, one
network told us that under an à la carte system, fewer networks would
remain financially viable and new networks would be less likely to be
developed. Three of the cable operators and four of the five financial
analysts we interviewed also said that smaller networks or those
providing specialty programming would be hurt the most by an à la carte
system. A number of the cable networks indicated that launching a new
network under an à la carte system would be very difficult. Similarly,
according to NCTA, an à la carte approach could result in the
disappearance of many networks and could undermine the prospects for
any new basic cable networks. Further, if an à la carte system resulted
in limited subscribers and decreased advertising revenue, several
networks said the quality of programming available might be adversely
impacted.
The manner in which an à 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--if not most--customers, if
faced with an à la carte selection of networks, would choose to receive
only a limited number of networks. This assumption is consistent with
the data on viewing habits--as previously mentioned, a recent study has
shown that most people, on average, watch only about 17 networks.
Nevertheless, under an à la carte scenario, cable companies may price
large packages of networks in a way that provides an incentive for
subscribers to choose a wide number of networks. Additionally, under
this approach, cable operators may choose to price cable services in an
entirely different way. One option suggested was that, similar to
common pricing schemes in the electric and natural gas industries,
subscribers might pay a flat charge for the connection to the cable
operator's system plus additional charges for each network the
subscriber chooses to purchase. This could result in subscribers
purchasing only a few channels paying a higher rate per channel than
subscribers purchasing many channels. One of the issues that some
industry representatives discussed with us concerned the value
consumers place 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. 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 à la carte approach. These factors
include how cable operators would price their services under an à 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.
Creating Additional Tiers of Service Is More Feasible, but Economic and
Technological Constraints Would Also Apply:
Another alternative to the à la carte approach that has been discussed
is a move to minitiers, under which subscribers would choose small
tiers of programming that are grouped by genre (such as sports, news
and information, and general entertainment). Although industry
representatives told us that this approach might be more viable than an
à la carte approach, we were also told that all of the issues
associated with an à la carte regime would also apply to minitiers.
Representatives of 8 of the 15 cable networks we interviewed indicated
that the creation of additional tiers would be a disadvantage to the
cable industry. Four cable network representatives stated that
increasing the number of tiers would result in the same outcome as an à
la carte system: a decline in cable network advertising revenue that
would force networks to increase their license fees to cable operators,
which would result in higher cable rates. Six of the 11 cable operators
we interviewed also noted that a minitier approach would also require
more deployment of addressable converter boxes. Finally, a
representative of 1 cable operator told us that after experimenting
with genre tiers in the past, the operator determined that this was not
a successful strategy. This representative stated that subscribers felt
the cable operator was forcing them to buy many tiers, since a typical
household wanted to see one or more networks in several of the tiers.
However, officials representing 5 of the 11 cable operators we
interviewed indicated that the tier concept might be viable in the case
of sports programming. A representative of 1 cable operator indicated
that a sports tier would be appropriate because sport fans are loyal
customers and the cost of sports programming is very high. A
representative of another cable operator noted that creating a sports
tier should be an option, but that other types of programming would not
work on separate tiers. Recently, several regional sports networks have
been placed on sports-only tiers in the New York City metropolitan
area.[Footnote 40]
Alternatively, representatives from two major sports leagues and a
sports network do not believe that a sports-only tier is necessary, and
some of these representatives did not believe such a tier would be
viable. One important objective of the major sports leagues is to
obtain the widest distribution of their games as possible. Therefore,
many games appear either on broadcast television or on cable networks
carried on the basic or expanded-basic tier. To ensure this wide
distribution of their games, the major sports leagues include
provisions in their contracts with cable networks that specify carriage
of their games on a tier with broad distribution. A representative of a
sports network said that if their network were offered on a sports-only
tier, the nature of the network would change. In fact, representatives
of the three leagues with whom we spoke said that if sports networks
were on a sports-only tier, the leagues would not want to sell the
right to carry certain events on those networks since it would likely
not be available to most viewers.[Footnote 41] One of these three
representatives said that under this scenario, sports-only networks
might cease to exist and any sports on cable would only be placed on
general entertainment networks that provide variety programming--
similar to broadcast networks. Finally, representatives from two of the
sports leagues and a sports network said that there is no reason to
believe that removing the sports networks from the expanded-basic tier
would result in any substantial reduction in the rate for expanded-
basic tier cable service. When two cable operators in the New York City
metropolitan area moved regional sports networks to a separate tier,
these companies lowered the expanded-basic cable rate by only 50 cents
to a dollar.[Footnote 42]
Industry Participants Have Cited Certain Options That May Address
Factors Contributing to Rising Cable Rates:
In recent years, there has been concern about the rapidity of cable
rate increases. As we previously noted, cable rates have risen by about
40 percent in the last 5 years, far outstripping increases in the
general rate of inflation. Several approaches for addressing the rise
in cable rates have been put forth. These approaches can be grouped
into the following two main categories: (1) the control of rates
through regulation and (2) the promotion of lower rates through market
mechanisms, such as through greater competition.
Some consumer groups have pointed to the lack of competition as
evidence that reregulation needs to be considered. One representative
of a consumer group noted that regulation might be the only alternative
to mitigate increasing cable rates and cable operators' market power.
For example, one consumer group has recommended, among a variety of
options, returning authority to reregulate cable rates to local and
state governments. However, some experts expressed concerns about cable
regulation after the 1992 Act. First, some academic critics believe
that cable regulation lowered the quality of programming, discouraged
investment in new facilities, and imposed administrative burdens on the
industry and regulators. Second, according to these same critics, there
is no strong evidence that cable rates were significantly constrained
during that regulated era. Finally, regulation today could be
considerably more complex than it was 11 years ago. Today, video
providers use varied platforms (cable, DBS) to provide an array of
communication services, including video service, Internet access, and
video on demand. A regulatory scheme would need to consider which
services and providers to regulate, and how to allocate the common
costs of a communications network in a regulatory context across the
various services provided.
Alternatively, taking steps to promote competition could help to reduce
or slow the growth of cable rates by leveraging the normal workings of
the marketplace. In those few local markets where a second wire-based
provider exists, we found that cable rates are about 15 percent lower
than local markets without this competition. Moreover, even though the
influence of DBS on cable rates is minor, our current finding--in
contrast to our earlier study and earlier studies by FCC that did not
find such an effect--is that the presence of DBS does help to lower
cable rates slightly. This may indicate that as more households
subscribe to DBS service, cable operators will ultimately respond by
reducing rates. Below, we discuss options that have been suggested for
addressing the cable rate issue. We note that in this overview, we are
neither making any specific recommendations regarding the adoption of
any of these options, nor suggesting that this list is a necessarily
comprehensive review of possible options.
Program access issues. The 1992 Act includes provisions aimed at, among
other things, enhancing competition in the subscription video industry.
As required by the act, FCC developed rules--commonly referred to as
the program access rules--which were designed in part 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. Since 1992,
some entering companies and consumer groups have stated that current
program access rules are not broad enough to provide assurances that
entrants can obtain necessary programming. In particular:
* Some have expressed concern that the law is too narrow because it
applies only to the satellite-delivered programming of vertically
integrated cable operators. In recent years, some regional cable
networks owned by cable operators have been delivered to their cable
facilities through wires--that is, they are not satellite delivered.
When this is the case, the cable operator need not make the programming
available to competitors. Additionally, although it is not clear how
widespread this practice is in local markets across the country, a
recent report by a consumer group raised concerns that it could become
more prominent at a national level.[Footnote 43] Although questions
have been raised about this issue--which has come to be called the
terrestrial loophole--FCC has pointed out that the statue is specific
in that the program access rules apply only to satellite-delivered
programming.
* Although the program access rules generally prohibit exclusive
contracts for programming of vertically integrated cable operators,
these rules do not prohibit exclusive contracts between a cable
operator and an independent cable network.[Footnote 44] Some operators
entering the market believe that some programming may not be available
to them because large incumbent cable operators have secured such
exclusive arrangements.
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. However, others have
noted that altering these provisions could reduce the incentive for
companies to develop innovative programming. That is, we were told that
companies may have less incentive to invest in certain new programming
if they are not able to market that programming through their own
distribution channels on an exclusive basis.[Footnote 45]
Promoting wireless competition. The medium used to provide video
services over wireless platforms--radio spectrum--is a scarce and
congested resource. 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.[Footnote 46] DBS companies gained the right to provide these
local stations in 1999, and this has been important in enabling them to
compete more effectively with locally based cable operators. However,
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. According to
executives at the two primary DBS companies, if DBS companies only
provided the local stations that they view as desired by their
subscribers, they might more quickly provide local broadcast stations
in more markets, thereby rendering DBS a more effective competitor to
cable. 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 fact, a U.S. Court of Appeals found that certain
government interests promoted by the carry one, carry all provisions
applicable to DBS providers are sufficient to justify this requirement
under a First Amendment analysis.[Footnote 47] Additionally, any review
of these rules would need to take into account how they relate to other
similar requirements, including, for example, must-carry requirements
for the cable industry as well as how must carry will be applied to
cable and DBS in the coming digital age. As with many complex policy
issues, balancing what are often conflicting considerations is very
complex.
Retransmission consent issues. 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
stations) could receive compensation from cable operators in return for
the right to carry their broadcast stations. Prior to the 1992 Act,
cable operators could retransmit local broadcast stations without
approval of the broadcasters and without compensation. As cable
operators began to carry more cable networks that competed with
broadcast networks for viewers and associated advertising revenues,
broadcasters argued that it was important for them to be able to
receive compensation for retransmission of their stations. The
retransmission consent provisions included in the 1992 Act allow local
broadcast stations and cable operators to negotiate for payment or some
other form of compensation in exchange for the cable operator's right
to carry broadcast networks.[Footnote 48]
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. We were
told that, after the passage of the 1992 Act, the cable industry
indicated its reluctance to pay for carriage of local broadcast
stations--which they had previously been carrying free of charge. The
negotiations for retransmission consent at that time quickly turned to
examining carriage of broadcaster-owned cable networks as compensation
for the right to carry the local broadcast station. Both the Congress
and FCC had indicated that carriage of broadcast-owned cable networks
would be a possible way for broadcasters to receive compensation for
carriage of broadcasters' over-the-air stations. A variety of parties
with whom we spoke mentioned specific broadcast-owned cable networks
(such as ESPN2 and MSNBC) that were launched as part of retransmission
consent agreements during the 1990s.
One concern that was expressed to us regarding retransmission consent
relates to its influence on the carriage decisions of cable operators.
In particular, many representatives from cable operators and several
independent (nonbroadcast) cable networks told us that because the
terms of retransmission agreements often include the carriage of
broadcast-owned cable networks, cable operators sometimes carry
networks they otherwise might not have carried. Several of the cable
networks we spoke with noted that this practice can make it difficult
for independent cable networks to gain carriage, particularly in the
case of new networks. Alternatively, representatives of the broadcast
networks told us that they did not believe that cable networks had been
dropped or that independent cable networks could not gain carriage
because of retransmission consent agreements. Further, these
representatives told us 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. Broadcast executives also told us
that the retransmission process has been very important in preserving
free over-the-air television.
Several of the industry representatives with whom we met also expressed
concern that ownership relationships between broadcast networks and
cable networks could lead to higher cable rates for consumers. Although
we did not find that license fees are higher when such an ownership
relationship exists, we did find that cable networks owned by broadcast
networks are more likely to be carried on cable systems than networks
not owned by broadcasters or by cable operators.[Footnote 49] (See app.
V for a discussion of our carriage model). As such, the influence of
retransmission consent on consumer rates is not clear, since these
rates could be affected by the carriage patterns.
Certain parties 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.[Footnote 50] However, other parties
have stated that such provisions serve to enable television stations to
obtain a fair return for the retransmitted content they provide--which
they believe was not the case prior to 1992. Moreover, these industry
representatives noted that retransmission rules help to ensure the
continued availability of free television for all Americans. Currently,
there is a petition pending before FCC that asks for a review of the
impact of retransmission consent.
