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Report to the Subcommittee on Antitrust, Competition Policy and 
Consumer Rights, Committee on the Judiciary, U.S. Senate:

February 2004:

TELECOMMUNICATIONS:

Wire-Based Competion Benefited Consumers in Selected Markets:

GAO-04-241:

GAO Highlights:

Highlights of GAO-04-241, a report to the Subcommittee on Antitrust, 
Competion Policy and Consumer Rights, Committee on the Judiciary, U.S. 
Senate 

Why GAO Did This Study:

One of the primary purposes of the Telecommunications Act of 1996 was 
to promote competition in telecommunication markets, but wire-based 
competition has not developed as fully as expected. However, a new 
kind of entrant, called broadband service providers (BSP), offers an 
alternative wire-based option for local telephone, subscription 
television, and high-speed Internet services to consumers in the 
markets they have chosen to enter. This report provides information on 
(1) BSPs’ business strategy, (2) the impact of BSPs’ market entry on 
incumbent companies’ behavior and consumer prices for 
telecommunications services, (3) the key factors that BSPs consider 
when making decisions about which local markets to enter, and (4) the 
success of BSPs in attaining subscribership and any key factors that 
may limit their success. 

We developed a case-study approach to compare 6 cities where a BSP has 
been operating for at least 1 year with 6 similar cities that do not 
have such a competitor. The 6 markets with a BSP presently account for 
more than 20 percent of the households nationwide that are in areas 
where BSPs currently offer the three-service package, but the results 
of these case studies are not generalizable to all markets.

What GAO Found:

BSPs’ primary business strategy is to build a fiber-optic network to 
provide consumers with a bundle of services, including subscription 
television, high-speed Internet access, and local telephone. To entice 
consumers to purchase more than one service of the three services they 
offer—a key marketing goal—all of the BSPs we reviewed offer 
substantial savings to consumers who buy more than one service. 
The rates for telecommunications services were generally lower in the 
6 markets with BSPs than in the 6 markets without a BSP. For example, 
expanded basic cable television rates were 15 to 41 percent lower in 5 
of the 6 markets with a BSP when compared with their matched market.

The 6 BSPs we interviewed said that demographic factors, such as city 
size, income, and computer use were important factors in their 
decision to enter a market. For example, most of the BSPs avoided 
entering large cities. Location of the markets to key facilities and 
receptivity of local government officials were also considered when 
deciding which markets to enter.

The 6 BSPs we interviewed have gained significant market shares for 
the services they provide, but they have also faced a number of 
obstacles that may be hindering their success. For example, the BSPs 
we spoke with are experiencing some financial difficulties and are 
putting off network expansion. Two of these companies also currently 
lack the resources necessary to adequately market their services 
within their existing markets.

We provided a draft of this report to the FCC and DOJ. The DOJ did not 
provide any comments, and FCC provided technical comments that we 
incorporated. We invited the Broadband Service Provider Association, 
the National Association of Telecommunications Officers and 
Administrators, the National Cable & Telecommunications Association 
(NCTA), and the United States Telecom Association to comment on a 
draft of this report. We summarize and discuss NCTA’s detailed 
comments in the report.

What GAO Recommends:

www.gao.gov/cgi-bin/getrpt?GAO-04-241.

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: 

BSPs' Business Strategy Focuses on Providing Bundled Telecommunications 
Services: 

Consumers Enjoy Lower Rates in Markets with BSPs: 

BSPs Consider Specific Demographic, Geographic, and Local Government 
Factors When Deciding Which Markets to Enter: 

BSPs Are Gaining Market Share, but a Variety of Factors May Hinder 
Their Success: 

Conclusions: 

Agency Comments: 

Industry Association Comments and Our Evaluation: 

Appendixes:

Appendix I: Scope and Methodology: 

Appendix II: Price and Channel Information in Six Market Pairs: 

Appendix III: Broadband Service Provider Association Member Markets as 
of February 2003: 

Appendix IV: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Staff Acknowledgments: 

Tables: 