Conclusions:
In the last decade, the subscription video industry has undergone
dramatic changes. The regulatory and competitive environments have both
evolved; cable rates have been regulated and later partially
deregulated; and limited wire-based competition has been supplanted by
nationwide competition from satellite-based companies. It appears that
this evolution has created problems for FCC's monitoring and reporting
on the industry. As mandated by the Congress, FCC prepares a yearly
report on cable rates in the United States. But, aspects of how
information for the report is collected--such as the cost factors
underlying cable rate increases--are closely associated with the
earlier, regulated era of the cable industry. For example, information
on cost changes underlying cable rate increases are reported to FCC on
a survey form that requires the cost factors and rate changes to
balance. Because rates and costs need not balance in an unregulated
environment, cable franchise representatives filing out the form made
accommodations in their answers that may have compromised the accuracy
of the cost data they were reporting. Similarly, maintaining current
information on the effective competition status of cable operators
under FCC's current process has proven difficult. Some expected
competitors have emerged but did not fully deploy their networks and,
in some cases, discontinued service altogether, and DBS companies--
which were not yet providing service in 1992--have thrived, but
information on their market participation is not readily available on a
local level. We found that because FCC's current process does not
provide for updates to the status of effective competition, some
designations do not appear to reflect current competitive conditions.
In the face of the rapid evolution of the subscription video industry,
it remains important for accurate, current, and relevant information to
be available to the Congress and FCC. Both the Congress and FCC monitor
and provide oversight of this industry, for which FCC's report can
serve as an important input. Additionally, FCC's report can provide
information relevant to the Congress, as it considers important policy
decisions, including the regulation of cable rates and/or services,
media consolidation, and the convergence of video, voice, and data
services. Lacking reliable information, the Congress and FCC face the
challenge of performing monitoring and oversight, as well as making
important policy decisions, without the benefit of important price,
cost, and competition information. As such, it is important for FCC's
report to provide accurate, current, and relevant information about the
cable industry.
Recommendations for Executive Action:
To improve the quality and usefulness of the data that FCC collects on
cable television rates and competition in the subscription video
industry, we recommend that the Chairman of the FCC take the following
actions:
* take immediate steps to improve the cable rates survey by (1)
including more detailed, standardized instructions and examples for how
to calculate the cost changes that the cable operators experienced in
the previous year and (2) eliminating the requirement for the cost
increases to sum to the change in rates and:
* review the commission's process for maintaining the status of
effective competition among franchises in order to keep these
designations more up to date.
Agency Comments and Our Evaluation:
We provided a draft of this report to FCC for comment. FCC had two key
comments on the draft report. First, FCC stated that they are taking
steps to redesign their survey questionnaire in an attempt to obtain
more accurate information. Second, FCC questioned on a cost/benefit
basis the utility of adopting a revised process to keep the status of
effective competition in franchises up to date. We believe that
providing the Congress with reliable information on cable rates and
competition is important, and that improving the accuracy of effective
competition designations would help to accomplish this. We recognize
that there are costs associated with FCC's cable price survey, and we
recommend that FCC examine whether cost-effective alternative processes
exist that would enhance the accuracy of its effective competition
designations. FCC's comments are contained in appendix VI, along with
our responses to those comments.
We also provided a draft of this report to several industry
participants and other experts for their review and comment. In
particular, we provided the draft to representatives of Consumers
Union, the Consumer Federation of America, the American Cable
Association, the National Association of Telecommunications Officers
and Advisors, the National Association of Broadcasters, the National
Cable and Telecommunications Association, the Satellite Broadcasting
and Communications Association, Walt Disney Company, the National
Broadcasting Company, Viacom, and the News Corporation. The comments
received covered a broad range of issues and each groups' comments are
summarized in appendix VII. In addition, these groups provided
clarifications to the draft report. As appropriate, we made changes in
our report that are based on the broad comments summarized in appendix
VII as well as the technical clarification provided to us by these
parties.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after the date of this letter. At that time, we will send copies to
interested congressional committees; the Chairman, FCC; and other
interested parties. We will also make copies available to others upon
request. In addition, this report will be available at no cost on the
GAO Web site at http://www.gao.gov.
If you or your staff have any questions concerning this report, please
contact me on (202) 512-6670 or at goldsteinm@gao.gov. Key contacts and
major contributors to this report are listed in appendix VIII.
Sincerely yours,
Mark L. Goldstein:
Director, Physical Infrastructure Issues:
Signed by Mark L. Goldstein:
[End of section]
Appendix I: Scope and Methodology:
To respond to the first objective of this report--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 51] 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. See appendix IV for a further discussion of this model. In
addition, we spoke with an array of industry stakeholders and experts
(see below) to gain further insights on these issues.
The second objective of this report 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 (see app. II). 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 objective--assess FCC's
classifications of effective competition--we examined FCC's
classification 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. We also reviewed filings for
effective competition that were based on DBS subscribership to assess
how data from SkyTRENDS are used in these filings.
To address the third, fourth, fifth, and sixth objectives (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. We also
acquired data from Kagan World Media,[Footnote 52] 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.[Footnote 53]
* 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. This model is discussed
in greater detail in appendix V. Further, we developed descriptive
statistics on the characteristics of various tiers of service and the
channels included in the various tiers.
[End of section]
Appendix II GAO Survey of Cable Franchises:
[See PDF for image]
[End of section]
Appendix III: GAO's Modifications to FCC's Competition Classification:
To determine the status of competition from a wire-based competitor for
our cable-satellite model, we took steps to review the accuracy of
FCC's classification of effective competition for the cable franchises
surveyed in 2001--the year of data used in our model. For those cases
in which a finding of effective competition had been made because of
the presence of a local exchange carrier (LEC) or a competitive
overbuilder, we took steps to determine if that competition was still
present as of 2001. For cases without a designation of effective
competition, we checked to see if there was a possible LEC or
overbuilder operating in the areas. This process was only designed to
check the status of competition other than that provided by DBS. This
is because we did not rely on FCC's competitive classifications related
to DBS because information on DBS for our model was obtained from a
different source, and we did not use FCC's classification at all in
that case.
Our sample contained 705 cable franchises, of which 133 had been found
to face effective competition from a LEC or overbuilder, and 572 had
not. In most cases in which a finding of effective competition had been
made (95 of the 133), we found evidence that, in fact, a nonsatellite
provider was competing with the incumbent cable provider. In the other
38 cases, we found evidence suggesting that a nonsatellite provider was
not present in 2001.[Footnote 54] To make these determinations, we used
various sources of information, including FCC's master list of cable
franchises. We noted that if there were competitive cable franchises,
we would expect to find two franchises operated by different companies
in the same geographic area. If, for example, we found only one
operating franchise in an area but that franchise was listed as having
effective competition, we investigated further. Also, if we found two
franchises operating in an area that were classified as having
effective competition, but both were operated by the same company, we
also investigated further. Also, in some cases, we made attempts to
determine if the nonsatellite competitor was operating as an MMDS,
which is sometimes referred to as wireless cable. This further
investigation usually involved Web research and information obtained
through contacts with local franchising authorities. In those instances
for which we were able to gather information indicating that an
incumbent cable provider that once faced a nonsatellite competitor no
longer did in 2001, we defined our nonsatellite competition variable
accordingly.
To check whether franchise areas without a designation of effective
competition might have nonetheless faced nonsatellite competition in
2001, we used lists of service areas of cable overbuilders and compared
these areas with the list of sampled franchises. We also examined FCC's
master franchise list for areas in which more than one company appeared
to operate an active franchise. We investigated these lists further by
calling local franchising authorities to determine whether those
franchise areas were geographically distinct or whether this pattern
could represent competition. We also attempted to identify areas where
wireless cable companies provided video service and whether any of
those areas overlapped sampled franchises. In all, we found a number of
cases where a nonsatellite provider appeared to be offering service in
areas where no filings for effective competition had been made. In
these cases, we defined our variable to reflect this competition. Of
the 572 franchises without a designation of effective competition, we
found that 28 were facing some form of nonsatellite competition in
2001.
Finally, we made a distinction between those franchises that were found
to face effective competition because of the availability of MMDS
versus areas with a wire-based overbuilder. We separated these kinds of
competition into distinct variables under the assumption that they may
have a differential effect on cable operators. We believed that this
might be the case because many MMDS providers have been modifying their
business plans and placing less emphasis on their video businesses. For
example, FCC noted that "MMDS has never become a significant competitor
in the market for the delivery of video programming, rather many MMDS
providers are focusing on data transmission rather than video
service."[Footnote 55]
[End of section]
Appendix IV: Cable-Satellite Model:
This appendix provides a brief description of our model of cable-
satellite competition. With this model, we estimate the influence of
wire-based, MMDS, and DBS competition, along with other variables, on
cable prices and services through a system of structural equations in
which certain variables that may be simultaneously determined are
estimated jointly. The model includes equations for cable prices, the
number of cable subscribers, the number of cable channels, and the DBS
penetration rate. Our October 2002 report provides a more detailed
discussion of the data sources, our process for merging various data
into a single dataset, and the specification of our model.[Footnote 56]
Definitions and Sources for Variables:
Table 1 includes a list of all the variables included in our model,
with the definition and source identified for each variable.
Table 1: Definition and Source for Variables:
Variable: Cable price; Definition: The monthly rate charged for the
Basic Service Tier, Cable Programming Service Tier, and rental of a
converter box and remote control; Source: FCC 2001 Cable Rate Survey.
Variable: Number of subscribers; Definition: The number of subscribers
to the Basic Service Tier and Cable Programming Service Tier; Source:
FCC 2001 Cable Rate Survey.
Variable: Number of channels; Definition: The number of channels
provided with the Basic Service Tier and Cable Programming Service Tier
(the most commonly purchased tier); Source: FCC 2001 Cable Rate
Survey.
Variable: Direct broadcast satellite (DBS) penetration rate;
Definition: The fraction of housing units in a cable franchise area
that have satellite service; Source: SkyREPORT.
Variable: DBS provision of local stations; Definition: A binary
variable that equals 1 if both DBS operators offer local broadcast
stations in the cable franchise area; Source: National Association of
Broadcasters.
Variable: Television market size; Definition: The number of television
households in the market; Source: Neilsen Media Research.
Variable: Horizontal concentration; Definition: A binary variable that
equals 1 if 1 of the 10 largest national multiple system operators
(MSO) provides service in the franchise area; Source: FCC 2001 Cable
Rate Survey.
Variable: Vertical relationship; Definition: A binary variable that
equals 1 if the cable operator is affiliated with an MSO that has an
ownership interest in a national or regional video programming
service; Source: FCC 2001 Cable Rate Survey and 2001 Annual Video
Report.
Variable: Presence of a wire-based competitor; Definition: A binary
variable that equals 1 if a second wireline company provides cable
service (including, for example, a local exchange telephone carrier
offering video services) in the franchise area; Source: FCC 2001 Cable
Rate Survey and GAO analysis.
Variable: Presence of multichannel multipoint distribution system
(MMDS) competitor; Definition: A binary variable that equals 1 if a
company provides cable service via MMDS technology in the franchise
area; Source: FCC 2001 Cable Rate Survey and GAO analysis.
Variable: Average wage; Definition: The average weekly wage for
telecommunications equipment installers and repairers in the state
where the cable franchise is located; Source: Bureau of Labor
Statistics.
Variable: Population density; Definition: The ratio of population to
square miles in the franchise area; Source: U.S. Census Bureau.
Variable: Number of broadcast stations; Definition: The number of over-
the-air broadcast stations in the television market; Source: BIA MEDIA
AccessPro.
Variable: Urbanization; Definition: The percentage of the county's
population that is classified as urban by the U.S. Census Bureau;
Source: U.S. Census Bureau.
Variable: Age of cable franchise; Definition: The number of years
between when the cable franchise began operation and 2001; Source: FCC
Master List of Cable Franchises.
Variable: Homes passed by cable system; Definition: The number of homes
passed by the cable system that serves the franchise area, including
homes outside of the franchise area; Source: FCC 2001 Cable Rate
Survey.
Variable: Median per-capita income; Definition: The median per-capita
income in the franchise area; Source: U.S. Census Bureau.
Variable: System megahertz; Definition: The capacity, measured in
megahertz, of the cable system that serves the franchise area; Source:
FCC 2001 Cable Rate Survey.
Variable: Percentage of multiple dwelling units; Definition: The
percentage of housing units accounted for by structures with five or
more housing units; Source: U.S. Census Bureau.
Variable: Nonmetropolitan areas; Definition: A binary variable that
equals 1 if the franchise area is outside of a metropolitan statistical
area (MSA); Source: U.S. Census Bureau.
Variable: Angle (or "elevation") of satellite dish; Definition: The
angle relative to the ground that a DBS subscriber must mount the
satellite dish to "see" the satellite; Source: Web pages of DIRECTV
and EchoStar.
Variable: Regulation; Definition: A binary variable that equals 1 if
the cable franchise is subject to regulation of the rate charged for
the Basic Service Tier; Source: FCC 2001 Cable Rate Survey.
Source: GAO (2003).
[End of table]
Estimation Methodology and Results:
We employed the three-stage least squares method to estimate our
model.[Footnote 57] Table 2 includes the descriptive statistics for the
variables included in our model, and table 3 includes the estimation
results for each of the four structural equations. All of the
variables, except dummy variables,[Footnote 58] are expressed in
natural logarithmic form, so coefficients can be interpreted as
elasticities--which is the percentage change in the value of the
dependent variable associated with a 1 percent change in the value of
an independent, or explanatory, variable.[Footnote 59] The coefficients
on the dummy variables are elasticities in decimal form.
Table 2: Descriptive Statistics:
Variable: Cable price; Mean: 36.15; Standard deviation: 5.02; Minimum
value: 14.00; Maximum value: 47.84.
Variable: Cable price per channel; Mean: 0.66; Standard deviation:
0.19; Minimum value: 0.30; Maximum value: 1.80.
Variable: Cable subscribers; Mean: 21,460.68; Standard deviation:
43,673.73; Minimum value: 4.00; Maximum value: 302,964.00.
Variable: Cable channels; Mean: 58.17; Standard deviation: 14.06;
Minimum value: 10.00; Maximum value: 99.00.
Variable: DBS penetration; Mean: 15.91; Standard deviation: 11.31;
Minimum value: 1.59; Maximum value: 63.64.
Variable: DBS provision of local stations; Mean: 0.52; Standard
deviation: 0.50; Minimum value: 0.00; Maximum value: 1.00.
Variable: Regulation; Mean: 0.36; Standard deviation: 0.48; Minimum
value: 0.00; Maximum value: 1.00.
Variable: Number of broadcast stations; Mean: 12.00; Standard
deviation: 5.64; Minimum value: 1.00; Maximum value: 25.00.
Variable: Median income; Mean: 43,965.25; Standard deviation:
16,202.17; Minimum value: 13,529.00; Maximum value: 139,997.00.
Variable: Horizontal concentration; Mean: 0.85; Standard deviation:
0.36; Minimum value: 0.00; Maximum value: 1.00.
Variable: Vertical relationship; Mean: 0.55; Standard deviation: 0.50;
Minimum value: 0.00; Maximum value: 1.00.
Variable: Presence of wire-based competitor; Mean: 0.16; Standard
deviation: 0.37; Minimum value: 0.00; Maximum value: 1.00.
Variable: Presence of MMDS competitor; Mean: 0.01; Standard deviation:
0.10; Minimum value: 0.00; Maximum value: 1.00.
Variable: Nonmetropolitan areas; Mean: 0.25; Standard deviation: 0.43;
Minimum value: 0.00; Maximum value: 1.00.
Variable: Urbanization; Mean: 73.53; Standard deviation: 28.12; Minimum
value: 0.00; Maximum value: 100.00.
Variable: Percentage of multiple dwelling units; Mean: 14.38; Standard
deviation: 13.70; Minimum value: 0.00; Maximum value: 98.12.
Variable: Age of cable franchise; Mean: 24.11; Standard deviation:
9.52; Minimum value: 2.00; Maximum value: 50.00.
Variable: Homes passed by cable system; Mean: 181,024.81; Standard
deviation: 235,085.38; Minimum value: 30.00; Maximum value:
1,260,734.00.
Variable: Cable system megahertz; Mean: 638.98; Standard deviation:
172.13; Minimum value: 216.00; Maximum value: 870.00.
Variable: Television market households; Mean: 1,459.89; Standard
deviation: 1,664.50; Minimum value: 50.00; Maximum value: 7,301.00.
Variable: Population density; Mean: 2,888.92; Standard deviation:
7,144.36; Minimum value: 2.25; Maximum value: 87,139.78.
Variable: State-level wages; Mean: 788.91; Standard deviation: 102.28;
Minimum value: 575.38; Maximum value: 1,045.58.
Variable: Dish angle or elevation; Mean: 40.29; Standard deviation:
6.67; Minimum value: 27.19; Maximum value: 57.28.
Source: GAO (2003).
[End of table]
Table 3: Three-Stage Least Squares Model Results:
Variable: Cable price per channel; Cable prices equation: [Empty];
Cable subscribers equation: -1.5368; [0.0001][A]; Cable channels
equation: [Empty]; DBS penetration equation: 0.7839; [0.0001][A].
Variable: Cable subscribers; Cable prices equation: 0.0079; [0.3938];
Cable subscribers equation: [Empty]; Cable channels equation: 0.0603;
[0.0001][A]; DBS penetration equation: [Empty].
Variable: Cable channels; Cable prices equation: 0.2428; [0.0001][A];
Cable subscribers equation: [Empty]; Cable channels equation: [Empty];
DBS penetration equation: [Empty].
Variable: DBS penetration; Cable prices equation: -0.0441;
[0.0898][C]; Cable subscribers equation: -2.2403; [0.0001][A]; Cable
channels equation: -0.0174; [0.5933]; DBS penetration equation:
[Empty].
Variable: DBS provision of local stations; Cable prices equation: -
0.0063; [0.7285]; Cable subscribers equation: 0.4276; [0.0800][C];
Cable channels equation: 0.0527; [0.0408][B]; DBS penetration equation:
0.3386; [0.0001][A].
Variable: Regulation; Cable prices equation: -0.0213; [0.1157]; Cable
subscribers equation: [Empty]; Cable channels equation: [Empty]; DBS
penetration equation: [Empty].
Variable: Number of broadcast stations; Cable prices equation:
[Empty]; Cable subscribers equation: 0.5896; [0.0081][A]; Cable
channels equation: [Empty]; DBS penetration equation: [Empty].
Variable: Median income; Cable prices equation: [Empty]; Cable
subscribers equation: -0.3772; [0.0813][C]; Cable channels equation:
0.0672; [0.0032][A]; DBS penetration equation: 0.1903; [0.0023][A].
Variable: Horizontal concentration; Cable prices equation: 0.0528;
[0.0006][A]; Cable subscribers equation: [Empty]; Cable channels
equation: [Empty]; DBS penetration equation: [Empty].
Variable: Vertical relationship; Cable prices equation: -0.0051;
[0.6682]; Cable subscribers equation: [Empty]; Cable channels equation:
-0.0335; [0.0351][B]; DBS penetration equation: [Empty].
Variable: Presence of wire-based competitor; Cable prices equation: -
0.1636; [0.0001][A]; Cable subscribers equation: -1.2766; [0.0001][A];
Cable channels equation: 0.0339; [0.1832]; DBS penetration equation: -
0.3797; [0.0001][A].
Variable: Presence of MMDS competitor; Cable prices equation: 0.0420;
[0.3697]; Cable subscribers equation: -0.2247; [0.7350]; Cable channels
equation: 0.0426; [0.5391]; DBS penetration equation: -0.1350;
[0.4596].
Variable: Nonmetropolitan areas; Cable prices equation: [Empty];
Cable subscribers equation: [Empty]; Cable channels equation: [Empty];
DBS penetration equation: 0.4456; [0.0001][A].
Variable: Urbanization; Cable prices equation: [Empty]; Cable
subscribers equation: 0.0541; [0.5117]; Cable channels equation:
[Empty]; DBS penetration equation: [Empty].
Variable: Percentage of multiple dwelling units; Cable prices
equation: [Empty]; Cable subscribers equation: [Empty]; Cable channels
equation: -0.0228; [0.0261][B]; DBS penetration equation: -0.2162;
[0.0001][A].
Variable: Age of cable franchise; Cable prices equation: [Empty];
Cable subscribers equation: 0.3027; [0.0463][B]; Cable channels
equation: [Empty]; DBS penetration equation: -0.1778; [0.0001][A].
Variable: Homes passed by cable system; Cable prices equation:
[Empty]; Cable subscribers equation: 0.2918; [0.0001][A]; Cable
channels equation: [Empty]; DBS penetration equation: [Empty].
Variable: Cable system megahertz; Cable prices equation: [Empty];
Cable subscribers equation: [Empty]; Cable channels equation: 0.5038;
[0.0001][A]; DBS penetration equation: -0.0434; [0.5304].
Variable: Television market households; Cable prices equation:
0.0072; [0.3639]; Cable subscribers equation: -0.2902; [0.0670][C];
Cable channels equation: -0.0023; [0.8489]; DBS penetration equation: -
0.1195; [0.0001][A].
Variable: Population density; Cable prices equation: -0.0120;
[0.0256][B]; Cable subscribers equation: [Empty]; Cable channels
equation: [Empty]; DBS penetration equation: [Empty].
Variable: State-level wages; Cable prices equation: 0.0392; [0.3676];
Cable subscribers equation: [Empty]; Cable channels equation: [Empty];
DBS penetration equation: [Empty].
Variable: Dish angle or elevation; Cable prices equation: [Empty];
Cable subscribers equation: [Empty]; Cable channels equation: [Empty];
DBS penetration equation: 0.6028; [0.0001][A].
Variable: Intercept; Cable prices equation: 2.4077; [0.0001][A];
Cable subscribers equation: 14.1843; [0.0001][A]; Cable channels
equation: -0.3218; [0.3259]; DBS penetration equation: 0.5324;
[0.5601].
Variable: Sample size; Cable prices equation: 705; Cable subscribers
equation: 705; Cable channels equation: 705; DBS penetration equation:
705.
Source: GAO (2003).
Note: System-weighted R-square: 0.65. P-values are shown in square
brackets.
[A] Significance at the 1 percent level.
[B] Significance at the 5 percent level.
[C] Significance at the 10 percent level.
[End of table]
We found that competition has an effect on the subscription video
market. Competition from a second wire-based operator appears to
significantly lower cable prices--cable prices were approximately 15
percent lower in areas where a second wire-based operator provides
service. [Footnote 60] Yet, this competition had no effect on the
quality of cable service, as measured by the number of channels the
cable operator provides. Additionally, we found that higher DBS
penetration rates were associated with a slight reduction in cable
prices; a 10 percent higher DBS penetration rate was associated with a
15 cent reduction in cable rates.[Footnote 61] In areas where both DBS
operators provide local broadcast stations, we found that cable
operators offer subscribers approximately 5 percent more channels than
cable operators in areas where both DBS operators do not provide local
stations. Unlike wire-based and DBS competition, we found that the
presence of a company providing video service via MMDS technology was
not associated with a different level of cable rates or number of
channels provided to subscribers.[Footnote 62]
We found that a variety of other factors affect the level of cable
prices and the quality of cable service. Cable prices are higher in
areas where the cable operator provides more channels, indicating that
some consumers may be willing to pay for additional channels and that
providing additional channels raises a cable company's costs. We found
that cable prices were 5 percent higher when the cable operator was
affiliated with 1 of the 10 largest MSOs. Finally, we found that cable
operators affiliated with a cable network provided their subscribers
with 3 percent fewer basic and expanded-basic cable networks than
similar cable operators unaffiliated with a cable network.