Table 1: Case-Study Cities and Industry and Local Government 
Participants: 

Table 2: Price and Channel Information in Six Market Pairs: 

Figures: 

Figure 1: Case-Study Locations and Telecommunications Companies 
Interviewed: 

Figure 2: Telecommunications Service Subscriptions: 

Figure 3: Average BSP À la carte and Bundle Price for Premium Three-
Service Bundle: 

Figure 4: Extent to Which Rates For Telecommunications Services Were 
Lower in the 6 Markets with BSP Competition When Compared with Each BSP 
Markets' Matched-Pair: 

Figure 5: Penetration of Subscription Television, High-Speed Internet, 
and Telephone Services for BSPs in Case-Study Markets, June 2003: 

Abbreviations: 

BSP: broadband service provider: 

BSPA:  Broadband Service Provider Association:

FCC:  Federal Communications Commission:

NATOA: National Association of Telecommunications Officers and 
Administrators:

NCTA:  National Cable & Telecommunications Association:

USTA: United States Telecom Association:

Letter February 4, 2004:

The Honorable Mike DeWine: 
Chairman: 
The Honorable Herb Kohl: 
Ranking Minority Member: 
Subcommittee on Antitrust, Competition Policy and Consumer Rights: 
Committee on the Judiciary: 
United States Senate:

One of the primary purposes of the Telecommunications Act of 1996 was 
to promote competition in telecommunications markets. In local 
telephone markets, companies began to provide competition to local 
telephone companies after passage of the act. Much of that competition 
focused on service to business customers, and many of these companies 
have gone out of business in the past few years. Regarding the 
subscription television market--that is, the market for pay television 
service--there were expectations that certain provisions of the act, 
along with some provisions of the earlier Cable Television Consumer 
Protection and Competition Act of 1992, would spur new competition in a 
market that had long been dominated by cable television providers. 
However, entry by wire-based providers (such as telephone companies) 
into the subscription television market has not developed as fully as 
expected.

In the past few years, a new kind of wire-based provider--typically 
known as a broadband service provider (BSP)--has emerged to provide 
competition to local incumbent telephone and cable television providers 
through a bundled offering of subscription television, local telephone, 
and high-speed (or broadband) Internet services. These BSPs could 
enhance the competitiveness of these markets, but they also may face 
certain challenges that make it difficult for them to become fully 
viable competitors.

You asked us to provide information about a variety of issues related 
to BSPs' operations and the influence of their entry into selected 
markets. For a selected set of markets, this report provides 
information on (1) BSPs' business strategy; (2) the impact of BSPs' 
market entry on incumbent cable and telephone companies' market 
behavior and on consumer prices of subscription television, high-speed 
Internet, and local telephone services; (3) the key factors that BSPs 
consider when making decisions about which local markets to enter; and 
(4) the success of BSPs in attaining subscribership and any key factors 
that may limit their success. We also recently issued a report on cable 
rates that examined several related issues.[Footnote 1]

To address these objectives, we developed a matched-pair case-study 
approach to compare cities, or markets, where a BSP is operating with 
similar cities that do not have such a competitor. We selected 6 cities 
in which a BSP had offered three services--local telephone, 
subscription television, and high-speed Internet access--for at least 1 
year. We then chose a match for each of the 6 cities by selecting 
another city in the same state, where possible, which was of a similar 
size and demographic profile, but that did not have a BSP. See figure 1 
for a list of 12 cities that were chosen. Of the 6 city pairs, 3 were 
small city pairs, 2 were medium-sized city pairs, and 1 was a large 
city pair. In the case of the large city with a BSP--Boston--we chose a 
matched city that was not in the same state because there was no 
appropriate in-state match for Boston, nor were there other large 
cities that had an extensive BSP presence. The 6 case-study markets 
with a BSP presently account for more than 20 percent of the households 
nationwide that are in areas where BSPs currently offer the three-
service package.[Footnote 2]

In each of the cities, we conducted semistructured interviews with 
relevant industry representatives as well as state and local regulatory 
officials. As depicted in figure 1, we interviewed officials from:

* six BSPs in the cities where there was such a provider,

* four incumbent cable companies that operate in our 6 matched-pair 
cities,

* four incumbent telephone companies that operate in our 6 matched-pair 
cities,

* twelve local franchising authorities, and:

* seven state public utility commissions.