DBS operators' provision of local broadcast stations is associated with
significantly higher DBS penetration rates. As shown in table 3, our
model results indicate that in cable franchise areas where these local
stations are available from both DBS operators, the DBS penetration
rate is approximately 40 percent higher than in areas where local
stations are not available via satellite from both DBS operators. This
finding suggests that in areas where local broadcast stations are
available from both DBS operators, consumers are more likely to
subscribe to DBS service; therefore, DBS appears to be more competitive
with cable than in areas where local stations are not available from
both DBS operators.
Several additional factors also influence the DBS penetration rate. Our
model results indicate that the DBS penetration rate is greater in
nonmetropolitan areas and also tends to increase as the size of the
television market decreases. Additionally, the DBS penetration rate is
higher in areas that require a relatively higher angle or elevation at
which the satellite dish is mounted and is lower in areas where there
are more multiple dwelling units. These two factors can be associated
with the need of DBS satellite dishes to "see" the satellite. That is,
a dish aimed more toward the horizon (as opposed to aimed higher in the
sky) is more likely to be blocked by a building or foliage, and people
in multiple dwelling units often have fewer available locations to
mount their dish.
[End of section]
Appendix V: Cable Network Carriage Model:
This appendix describes our model of cable network carriage that we
developed to test whether ownership affiliations influence cable
operators' decisions about what networks they will carry. Specifically,
we discuss (1) the set-up of our model, (2) the data sources and
descriptive statistics, (3) the estimation methodology and results, and
(4) an alternative specification.
Set-up of Our Cable Network Carriage Model:
A cable operator will carry a cable network if, on the margin, the
network increases the operator's profit or increases its profits more
than an alternative cable network. Cable operators receive revenue
associated with cable networks from both subscriber fees and local
advertising. Therefore, the addition of a popular cable network will
likely increase the operator's revenues by allowing the operator to
impose higher monthly cable rates on subscribers and sell additional
local advertising at higher rates than would be possible with a less
popular network. At the same time, the cable operator will incur
programming costs associated with the cable network. Thus, the cable
operator will balance these various revenue and cost factors when
deciding whether to carry a given cable network.
In interviews with 11 cable operators, we were told that broadcast
networks often link carriage of cable networks to retransmission of
local broadcast stations. In addition to these broadcaster affiliations
with cable networks, some cable operators are also affiliated with
cable networks. In fact, several studies have indicated that cable
ownership of cable networks influences the carriage of cable networks-
-so there is some precedent that ownership, albeit of a different form,
influences carriage decisions.[Footnote 63] To examine whether these
ownership affiliations--broadcaster and cable operator ownership of
cable networks--influence the carriage of cable networks by cable
franchises, we employed a model that tests whether certain variables
increase or decrease the probability of a cable network being carried
on a particular cable franchise. To empirically test these hypotheses,
we estimated the following. Carriage of a cable network on a cable
franchise is a function of:
* the age of the cable network,
* the popularity of the cable network as measured by advertising
revenues per subscriber,
* whether the cable network primarily distributes news-or sports-
related programming,
* whether the cable network is affiliated with a broadcast network or a
cable operator,
* cable system capacity in terms of megahertz,
* the number of households passed by the cable system,
* the percentage of people in the franchise area between ages 25 and
65,
* the percentage of households in the franchise area that own their
homes, and:
* whether the cable franchise is owned by a cable multiple system
operator.
Data Sources and Descriptive Statistics:
We required several data elements to build the dataset used to estimate
this model. The following is a list of our primary data sources. In
addition, we list all of the variables, definitions, and sources in
table 4 and basic statistical information on all of the variables in
table 5.
* We obtained data on the carriage of individual cable networks on
cable franchises from FCC's 2002 survey of cable franchises. FCC's
survey asked a sample of cable franchises whether the franchise carried
various cable networks. We used the survey to define a variable
representing whether a given cable network was carried on either the
basic or expanded-basic tier. In addition, we used the survey to define
variables measuring (1) the system megahertz (the capacity of the cable
system in megahertz), (2) the number of households passed by the cable
system, (3) the affiliation of the cable franchise with a multiple
system operator, and (4) the ownership affiliation of the cable
operator.
* From Kagan World Media, we obtained data on cable networks, including
(1) the year the cable network launched, (2) the number of cable
subscribers that received the cable network in 2002, (3) the
advertising revenue the cable network received in 2002, and (4) the
ownership affiliation of the cable network.
* We used the most recent data from the U.S. Census Bureau to obtain
the following demographic information for each franchise area:
proportion of the population between ages 25 and 65 and the percentage
of the households that reside in owner-occupied housing.
Table 4: Definitions and Sources of Variables:
Variable: Carry; Definition: A binary variable that equals 1 if the
cable network is carried on the basic or expanded-basic tier; Source:
FCC 2002 cable rate survey.
Variable: Age; Definition: 2003 minus the launch year of the cable
network; Source: Kagan World Media.
Variable: Advertising revenue per subscriber; Definition: The cable
network's advertising revenues divided by the number of subscribers
that could receive the cable network in 2002; Source: Kagan World
Media.
Variable: News; Definition: A binary variable that equals 1 if the
cable network primarily delivers news-related programming; Source: GAO
analysis.
Variable: Sports; Definition: A binary variable that equals 1 if the
cable network primarily delivers sports-related programming; Source:
GAO analysis.
Variable: Broadcaster affiliation; Definition: A binary variable that
equals 1 if the cable network is affiliated with a broadcast network
group (Disney/ABC, Viacom/CBS, News Corporation/Fox, General Electric/
NBC, or Scripps), and the cable network began operation in 1992 or
later; Source: Kagan World Media.
Variable: Cable affiliation; Definition: A binary variable that equals
1 if the cable network is affiliated with a cable operator (Time
Warner, Cablevision, or Comcast); Source: Kagan World Media.
Variable: Homes passed by cable system; Definition: The number of
households passed by the cable system that serves the franchise,
including homes outside of the franchise area; Source: FCC 2002 cable
rate survey.
Variable: Cable system megahertz; Definition: The capacity, measured in
megahertz, of the cable system that serves the franchise area; Source:
FCC 2002 cable rate survey.
Variable: Multiple system operator; Definition: A binary variable that
equals 1 if the cable franchise is affiliated with a cable multiple
system operator; Source: FCC 2002 cable rate survey.
Variable: Population between ages 25 and 65; Definition: The percentage
of the population in a franchise area between ages 25 and 65; Source:
U.S. Census Bureau.
Variable: Home ownership; Definition: The percentage of households in
the franchise area residing in owner-occupied housing units; Source:
U.S. Census Bureau.
Source: GAO (2003).
[End of table]
Table 5: Descriptive Statistics:
Variable: Carry; Mean: 0.43; Standard deviation: 0.50; Minimum value:
0.00; Maximum value: 1.00.
Variable: Age; Mean: 10.68; Standard deviation: 6.61; Minimum value:
1.00; Maximum value: 27.00.
Variable: Advertising revenue per subscriber; Mean: 1.91; Standard
deviation: 2.19; Minimum value: 0.00; Maximum value: 10.98.
Variable: News; Mean: 0.06; Standard deviation: 0.24; Minimum value:
0.00; Maximum value: 1.00.
Variable: Sports; Mean: 0.09; Standard deviation: 0.28; Minimum value:
0.00; Maximum value: 1.00.
Variable: Broadcaster affiliation; Mean: 0.25; Standard deviation:
0.43; Minimum value: 0.00; Maximum value: 1.00.
Variable: Cable affiliation; Mean: 0.20; Standard deviation: 0.40;
Minimum value: 0.00; Maximum value: 1.00.
Variable: Homes passed by cable system; Mean: 178,212.05; Standard
deviation: 244,160.35; Minimum value: 73.00; Maximum value:
1,286,698.00.
Variable: Cable system megahertz; Mean: 672.57; Standard deviation:
171.08; Minimum value: 212.00; Maximum value: 870.00.
Variable: Multiple system operator; Mean: 0.95; Standard deviation:
0.23; Minimum value: 0.00; Maximum value: 1.00.
Variable: Population between ages 25 and 65; Mean: 52.09; Standard
deviation: 2.92; Minimum value: 37.26; Maximum value: 62.94.
Variable: Home ownership; Mean: 68.16; Standard deviation: 10.02;
Minimum value: 19.46; Maximum value: 84.90.
Source: GAO (2003).
[End of table]
Estimation Methodology and Results:
Because we are estimating a binary choice model--that is, the cable
franchise either carries or does not carry a given cable network--we
employed the logit method to estimate our reduced-form equation of
cable network carriage.[Footnote 64] We present the estimation results
for our reduced-form equation in table 6.
Table 6: Logistic Model Results:
Variable: Age; Parameter estimate and [p-value]: 0.1558; [0.0001][A].
Variable: Advertising revenue per subscriber; Parameter estimate and
[p-value]: 0.7537; [0.0001][A].
Variable: News; Parameter estimate and [p-value]: 0.6769; [0.0001][A].
Variable: Sports; Parameter estimate and [p-value]: 0.0812;
[0.0472][B].
Variable: Broadcaster affiliation; Parameter estimate and [p-value]:
0.8265; [0.0001][A].
Variable: Cable affiliation; Parameter estimate and [p-value]: 0.5817;
[0.0001][A].
Variable: Homes passed by cable system; Parameter estimate and [p-
value]: 0.0000; [0.0011][A].
Variable: Cable system megahertz; Parameter estimate and [p-value]:
0.0029; [0.0001][A].
Variable: Population between ages 25 and 65; Parameter estimate and [p-
value]: 0.0061; [0.1191].
Variable: Home ownership; Parameter estimate and [p-value]: 0.0068;
[0.0001][A].
Variable: Multiple system operator; Parameter estimate and [p-value]:
0.3059; [0.0001][A].
Variable: Intercept; Parameter estimate and [p-value]: -6.5658;
[0.0001][A].
Variable: Sample size; Parameter estimate and [p-value]: 55,728.
Variable: Rescaled R-square; Parameter estimate and [p-value]: 0.5075.
Source: GAO (2003).
[A] Significance at the 1 percent level.
[B] Significance at the 5 percent level.
[End of table]
Our model results indicate that ownership affiliation does influence
the carriage of cable networks, as both broadcaster affiliation and
cable operator affiliation are associated with a greater probability of
a cable network being carried on a cable franchise. When calculated at
the mean values for all of the variables in the model, cable networks
affiliated with broadcast networks are 46 percent more likely to be
carried than networks that do not have broadcast ownership.[Footnote
65] Similarly, when calculated at mean values for all of the variables
included in the model, cable networks affiliated with a cable operator
are 31 percent more likely to be carried on a cable franchise than
noncable-affiliated networks.
The remaining variables generally had the expected impact on the
likelihood of a cable network being carried on a cable franchise.
Popular networks--as represented by high levels of advertising revenues
per subscriber--and news-and sports-related networks were more likely
to be carried on franchises than less popular networks and networks
primarily delivering other program genres. Also, cable franchises with
larger capacity were more likely to carry any given cable network, and
franchises with a high percentage of people residing in owner-occupied
housing were also more likely to carry any given network.
Alternative Specification:
In addition to the above specification, we also considered a narrower
definition of cable affiliation. In this specification, a cable network
was only considered to be cable affiliated if the cable operator that
owned the cable network also owned the cable franchise. For example, a
cable network owned by Comcast would be considered cable affiliated
when it appeared on a Comcast cable franchise, but not on another cable
company's franchise, such as a Time Warner franchise. In this
specification, cable networks affiliated with a cable operator are 64
percent more likely to be carried on the affiliated cable franchise
than a nonaffiliated cable network. Cable networks affiliated with
broadcast networks remain more likely to be carried than cable networks
not affiliated with broadcasters. We present the estimation results for
this alternative specification in table 7.
Table 7: Logistic Model Results:
Variable: Age; Parameter estimate and [p-value]: 0.1558; [0.0001][A].
Variable: Advertising revenue per subscriber; Parameter estimate and
[p-value]: 0.7360; [0.0001][A].
Variable: News; Parameter estimate and [p-value]: 0.6495; [0.0001][A].
Variable: Sports; Parameter estimate and [p-value]: 0.1558;
[0.0001][A].
Variable: Broadcaster affiliation; Parameter estimate and [p-value]:
0.6877; [0.0001][A].
Variable: Cable network owned by operator; Parameter estimate and [p-
value]: 1.4091; [0.0001][A].
Variable: Homes passed by cable system; Parameter estimate and [p-
value]: 0.0000; [0.0131][B].
Variable: Cable system megahertz; Parameter estimate and [p-value]:
0.0029; [0.0001][A].
Variable: Population between ages 25 and 65; Parameter estimate and [p-
value]: 0.0054; [0.1677].
Variable: Home ownership; Parameter estimate and [p-value]: 0.0069;
[0.0001][A].
Variable: Multiple system operator; Parameter estimate and [p-value]:
0.2915; [0.0001][A].
Variable: Intercept; Parameter estimate and [p-value]: -6.3393;
[0.0001][A].
Variable: Sample size; Parameter estimate and [p-value]: 55,728.
Variable: Rescaled R-square; Parameter estimate and [p-value]: 0.5065.
Source: GAO (2003).
[A] Significance at the 1 percent level.
[B] Significance at the 5 percent level.
[End of table]
[End of section]
Appendix VI: Comments from the Federal Communications Commission:
Note: GAO comments supplementing those in the report text appear at the
end of this appendix.
Federal Communications Commission Washington, D.C. 20554:
September 24, 2003:
Mr. Mark Goldstein:
Acting Director, Physical Infrastructure Issues
United States General Accounting Office
Washington, DC 20548:
Dear Mr. Goldstein:
Thank you for the opportunity to review GAO's draft report entitled
Telecommunications: Issues Related to Competition and Subscriber Rates
in the Cable Television Industry (GAO-04-8). It is my understanding
that your staff has met with Commission staff and has received data,
comments, and assistance from them.
There are two primary areas of the draft report that are seriously
misleading and upon which we would like to comment. The first relates
to the statutory framework that the Commission is legally obligated to
adhere to in making effective competition determinations. The second
relates to the Commission's use of estimates provided by cable
operators to determine the relative importance of factors that explain
cable television rate increases.
The GAO Report states that the "FCC's designations of franchise areas
as having (or not having) effective competition do not always
accurately reflect current competitive conditions and, in the case of
effective competition based on DBS service, FCC has not sought to
validate the industry data used to substantiate these filings." Our
Annual Price Survey is not an independent inquiry into competitive
conditions, but rather a statutorily defined survey based on a legal
framework --adopted by Congress --which specifies the definition of
effective competition and the administrative process through which
cable operators file petitions seeking findings of effective
competition.
The rate regulation provisions enacted by Congress require
participation by the local franchising authorities (LFAs) to work
effectively. An LFA may regulate basic rate increases if the local
cable system is not subject to effective competition. An LFA must be
certified to regulate basic rates, if it would like to do so. A cable
operator seeking effective competition status files a petition with the
Commission providing data to demonstrate that it meets one of the four
statutory tests for effective competition. The cable operator is
required to serve its petition on the LFA, which provides an
opportunity for the LFA to oppose the petition and provide
countervailing evidence for Commission review.
In making determinations of effective competition, the statutory
process allows the Commission to rely on data from external sources,
for example DBS penetration data from SkyTRENDS. Because copies of the
petitions for determination of effective competition filings --
including
copies of the full SkyTRENDS reports for the relevant communities --are
available to the LFAs under the statutory framework, the LFAs have an
opportunity to file objections in the effective competition proceedings
if they believe the data are inaccurate. No LFA has ever made a serious
charge that the SkyTRENDS data were not sufficiently accurate for these
purposes; nor are we aware of a better source for such data.
If circumstances change and the criteria for "effective competition" as
defined by our governing statute are no longer present, the statute
provides LFAs have an opportunity to file for recertification, but they
are under no obligation to do so. If an LFA chooses not to file for
recertification, the Commission has no legal basis upon which to act to
change a cable operator's effective competition status for purposes of
rate regulation. In situations where a cable operator has met the
definition of effective competition and a finding to that effect has
been made, the cable operator has no obligation under the statute to
inform the LFA or the Commission of changed circumstances. In addition,
there may be situations in which LFAs may be aware of changed
circumstances and for various reasons choose not to file for
recertification.
The statutory framework establishes no mechanism --other than
recertification by the LFA --for the Commission to become cognizant of
changes in competitive conditions. Further, as a practical matter, the
Commission does not have the resources that would be needed to monitor
the entire cable industry and update designations of effective
competition on a rolling basis. Indeed, even if the FCC were to do so
based on some independent authority, it is not clear that this
information could be used in an annual cable rate survey. The
Commission is required to report annually on cable rates, comparing
cable systems subject to "effective competition" with those not subject
to "effective competition" as defined in the statute. Even if the
Commission could determine changes in competitive status, the law would
require that we continue to report cable rates pursuant to the legal
definition of effective competition. Thus, to the extent the report
suggests that the FCC should update periodically its view of the
competitive situation in individual franchise areas, such an effort
would not only be ultra vires and beyond the limits of the Commission's
resources, it ultimately would not provide the data needed to fulfill
our legal obligation to report on cable industry prices.
By making ad hoc determinations of competitive status based on current
market conditions and using an econometric model, GAO found a 15%
differential in cable rates between wire-based competitors and
noncompetitive operators. In the 2002 Price Survey Report, also using
an econometric model, the Commission found a 7% differential between
wire-based competitors and noncompetitive operators. The GAO report may
be misleading in this regard because it draws a comparison between
these two percentages even though they were estimated based on two
different sets of competitive cable operators. As mentioned in the
report, GAO sought to determine the current status of competition in
each franchise. The Commission, on the other hand, followed the
statutory framework and included only those operators where a finding
of effective competition has been made.[NOTE 1]:
With respect to the Commission's use of estimates to explain rate
increases, the GAO report suggests that our Price Survey Report may not
provide "a reliable source of information" on the factors that underlie
recent cable rate increases because the cable operators participating
in our survey did not respond to these questions in a consistent
manner. The report further observes that many cable operators
responding to our survey may have underestimated the importance of
certain factors, and by so doing, would have overestimated the
importance of programming costs as a factor contributing to rate
increases.
We acknowledge in our 2002 Price Survey Report that the responses to
these particular questions may not have the same degree of accuracy as,
for example, the responses to questions regarding monthly rates. We
also observe that because the survey requires the factors to equal the
amount of the rate increases that are being explained, if one or more
factors are underestimated, then the remaining factors will be
overestimated. Despite these shortcomings, we provided the estimates
because we believed that, on balance, they provide information that
helps put the changes in rates in perspective with reported cost
increases. It is instructive to note that GAO's findings, which were
arrived at through an independent survey, appear to corroborate the
estimates provided in our Price Survey Report. For example, we reported
that cable operators attributed 65.8% of their rate increases for 2002
to increases in programming costs. Using information in GAO's report,
we can calculate that your survey finds that programming cost increases
would explain about 60% of rate increases for 2002. [NOTE 2] Although
these results differ by approximately 5.8 percentage points, on
balance, our estimates provide useful information that helps put the
change in rates in perspective and are consistent with your findings.
Finally, based on discussions with GAO staff, we have redesigned our
survey questionnaire for 2003 to eliminate questions that rely on
estimates and to substitute other questions for which we believe cable
operators can provide more accurate information. We also provide more
complete explanations for these questions in our 2003 questionnaire, as
recommended by the GAO.
We very much appreciate the opportunity to review and comment on this
draft report, and thank GAO staff for their helpful suggestions that we
are incorporating in our next Price Survey questionnaire.
Sincerely,
Signed for:
Andrew S. Fishel
Managing Director:
[See PDF for image]
[End of figure]
Federal Communications Commission Washington, D.C. 20554:
October 9, 2003:
Mr. Mark Goldstein:
Acting Director, Physical Infrastructure Issues United States General
Accounting Office Washington, DC 20548:
Dear Mr. Goldstein:
This is in response to our discussion regarding the Commission's
statutory authority to modify its findings of effective competition or
establish new procedures to account for changed circumstances with
respect to effective competition adjudications in particular local
franchise areas ("LFAs").
Pursuant to Section 623 of the Communications Act, the Commission is
authorized to make findings of effective competition and has
established rules to do so. In accordance with the authority granted to
the Commission in Section 623, the procedure for making a decision as
to the presence or absence of effective competition is necessarily an
adjudicatory one. As currently promulgated, the Commission's rules do
not contemplate a reassessment of an effective competition
adjudication, except through the LFA recertification procedure. The
Communications Act neither explicitly authorizes the Commission to, nor
prohibits the Commission from, revising its rules to limit the duration
of such findings or require a cable operator to periodically certify
that it continues to meet the specific standard which was the basis of
its grant of effective competition status. In today's increasingly
competitive environment and from a cost/benefit perspective, however,
we seriously question the utility of such an approach for several
reasons.
First, based upon our experience, it is unlikely that such a mechanism
would significantly change our findings with respect to the comparison
of rates charged by competitive and noncompetitive cable operators. We
have examined various combinations of competitive operators and at the
possibility of reformulating the competitive list in various ways and
find that the end result would be an almost negligible change in the
average rate found for the competitive group.
In this regard, we note that there are other considerations and issues
that must be taken into account in the context of our price survey and
effective competition findings. Although the Commission could possibly
modify the procedural rules associated with findings of effective
competition, it is not clear that it could, for purposes of comparing
the rates of competitive and noncompetitive operators, by-pass the due
process requirements involved in order to properly evaluate those
communities that have never been the subject of an effective
competition finding. In other words, shifting from a comparison that is
based on the legal status of the communities in question as is done
now, to a comparison based on an updated review of only those
communities subject to a previous adjudication would not appear to
improve the overall process. This would
particularly appear to be the case where the level of competition is
increasing year-to-year so that the number of communities reverting to
a non-competitive status is likely to be limited and the number of
communities facing effective competition for the first time is likely
to be significant. Any attempt to reevaluate the effective competition
findings formally while looking at the lack of effective competition
situations informally would involve mixing two entirely different types
of decision making. Such an effort also would increase the level of
resources that would have to be devoted to the price survey process
without necessarily improving the value of the work product
significantly.
Second, it appears that the under the new procedures you suggest we
would only reexamine those cable systems determined to face effective
competition, a process that does not address the very large number of
"noncompetitive" cable systems where the conditions for "effective
competition" are actually present but there has been no formal
determination. For example, DBS penetration has reached an average of
15% or more (the threshold for a finding of effective competition) in
at least 40 states, suggesting that there are many cable systems in
those states that would meet the "effective competition" test should a
petition come before us. There are more than 33,400 franchise areas
registered with the Commission. In order to update our list of
"noncompetitive" operators for current circumstances, we would have to
review virtually all of those franchise areas for the current status of
competition. This would represent a burden that would be significantly
beyond our resources. Moreover, as we have noted in previous
discussions, the data necessary for this exercise is not readily
available to us.