Figure 1: Case-Study Locations and Telecommunications Companies 
Interviewed:

[See PDF for image]

[End of figure]

Although our analysis provides details on the 12 geographic locations 
we examined, because we used a case-study method, our results are not 
generalizable to all markets. Statistics presented in the Background 
section of this report regarding the local telephone, subscription 
video, and high-speed Internet markets were obtained from the Federal 
Communications Commission (FCC). This information was presented for 
background and illustrative purposes only; therefore, we did not assess 
the reliability of this information.

We performed our work from May 2003 through December 2003 in accordance 
with generally accepted government auditing standards. See appendix I 
for a more detailed discussion of our scope and methodology.

Results in Brief:

BSPs focus on a core business strategy of building a new fiber-optic 
network over which they can provide three services to consumers: local 
telephone, subscription television, and high-speed Internet services. 
The BSPs we interviewed attempt to entice subscribers to take more than 
one service, and they have specific targets for the average revenues 
that they hope to obtain per subscriber. In order to encourage 
subscribers to take more than one of the three services they offer, 
these providers offer significant discounts for purchases of packaged 
services.

On the basis of 12 markets we examined, it appears that BSPs' entry 
into a market benefited consumers in the form of lower prices for 
subscription television, high-speed Internet access, and local 
telephone services. Incumbent cable operators often responded to BSP 
entry by lowering prices, enhancing the services that they provide, and 
improving customer service. Incumbent local telephone providers did not 
appear to have responded as much to BSP entry as was the case with 
cable providers; these local telephone providers told us that certain 
federal and state laws limit their ability to respond to new entrants. 
The combined effect of BSP entry and incumbent companies' response 
provides significant benefits for consumers. The rates for 
telecommunications services were generally lower in the 6 markets with 
BSPs than in the 6 markets without a BSP. For example, expanded basic 
cable television rates were 15 to 41 percent lower in 5 of the 6 
markets with a BSP when compared with their matched market. The prices 
were also generally lower in markets with BSPs for local telephone and 
high-speed Internet services. In some cases, the lowest price in the 
BSP market was that offered by the BSP, while, in other cases the 
lowest price in that market was that offered by the incumbent provider. 
Some of the rate impacts that we found may be due to factors other than 
the BSP entry, such as population density.

BSPs analyze a variety of factors when determining which local markets 
to enter. For the 6 BSPs we interviewed, demographic characteristics, 
such as the size of the city and the income and level of computer use 
of its residents, were important factors that BSPs considered when 
determining which markets to enter. For example, these providers 
generally targeted small to medium markets because, in their view, it 
would be difficult to quickly construct infrastructure in larger 
markets. Also, the BSPs we interviewed enter markets that are 
geographically close to a parent company or close in proximity to other 
key facilities, such as the BSP's headquarters, network, or other 
needed infrastructure. Finally, 5 of the 6 providers selected specific 
markets that, in their view, had officials in city government who were 
actively interested in having new competition and who took steps to 
ease the providers' entry.