Third, many effective competition decisions, particularly those
involving LEC competition pursuant to Section 623(l)(1)(D), are not
objectively clear cut such that parties could reliably certify or
recertify the existence or non-existence of effective competition
periodically. By their very nature, LEC effective competition decisions
are not reducible to neat equations by which cable operators can
periodically self-certify. Decisions under the LEC test often turn on
Commission value judgments based on variables such as build-out
schedules, performance bonds, incumbent response and lack of obstacles
to construction. It would be extraordinarily difficult for the
Commission to rely on an operator's decision to certify that the
circumstances underlying a LEC adjudication are unchanged. Only through
the adjudicatory process can the decisional import of such factors be
determined, i.e., the process intended by Congress as reflected in the
statutory scheme.
We appreciate the opportunity to engage in this dialog.
Signed by:
w. Kenneth Ferree
Chief, Media Bureau:
NOTES:
[1] Although both GAO and the Commission use simultaneous equation
models estimated via three-stage least squares, GAO uses a different
set of explanatory variables than the Commission. This could explain
some of the difference between GAO's and the Commission's findings. In
addition, we believe that multicollinearity is present among the
explanatory variables included in the GAO model, i.e., the explanatory
variables influence each other as well as the variables being
explained. This makes the GAO model sensitive to even small changes in
the choice of explanatory variables, i.e., a small change in the list
of variables selected as explanatory variables will result in a large
change in the result. This also could explain why some of the
estimates in the GAO model are statistically not significant and have
the opposite sign from that which would be intuitively expected.
[2] The GAO report observes that for the nine operators included in
GAO's survey (which covers 62% of all cable subscribers) annual
programming expenses on a per subscriber basis increased from $122 in
1999 to $180 in 2002, a 48% increase over three years. On a monthly
basis, that equals $10.16 in 1999 and $15.00 in 2002, a $4.84 increase
over three years, or an average increase of $1.61 per year. An
increase in programming costs of $1.61 (per month per subscriber)
would explain 60% of the $2.66 by which basic and expanded basic cable
service rates increased in 2002. We note that 60% falls within the
confidence interval around the 65.8% estimate provided in our report.
Several caveats are necessary for comparison of these two percentages.
First, the GAO survey covers a particular segment of the industry --
nine of the larger MSOs --while our survey covers a random sample of
the entire industry. Typically, smaller cable operators pay somewhat
more than larger operators for their programming, and thus may face
larger cost increases. Therefore, the GAO sample may understate the
importance of programming cost increases from the perspective of the
entire industry. Second, the 60% figure derived from GAO's survey is
based on an average over the three years covered by GAO's data - 1999
to 2002, while our data covers a two year period, 2001 and 2002, and
reports each year separately. If programming cost increases were
accelerating during those three years, the increase in 2002 would be
greater than average. Similarly, if decelerating, the increase in 2002
would be less than average. The GAO report provides some information,
particularly in the charts on pages 23 and 24, that suggests that
programming cost increases accelerated in 2002 in comparison with the
trend of the prior three years.
The following are GAO's comments on the Federal Communications
Commission's letters dated September 24 and October 9, 2003.
GAO Comments:
1. In a letter dated September 24, 2003, FCC contended that under the
statutory framework to which the commission is legally obligated to
adhere in making effective competition determinations, it would be
ultra vires for the commission to update designations of effective
competition on a periodic basis. In other words, FCC stated that it did
not have the legal authority to update periodically its view of the
competitive situation in individual franchise areas. We disagree that
the commission's authority is so limited. In order to better understand
the view that the commission stated in its letter (i.e., it was
prohibited from modifying its rules to ensure that effective
competition designations are reflective of current conditions and
continue to meet the statutory definition to the maximum extent
possible), we contacted FCC. On the basis of a conversation between
commission staff and GAO staff, FCC provided us with a second letter
dated October 9, 2003, that modified its views as expressed in the
September 24 letter. In the second letter, FCC acknowledged that it was
not statutorily prohibited from revising its process (see GAO's comment
8).
2. Although local franchising authorities do see the information that a
cable franchise provides to FCC in an application for effective
competition, from filings that we reviewed, we found that these
authorities at times question the validity of the data and/or
estimation methodologies. For example, some have noted that reliance on
2000 census data on housing units can lead to an overstatement of DBS
penetration because in areas with growing populations, housing
estimates from 2000 will understate the current number of housing units
in an area. Such an understatement will result in an overstatement of
the DBS penetration rate. Moreover, under FCC's rules, local
franchising authorities have limited time to review such information
after it is submitted.
3. Resources could clearly be an issue for taking steps to update the
status of effective competition, and FCC should consider this issue
when revising its process to keep the status of effective competition
up to date. FCC could consider requiring cable operators to certify on
a periodic basis that they still meet the statutory definition and if
no certification is provided, the finding would be removed.
Alternatively, as part of the cable rate survey, FCC could ask any
franchise having a designation of effective competition to provide
information if that status has changed and, under modified rules, use
this as a basis for changing the effective competition finding.
4. To develop our measure of competition, we reviewed many sources of
information, including information from FCC, information from and about
particular providers, as well as information gathered through
discussions we had with local franchising authorities. We were not
attempting to determine which franchises would have effective
competition under the legal definition. Instead, we focused on
establishing when meaningful competition, from an economic perspective,
was likely to exist.
5. We cite FCC's finding on the difference in prices in places with and
without effective competition, but the more direct comparison for our
model is FCC's output from its econometric model contained in its 2002
Cable Pricing report. In that model, FCC tests for the price reduction
that occurs where there is wireline competition. Although FCC did not
explicitly define this term in their report, our review of that
analysis led us to believe that this measure is equivalent or very
close in concept to our definition of wire-based competition. That is,
FCC is attempting to measure how prices differ when a cable franchise
faces a direct wireline overbuilder in the area, which does not include
all places that have effective competition. Thus, we believe that the
two measures of wireline competition--that is FCC's and GAO's--did not
differ in concept.
6. We performed standard statistical tests for the evidence of
multicollinearity in our model and did not find a significant problem.
Moreover, we tested FCC's variable for wireline competition in our
model, and we tested our measure of wireline competition on FCC's
model. Since we know the findings from each agencies' variable on its
own model, we were able to discern whether the differences in the
findings from the two models were caused by differences in the two
models or by the measure of wireline competition. We found that using
FCC's measure of wireline competition in our model produced a finding
similar to that reported by FCC, and using our measure of competition
in FCC's model produced a finding similar to that found in our model.
From these findings, we have concluded that any differences between the
findings of FCC and those of GAO are not caused by differences in the
two models, but are due to differences in how the wireline variable was
measured. Further, the GAO and FCC models have much overlap in the
independent variables specified in the model, and, as such, the degree
to which there are concerns about multicollinearity, this would be true
of both models.
7. We agree that FCC's estimate of the percentage of the yearly rate
increase that can be attributed to programming costs is relatively
accurate because, as we note in our report, most of the 100 cable
franchises we interviewed noted that they used actual data when
calculating these costs. However, we did find that other cost items,
such as infrastructure investment, were reported with less accuracy
and, in some instances, were simply "plugs" to ensure that the cost and
rate increases were equal. In fact, while FCC found that in 2002 about
6.2 percent of the rate increase was attributable to infrastructure
costs, the findings from our survey of 9 large cable operators shows
that overall infrastructure costs increased by $2.23 per month per
subscriber--or about 84 percent of the average rate increase reported
in 2002. While these estimates of infrastructure costs vary
considerably, we recognize that our reported infrastructure cost are
not directly comparable to the average rate increase since the average
cost of $2.23 per month per subscriber includes some infrastructure
costs not attributable to the basic and expanded-basic tiers of video
service. We believe that these findings are consistent with a major
point in our report: that is, the data reported on cost increases for
programming were largely accurate, but the requirement that the sum of
cost increases equal the average rate increase may have caused reduced
estimates for other cost factors.
8. In its October 9 letter, FCC recognizes that while the statute
authorizes it to make findings of effective competition, the commission
implements this authority through the rules it has established. The
commission notes that its current rules do not contemplate a
reassessment of effective competition adjudication, except through the
Local Franchise Authority recertification process. However, FCC states
that the statute neither explicitly prohibits nor authorizes the
commission from revising its rules. Accordingly, FCC now acknowledges
that it could possibly modify the procedural rules associated with
findings of effective competition, although the commission notes that
it is unclear, in its view, whether this would work in communities
lacking an effective competition designation.
9. We believe that when effective competition designations more
accurately reflect current conditions, the resulting analysis provides
a better measure of the impact of competition on cable rates. As we
note in our report, we found that wire-based competition was associated
with 15 percent lower cable rates, while FCC's report found that cable
rates were approximately 7 percent lower with this competition. We
believe the difference in these results is primarily the result of
steps we took to update FCC's wire-based competition variable (see
GAO's comment 6).
10. In our subsequent conversation with FCC staff, they asked us to
identify possible ways that effective competition determinations could
be kept more up to date. We identified a number of possible options
that the commission could consider, recognizing that the commission
would be the appropriate party to determine how this could best be
done. We made a number of suggestions including (1) having effective
competition determinations be time limited, (2) having the cable
operator periodically certify that the circumstances under which the
effective competition determination had been made had not changed, and
(3) utilizing the information gathered as part of its Annual Price
Survey to update the effective competition determinations. In its
October 9 letter, the commission questions from a cost/benefit
perspective the utility of such approaches.
FCC's underlying concerns about these approaches is that the market has
changed. The commission notes that the level of competition is
increasing year to year so that the number of communities reverting to
a noncompetitive status is likely to be limited, while the number of
communities facing effective competition for the first time is likely
to be significant. For example, the commission provides that DBS
penetration has reached an average of 15 percent or more (the threshold
for a finding of effective competition) in at least 40 states. In our
view, these changes in the market emphasize the need for FCC to review
its process for making effective competition determinations. Moreover,
as FCC emphasizes, the commission has a statutory mandate to report on
average prices comparing cable systems that it has found are subject to
effective competition with cable systems that it has found are not
subject to effective competition. We believe that this report should,
to the maximum extent possible, reflect the current conditions in order
to ensure its utility.
[End of section]
Appendix VII: Comments from Industry Participants:
Below we summarize the written and oral comments that we received from
industry participants that reviewed a draft of our report. Because many
of these comments are opinion-based, we are not offering our views on
them. In one case, however, we provide some clarifying information
about the GAO model on cable rates.
American Cable Association:
The American Cable Association (ACA) noted that because we focused much
of our analysis on larger cable operators, the report does not address
issues of great importance to ACA and its membership, which are mostly
small cable operators. ACA noted that for smaller cable operators, DBS
providers are highly competitive, and programming costs are an even
higher percentage of overall costs than is the case for larger cable
operators. As a result, ACA disagreed with our suggestion that greater
competition is a potential solution to increasing cable rates.
ACA provided, in its comments, a number of policy solutions that would
address, in their view, the level of programming costs. Such options
include mandating public disclosure of programming rates, requiring an
à la carte or minitier regime, overhauling of the retransmission
consent process, and requiring similar regulatory obligations for the
DBS and the cable industries. Additionally, ACA disagreed with our
conclusion that an à la carte system would impose additional technical
costs and not cause cable rates to generally decline. Further, ACA did
not believe that we adequately addressed the link between increased
carriage of cable networks affiliated with broadcasters and higher
cable rates.
Consumer Federation of America:
A representative of the Consumer Federation of America suggested that
the costs associated with infrastructure upgrades were recouped from
revenues generated by advanced services, such as the digital tier and
cable modem service, and should not influence cable rates for the basic
and expanded-basic tiers. Therefore, this representative believes that
we overstate the contribution of infrastructure costs to increasing
cable rates. Moreover, this representative noted that we do not fully
account for the revenue obtained from advertising, which in this
representative's view, should mitigate the need for increasing cable
rates.
This representative also provided several comments on GAO's cable
network carriage econometric model. First, this representative
suggested that advertising revenues per subscriber could be treated as
an endogenous variable--that is, it is a variable that is codetermined
with other dependent variables in the model. Second, this
representative suggested that we include a table reporting the results
for the alternative specification, in which we consider cable networks
owned by a cable operator.
Consumers Union:
A representative of Consumers Union believes that our finding that
cable rates are 15 percent lower where a second wire-based competitor
is present is evidence of cable operators' market power. He believes
that we should measure the savings to American consumers that would
accrue if cable rates were 15 percent lower in all franchises
throughout the country. Additionally, this representative believes that
our draft overstated the negative aspects of regulation. He stated that
regulation may be the only viable option for addressing cable
operators' market power because wire-based competition may not be
feasible on a widespread basis.
Regarding our analysis of ownership affiliations, this representative
believes that we should test for the impact of lower ownership
thresholds, in addition to the analysis of majority-owned networks.
This representative made numerous comments regarding an à la carte
system. First, he suggested that we overstated the costs of equipment
associated with an à la carte system, and he noted that (1) the
necessary equipment is currently being deployed and (2) the Congress is
pushing the cable industry toward a digital conversion. Second, he
noted that our discussion assumed that cable operators would pay any
increases in license fees arising from a decline in cable networks'
advertising revenues. But, he believes cable operators will exercise
their market power and therefore refuse to fully pay the higher license
fees that cable networks will seek. Moreover, this representative did
not accept that advertising revenues would dramatically decline in an à
la carte regime, and he stated that advertising revenues for the most
popular cable networks might increase because advertisers will be able
to clearly target subscribers viewing these networks. Third, he stated
that GAO understates how many subscribers could benefit from an à la
carte approach. He also stated that a substantial percentage of
subscribers--perhaps as many as 40 percent--could see their monthly
bill decline because most subscribers do not watch many networks.
Finally, he noted that fundamentally there is tremendous uncertainty
regarding the outcome under an à la carte regime.
National Association of Broadcasters:
National Association of Broadcasters officials identified several
issues associated with the cable industry. First, they stated that
while our report implies that a greater number of channels are a
benefit to subscribers, it is not clear whether this is the case.
Second, they also noted a concern about how we measured the popularity
of cable networks for the cable network carriage model.
These officials noted that in discussing pricing under an à la carte
system, we should include the possibility of cable operators
implementing a pricing scheme wherein subscribers are charged a flat
monthly fee for access to the cable network and additional fees for
each network selected. They believe that this would be the pricing
structure implemented because cable operators must be able to recoup
costs associated with their networks and overhead that are currently
imbedded in the price for the basic and expanded-basic tiers.
Regarding retransmission consent, these officials do not believe there
was sufficient discussion in our report of the history of
retransmission consent. In particular, the option for cable network
carriage in lieu of cash payment for retransmission of the broadcast
station was largely supported by the cable industry. Additionally, they
noted that our discussion regarding how retransmission consent is used
was too broad because it implied that all broadcast stations use
retransmission consent to gain carriage, while there are only a limited
number of stations that do so.
National Association of Telecommunications Officers and Advisors:
The National Association of Telecommunications Officers and Advisors
(NATOA) noted that the focus of our review was cable rates for the
basic and expanded-basic service tiers, but equipment rental--such as
converter boxes--are also rising. NATOA noted that we correctly pointed
out that the benefits of infrastructure investment may confer largely
to subscribers of advanced services, but it noted that FCC rules
continue to allow these costs to be allocated to basic rates and rates
for equipment.
NATOA also raised concerns about the lack of government data on cable
rates and related issues. NATOA expressed concerns that we relied on
FCC data--which we have noted may not be of high reliability--as well
as on data from Kagan World Media, a cable industry data vendor. For
example, NATOA expressed concern that we had no hard data on
expenditures on customer service. NATOA noted that we should recommend
to the Congress that some responsible agency (such as the Department of
Justice) conduct an audit of the cable industry, including an
examination of the contracts between cable networks and cable operators
for the purchase of programming.
NATOA also raised concerns about how we analyzed the effect of
ownership relationships on the cost of programming. NATOA's comments
noted that our analysis of the effect of "majority-owned" programming
was too limited, and that we should have included a broader definition
of ownership affiliations, including, for example, agreements between
companies that are separately owned, for this analysis.
According to NATOA, infrastructure investments are largely a benefit to
subscribers of advanced services and, to the extent that basic and
expanded-basic rates rise due to these investments, it represents a
cross-subsidy.
NATOA also pointed out that, as we have noted, DBS penetration data
used for effective competition filings have not been fully validated
and are generally not available to stakeholders other than the cable
operators. Moreover, NATOA noted that the Congress should reevaluate
the 15 percent penetration level required under law for a finding of
effective competition when the basis is competition from DBS providers.
NATOA also noted that our finding of a 15 percent price reduction in
areas with a wire-based competitor may be the result of temporary price
discounts by new companies. Finally, NATOA noted that we do not fully
discuss in this report the ramifications of a finding of effective
competition. In particular, NATOA noted that we did not discuss that
cable franchises with such a finding no longer have to price uniformly
across the franchise area and are no longer subject to the tier buy-
through provisions of the Cable Television Consumer Protection and
Competition Act of 1992.
Lastly, NATOA noted that it is critical for us to make it clear that,
on the basis of the model results, there is only a slight reduction in
cable rates due to the level of DBS penetration.
National Broadcasting Company:
National Broadcasting Company (NBC) officials suggested that we explain
why broadcaster-owned cable networks are more frequently carried than
other cable networks. In their view, cable operators, as a rule, do not
pay any license fees for the right to carry a local broadcast station,
notwithstanding the value of that programming to the cable operator.
They also noted that, according to our data, cable operators also do
not pay higher license fees for the right to carry these broadcaster-
affiliated networks. Instead, NBC officials said that the sole
compensation that broadcasters receive in exchange for retransmission
of the local broadcast stations' programming is an arguably higher
penetration of cable carriage for their affiliated programming
networks.
National Cable and Telecommunications Association:
The National Cable and Telecommunications Association (NCTA) had
serious concerns about the finding from our econometric model, which
indicates that cable rates are 15 percent lower in markets with a
second wire-based competitor. NCTA officials noted that only about 45
franchise communities have such an overbuilder compared with about
10,000 cable systems nationwide. They also noted that the number of
such overbuilders has declined in recent years, and the type of
companies operating these businesses has been changing. As such, they
believe that it is not appropriate to extrapolate these findings for
the vast majority of markets that currently have no wireline
competition. In its written comments, NCTA noted that "given the
limited nature of wireline overbuild competition, it is important not
to overstate its importance to determining a 'competitive'
rate."[Footnote 66]
NCTA officials stated that there is no link between the possible
exercise of market power and the increase in cable rates. They noted
that, according to FCC's survey, rates for areas with effective
competition have actually risen in the last 2 years at a slightly
faster pace, on a percentage basis, than rates in areas without
effective competition.
These officials also noted that our study did not take into account the
rise in the quality of cable programming. In particular, they noted
that a recent study by Professor Wildman, of Michigan State University,
found that when analyzed on a price per-viewing-hour basis, cable rates
have declined significantly in recent years. Additionally, they noted
that there have been enormous benefits from the upgraded infrastructure
of cable systems. They also noted that important benefits to those
upgrades accrue to video subscribes (even if they do not take advanced
services) in the form of better picture quality and more reliable cable
service.
NCTA officials had two comments related to cable operators ownership of
cable networks. First, they stated that our discussion of program
access rules implied that there could be a significant problem for
entrants' gaining access to programming. Conversely, they noted that
program access concerns have always been minimal and that, if anything,
these problems have declined in recent years, in part because few cable
networks are owned by cable operators. Second, in terms of the carriage
benefits that accrue to cable networks owned by cable operators, these
officials noted that few cable networks are owned by cable operators.
As such, they believe that while these cable networks may have an
advantage in carriage, this is not a serious concern.
News Corporation:
Regarding programming costs, News Corporation (Fox) officials stated
that the 59 percent increase in the cost of sports programming that we
reported seemed high, and they suggested that we mention that the
analysis did not include regional sports networks. Further, these
officials also noted that the 72 networks that we compared with the
sports programming networks include some networks that are not widely
distributed. They said that our inclusion of such networks could
exacerbate the difference in programming costs between the sports and
nonsports networks because some of the less distributed networks would
have low license fees.
News Corporation officials noted that one reason the sports leagues
might have told us that the cost of sports rights has not increased
much in the past year is because the leagues are in the middle of
multiyear contracts. These officials noted, however, that when compared
with previous multiyear contracts, there has been a large increase in
the cost of sports rights.
Regarding retransmission consent, News Corporation officials noted that
broadcast networks are highly valuable to consumers. Further, they
noted that there are important objectives served by the retransmission
provisions that should be more fully discussed in the body of our
report.
These officials cited two concerns regarding our cable network carriage
model. First, they indicated that we should include an explanatory
variable for the price, or license fee, for each cable network. Second,
they believe our model should include a variable that incorporates
launch fees.
News Corporation officials believe that it is important to note that
even if people only watch 17 channels, consumers value having access to
more than 17 channels. Moreover, they indicated that consumers may not
choose to watch the same 17 channels in any given year.
Satellite Broadcasting and Communications Association:
The Satellite Broadcasting and Communications Association chose to
provide no comments.
Viacom:
Viacom (CBS) chose to provide no comments.
Walt Disney Company:
Walt Disney Company (ABC) officials said that our draft provided
extensive information on how programming costs have increased over
time, but did not provide enough coverage of how infrastructure costs
have changed over time. Additionally, they believe the figures for
programming costs that we reported are too high, and similarly that
advertising revenues offset a greater portion of programming costs than
we reported.
Disney officials noted that the value of cable service today is much
greater than it was in the past in terms of the number of networks and
quality of programming that subscribers receive. As evidence, they said
that subscribers are watching cable networks more and broadcast
networks less. They referred to a study prepared by Professor Wildman,
of Michigan State University, which estimated the "real" cost of cable
by considering viewing hours; the study finds that the value of cable
service to subscribers has risen dramatically in recent years.
Regarding a sports tier, these officials noted that a sports tier only
exists in New York, and that it has been bitterly fought-over, involved
mediation, and is only a 1-year agreement. Moreover, they believe we
should emphasize that the Yankees Entertainment and Sports (YES)
network agreement only applies to regional sports networks, not ESPN.
They said that the YES arrangement does not represent a trend and
noted, for example, that cable operators continue to place cable-
affiliated sports networks on the expanded-basic tier.
Regarding retransmission consent, Disney officials said that we should
provide more discussion about why the Congress passed this provision.
They believe that without retransmission consent, free over-the-air
television would be undermined. Moreover, they said that, prior to:
retransmission consent, broadcasters were required to provide content
free of charge to cable operators that they subsequently sold to
subscribers. Additionally, they said that it is important to note that
the option of carriage of broadcaster-affiliated cable networks instead
of payment for retransmission was discussed by Congress and has been
endorsed by FCC. More importantly, according to these officials, Disney
always offers a cash option to cable operators--their most recent offer
was 70 cents per subscriber per month.
[End of section]
Appendix VIII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Amy Abramowitz, (202) 512-2834 Michael Clements, (202) 512-2834:
Staff Acknowledgments:
In addition to those named above, Stephen Brown, Julie Chao, Andy
Clinton, Keith Cunningham, Michele Fejfar, Sally Moino, Tina Sherman,
Wendy Turrene, Mindi Weisenbloom, and Carrie Wilks made key
contributions to this report:
FOOTNOTES
[1] See U.S. General Accounting Office, Telecommunications: Issues in
Providing Cable and Satellite Television Service, GAO-03-130
(Washington, D.C.: Oct. 15, 2002).
[2] Each year, FCC samples between 700 and 800 of the universe of
roughly 10,000 cable systems using a stratified sampling approach that
is based on the status of effective competition and the size of the
cable system.
[3] These 9 cable operators that provided data to us serve
approximately 62 percent of all cable subscribers in the United States
as of 2002.
[4] While programming expenses are directly related to the cable rates,
it is less clear how much of the infrastructure investment underlies
cable rate increases since some of these costs are more directly
related to the provision of digital cable tiers and cable modem
service.