Despite making significant progress in attracting customers to purchase 
their services, the BSPs we interviewed face some obstacles in the 
application of their business strategy. In the 6 markets we reviewed, 
the BSPs have attracted, on average, 25 percent of households to their 
subscription television service, 29 percent to their local telephone 
service, and 17 percent to their high-speed Internet services. The 
penetration levels--that is, the percentage of the population in an 
area that are subscribing to a BSP's service--vary considerably across 
the markets and services, ranging from a low of 6 percent penetration 
for high-speed Internet in 1 market to a high of 63 percent penetration 
in telephone service in another market. We also found that BSPs' 
business strategy can be difficult to implement because of certain 
factors that may limit their success. First, BSPs we interviewed noted 
that certain factors could hinder their ability to effectively compete 
in the specific markets that they have entered. For example, some of 
these providers said that an inability to gain access to certain cable 
networks that subscribers want to receive, or difficulty being able to 
provide service to residents of some apartment and condominium 
complexes, created barriers to their success in certain markets. 
Second, the BSPs we interviewed may be facing more competition in the 
markets they have entered than they may have envisioned when they 
developed their marketing plans, which is making it difficult to reach 
the penetration targets they had set. Lastly, the BSPs we interviewed 
have had difficulties securing continued access to adequate financial 
resources that are needed to rapidly construct their networks and 
market their services. As a result, the BSPs we interviewed are 
currently experiencing varying states of financial problems due to a 
lack of capital. None of the 6 companies are actively expanding their 
networks, and 2 currently lack the resources that are necessary to 
adequately market their services within their existing markets. These 
financial problems may be alleviated as the nation's telecommunications 
sector recovers.

We provided a draft of this report to the FCC and the Antitrust 
Division of the Department of Justice for their review and comment. The 
Department of Justice did not provide any comments, and the FCC 
provided technical comments that we have incorporated.

We also invited representatives from the Broadband Service Provider 
Association (BSPA), the National Association of Telecommunications 
Officers and Administrators (NATOA), the National Cable & 
Telecommunications Association (NCTA), and the United States Telecom 
Association (USTA) to review and comment on the draft report. USTA did 
not provide any comments. BSPA and NATOA provided technical comments 
that we have incorporated as appropriate. NCTA provided detailed 
comments. In particular, NCTA stated that because the sample of 
franchises examined as part of this case study was so small, no broad 
conclusions should be drawn. Moreover, they noted that the observed 
pricing differences between cities with and those without a BSP entrant 
could have occurred for reasons other than competitive entry. Finally, 
they noted that GAO did not evaluate whether the lower prices available 
in cities with BSPs represented economically sustainable price levels. 
GAO's response to these comments, as well as a more complete summary of 
NCTA's comments appears at the end of this report.

Background:

Today, 95 percent of American households purchase local telephone 
service, 85 percent purchase subscription television service (usually 
from a cable company or a satellite provider), and about 62 percent 
purchase some form of access to the Internet. Of those with access to 
the Internet, about 39 percent have a high-speed--or broadband--
connection usually through either a cable modem or a digital subscriber 
line provided over a telephone connection.

Local telephone service has been available since the late 1800s, and, 
by 1950, over 60 percent of households had telephone service. Since the 
early 20th century, certain aspects of telephone service, such as its 
price, have been regulated by state public utility commissions and by 
the FCC. With the Telecommunications Act of 1996, the Congress sought 
to increase competition in the local telephone market. Today, incumbent 
local telephone companies face competition from a variety of types of 
companies. However, nearly 87 percent of residential local telephone 
subscribers continue to receive service from an incumbent, or 
traditional, local telephone company.

Subscription television service has been available since the late 1940s 
when cable television providers first emerged, and, by the late 1980s, 
cable service was available to nearly 90 percent of households 
throughout the United States. Today, according to FCC, about 67 percent 
of American households purchase cable service.[Footnote 3] The 1992 
Cable Television Competition and Consumer Protection Act took steps to 
increase competition to cable providers. The act prohibited the 
awarding of exclusive franchises by local franchising authorities. 
Also, as required by the act, FCC developed rules--commonly referred to 
as program access rules--that require cable operators that have 
affiliated cable networks to make those networks (if they are delivered 
to the cable operator via satellite) available to competitors.[Footnote 
4] The Telecommunications Act of 1996 also took steps to allow 
telephone and electric companies to enter the subscription television 
market. In the 1990s, direct broadcast satellite providers (such as 
DIRECTV and EchoStar) began offering subscription television service 
through satellites. According to FCC, over 17 percent of American homes 
currently purchase satellite television service, and these providers 
have become the primary competitors to the cable television industry. 
At this time, competition in the subscription video market from wire-
based providers exists in only about 2 percent of markets nationwide, 
according to FCC information.