[5] In some cases, state public service commissions are also involved
in cable regulation.
[6] The 1984 Act restricted regulation to only basic services for cable
systems that were not subject to effective competition. In its
rulemaking, FCC initially said that effective competition existed if
three or more over-the-air broadcast signals existed in a given market.
Under this definition, over 90 percent of all cable systems would be
subject to effective competition and therefore not subject to rate
regulation.
[7] Under statutory definitions in the 1992 Act, substantially more
cable operators would be subject to rate regulations than had
previously been the case.
[8] 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.
[9] 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).
[10] 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 this
analysis.
[11] This cable operator also noted that current rates in the market
are not sustainable given the increasing cost of programming.
[12] 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 signals 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.
[13] See Ninth Annual Report, FCC 02-338.
[14] In our October 2002 report (GAO-03-130), we did not find that DBS
competition was associated with lower cable rates. Although the
parameter estimate was negative--indicating that DBS competition was
associated with lower cable rates--the estimate was not statistically
significant. As part of our analysis for this report, we further
examined and refined our competition measures to more accurately
reflect the true nature of competition in the franchise areas that were
included in our analysis. Although the parameter estimate remains
negative and the estimate is now statistically significant, the
magnitude of estimate is very small.
[15] 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), page 7, for a summary of the approaches used by cable operators
to complete the form.
[16] In unregulated markets, for example, costs are an important factor
in price setting by companies, but several other key factors, such as
consumer demand and the competitiveness of the market, also influence
the market price. Thus, costs and prices need not move in tandem.
[17] Many cable franchises we surveyed said that their profit margins
for basic and expanded-basic cable services decreased in 2002, but many
also said that those decreases were offset by increased profits from
other services, such as cable Internet and digital cable.
[18] For example, 15 cable franchises said that they entered dollar
values in the factors until the entire rate increase was justified and
did not consider the remaining cost factors; many others cited specific
cost factors that were adjusted to reach a balance.
[19] See Federal Communications Commission, Report on Cable Industry
Prices (Washington, D.C.: Apr. 1, 2002). This is the most recent FCC
report that is consistent with the data used in our analysis.
[20] The 1992 Act established three conditions for a finding of
effective competition, and a fourth was added in the 1996 Act.
Specifically, a finding of effective competition in a franchise area
requires that FCC has found one of the following conditions to exist:
fewer than 30 percent of the households in the franchise area subscribe
to cable service (low-penetration test); at least two companies
unaffiliated with each other offer comparable video programming service
(through a wire or wireless (e.g., DBS service)) to 50 percent or more
of the households in the franchise area, and at least 15 percent of the
households take service other than from the largest company
(competitive provider test); the franchising authority offers video
programming service to at least 50 percent of the households in the
franchise area (municipal test); or a local telephone company or its
affiliate (or any other company using the facilities of such a carrier
or its affiliate) offers video programming, by means other than DBS,
that is comparable to that offered by the cable provider in the
franchise area (local exchange carrier (LEC) test). For the LEC test to
be applicable, the telephone company and the cable provider must be
unaffiliated.
[21] Without a finding of effective competition, the cable operator
must also charge a uniform rate for cable services throughout the cable
franchise.
[22] The low-penetration test of effective competition applies if fewer
than 30 percent of the households in the franchise area subscribe to
cable service.
[23] We calculated the penetration rate by dividing the number of
franchise subscribers by the number of households in the franchise
area, as reported by the cable operator to FCC.
[24] The provision of DBS data for effective competition has recently
been transferred to the Satellite Broadcasting and Communications
Association.
[25] In addition to the BLS cable television subcategory index, FCC
also reports the price per channel over time. Contrary to the BLS index
indicating that cable prices increased just under 30 percent, FCC found
that the price per channel rose by about 5 percent during this 5-year
span.
[26] See Wildman, S.S. Assessing Quality-Adjusted Changes in the Real
Price of Basic Cable Service. Michigan State University: September 10,
2003.
[27] Since the rates that cable networks negotiate with their clients/
affiliates are confidential, we do not know the actual fees cable
operators pay to carry the networks. We thus relied on license fee data
compiled by Kagan World Media.
[28] 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.
[29] Two of the three sports leagues with whom we spoke told us that
the cost of sports rights, paid by networks to the leagues, has not
increased faster than the cost of other network programming in the last
couple of years. However, representatives of the leagues did note that
the cost to sports networks of producing sports programming is
increasing because these are live events that require complex and
costly production.
[30] For this analysis, we only used networks included in the Kagan
publication that had financial data for the years 1999 to 2002. Later
in this report, we have other analyses that use more of the networks
included in the Kagan publication. In those analyses, we did not need 4
historical years of data.
[31] Advertising sales revenues net of expenses incurred to insert and
sell local advertising would offset a lower percentage of cable
operators' programming expenses.
[32] 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.
[33] We also performed the analysis reported in this section with a 20
percent ownership affiliation threshold--that is, we considered a
network as "owned" by a broadcast network or cable operator if the
network was at least 20 percent owned by either of these types of
providers. With this ownership threshold, our findings were nearly
identical to those reported here.
[34] Only 3 of the large cable operators are majority owners of
national cable networks.
[35] License fees received by broadcaster-affiliated networks were
higher than those received by cable networks that were not majority-
owned by broadcasters or cable operators, but the difference was not
statistically significant. Moreover, when sports networks were
eliminated from the analysis, the average level of license fee was
almost identical across these two groups.
[36] 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 appendix I for a list of variables
included in that model.
[37] Representatives of a broadcast organization told us that the
digital local broadcast signals are sometimes carried on a digital
tier.
[38] See The Carmel Group, The Telecom Future of Independent Cable: ACA
Member Concerns and Issues (Carmel-by-the-Sea, CA: May 2003), a report
prepared for the American Cable Association.
[39] Sometimes certain cable networks are transmitted unscrambled and
trapping devices are used outside of the customer's home to keep
networks that the home has not purchased from transmitting to the
customer's televisions. This trapping technology would not be
economically viable in an à la carte regime.
[40] Recently, the Yankees Entertainment and Sports (YES) network was
placed on a sports-only tier, with Madison Square Garden and FOX Sports
Net New York, on selected Cablevision systems in the New York City
metropolitan area following a lengthy dispute between YES and
Cablevision. Subsequently, YES was offered on an à la carte basis on
Time Warner Cable franchises in New York.
[41] One sports league also requires its cable network carriers to
arrange for all cablecast games to be simulcast (subject to league
sell-out rules) on free over-the-air television in the home cities of
the participating clubs.
[42] In one case, the cable operator simultaneously added one or two
other networks to the expanded-basic tier.
[43] U.S. Public Interest Research Group, The Failure of Cable
Deregulation: A Blueprint for Creating a Competitive, Pro-Consumer
Cable Television Marketplace (Washington, D.C.: August 2003).
[44] Under the Communications Act, the prohibition on exclusive
contracts enacted as part of the program access provisions in the 1992
Act were set to sunset in October 2002 unless FCC determined the rules
were still necessary. In 2002, FCC extended the prohibition until
October 2007 because the commission determined that the prohibition
continues to be necessary.
[45] In July 2003, FCC adopted a Notice of Inquiry asking for comment
on a variety of issues related to competition in the video market. One
of the issues related to program access issues.
[46] Recently, DIRECTV announced that it would provide local broadcast
stations in all 210 television markets by 2008.
[47] Satellite Broadcasting and Communications Association v. FCC, 275
3d 337 (4th Cir. 2001) cert. Denied 536 U.S. 922 (2002).
[48] Each local broadcast station has the right to negotiate for
retransmission or to assert must-carry status. Under must carry, the
cable operator is required to carry a local broadcast station, but can
do so without paying any compensation.
[49] We also found that cable networks owned by cable operators are
also more likely to be carried than networks not owned by broadcasters
or cable operators.
[50] One possible option would be to replace the retransmission consent
provisions with a must-carry right.
[51] See U.S. General Accounting Office, Telecommunications: Issues in
Providing Cable and Satellite Television Services, GAO-03-130
(Washington, D.C.: Oct. 15, 2002).
[52] Kagan World Media, Economics of Basic Cable Networks 2003 (Carmel,
CA: 2003).
[53] Due to the confidential requirement of industry contracts, we
could not independently verify the data from Kagan World Media. To
assess the reliability of these data, we asked cable networks that we
interviewed about the Kagan data. Eight of the 12 national cable
networks we interviewed said that Kagan data on license fees, revenues,
and programming expenses were fairly accurate.
[54] In the course of our review, we also identified some cable
franchises that were apparently sampled because of clerical-type
mistakes, such as the transposition of a franchise identification
number or an inconsistency between franchises identified in the
effective competition report and the franchises ultimately sampled.
[55] 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).
[56] See GAO-03-130.
[57] See GAO-03-130 for a discussion of why we use the three-stage
least squares method, rather than the two-stage least squares method.
[58] A dummy variable takes a value of 1 if a certain characteristic is
present and a value of 0 otherwise.
[59] The dummy variables in the model include the following: horizontal
concentration of cable systems, vertical relationship, regulation,
presence of a wire-based competitor, presence of a MMDS competitor, DBS
provision of local channels, and nonmetropolitan area. Also, because
the natural log of 0 is undefined, we added 1 to the observed value of
any continuous variable that can take the value of 0.
[60] For dummy variables (those variables that can take a value of 0 or
1 depending on the presence of a condition (e.g., presence of wire-
based competitor, DBS providers offering local broadcast stations)), we
report the percentage change arising from a discrete change from 0 to
1. We calculated this percentage change as: [exp(parameter estimate)-1]
times 100.
[61] In our October 2002 report (GAO-03-130), we did not find that DBS
penetration was associated with lower cable rates. As part of our
analysis for this report, we further refined our measure of competition
to more accurately reflect the actual status of competition at the time
our data were gathered. These refinements contributed to our finding
that DBS penetration was associated with lower cable rates.
[62] In our October 2002 report(GAO-03-130), MMDS competitors were
included in our variable that measured nonsatellite competition. For
this report, we removed MMDS competitors from the nonsatellite
competition variable, thereby creating a wire-based only competition
variable, and created a separate variable for MMDS competition. We made
this adjustment because (1) MMDS relies on a different technology than
either wire-based or DBS competitors and (2) many MMDS operators are
scaling back or discontinuing video service.
[63] For example, see Waterman, D. and A.W. Weiss, "The Effects of
Vertical Integration Between Cable Television Systems and Pay Cable
Networks," Journal of Econometrics, 72 (1996): 357-395 and Chipty, T.,
"Vertical Integration, Market Foreclosure, and Consumer Welfare in the
Cable Television Industry," American Economic Review, 91(3) (2001):
428-453. These studies found that cable operators were more likely to
carry networks that they owned. These studies, however, did not test
whether cable operators were more likely to carry a network owned by a
broadcaster.
[64] An alternative method to estimate the reduced-form equation is the
probit model. In a binary choice model, the differences between the
logistic and probit models are generally not significant. Differences
can arise in the multinomial model, where there are three or more
choices, because the logistic model imposes independence conditions
that sometimes do not reflect the conditions being modeled. Such was
not the case in our model, since we estimated a binary choice equation.
[65] We calculated these percentages by taking the mean values of all
variables included in the model and deriving a predicted value of
carriage for a broadcast-affiliated network and a nonbroadcast-
affiliated network. We then took the percentage differences in these
predicted values. The same methodology was used for determining the
relative likelihood that a cable-affiliated network would be carried.
[66] In our model, we included approximately 100 franchises that were
classified as facing wire-based competition--we believe that FCC's
number of only 45 overbuilders, as cited by NCTA, does not include all
wire-based competitors. Moreover, the sample of franchises included in
our model was only about 720, which were randomly selected by FCC to be
representative of the universe of franchises. As such, approximately 16
percent of the franchises included in our model were classified as
having a wire-based competitor.
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