High-speed Internet is a relatively new service that provides a 
continuous, high-speed, high-capacity connection to the 
Internet.[Footnote 5] High-speed connections to the Internet became 
widely available in the late 1990s, and, as of mid-2002, nearly 15 
percent of American homes had a high-speed connection to the Internet. 
In recent years, local telephone companies adapted their networks to 
provide new services, such as digital subscriber line service, which is 
a form of high-speed Internet service. Through their digital subscriber 
line service, telephone companies serve approximately 33 percent of 
subscribers who purchase a broadband connection. Similar to local 
telephone companies, many cable television companies upgraded their 
networks to provide high-speed Internet service through cable modem 
service. Cable modem service is the most widely subscribed to high-
speed service with approximately 57 percent of subscribers purchasing 
this service.[Footnote 6]

Figure 2 provides information on the extent of competition in the local 
telephone, subscription television, and high-speed Internet markets.

Figure 2: Telecommunications Service Subscriptions:

[See PDF for image]

[End of figure]

BSPs' Business Strategy Focuses on Providing Bundled Telecommunications 
Services:

Broadband service providers are a new type of telecommunications 
provider. Unlike local telephone and cable television companies, which 
are adapting their existing networks to provide additional services, 
and other entrants that focus on providing service in one 
communications market, broadband service providers focus on a core 
business strategy of building a new fiber-optic network over which they 
can provide local telephone, subscription television, and high-speed 
Internet services.

A fiber-optic network requires a long-term commitment to build. 
According to the BSPA, companies must first obtain a local franchise 
that authorizes them to begin construction. They then must obtain the 
rights-of-ways to build the network and work with utility companies to 
make sure that they do not disrupt other services. Once the BSP begins 
building its network, construction usually takes between 2.5 to 4 years 
if the company (1) has steady access to capital and has no difficulties 
in obtaining the necessary local government accommodations and (2) is 
able to receive needed information from utility companies. According to 
the BSPA, the time it takes to build a network varies with the size of 
the market and whether the BSP can string its cable on poles or if it 
must bury the cable in the ground. Because it takes 4 to 5 times longer 
for a BSP to build a network if it must bury the cable, some BSPs 
target communities that allow them to string their cable on poles 
according to the BSPA. A BSPA document indicates that BSPs have spent 
over $6 billion in capital investments to build 32,000 miles of fiber 
network. BSPs' networks currently expand across areas that would enable 
them to service up to 4 million homes as of June 2003; of this possible 
subscriber base, these companies have gained over 1 million 
subscribers.

A representative of the BSPA said that most BSPs have specific targets 
regarding the minimum threshold of the potential customers in an area 
they need to attract in order to ensure that the large financial 
investment is profitable. Additionally, a common goal is to have most 
of their subscribers purchase more than one of the three offered 
services. Finally, we were told that the target average revenue per 
subscriber each month is about $100. In order to be able to achieve 
these goals, BSPs use several marketing strategies. First, part of the 
BSP business strategy is to enter markets that do not have any wire-
based providers other than the incumbent cable and telephone providers. 
That is, BSPs look to become the second major wire-based provider of 
subscription television and local telephone service in each of the 
markets they enter. Second, BSP officials told us that they attempt to 
entice customers to stay with their company in the long term by 
building the most modern network in the market, thus enabling the BSPs 
to upgrade services as new technologies become marketable. Third, and 
most central to the BSP business strategy, the 6 BSPs we interviewed 
offer pricing discounts to encourage the purchase of multiple services. 
This business focus allows the BSPs to capitalize on network 
efficiencies by generating more marginal revenue on the second or third 
service that the subscriber purchases.

In order to illustrate the savings available to consumers from BSPs' 
bundled telecommunications offerings, we compared the packaged price of 
a certain bundle of communications services offered by BSPs with the 
prices that these companies would charge for the same set of services 
individually. While some of the BSPs offered packaged deals on a 
relatively low end package of services, we found that to compare a 
similar package of services across the 6 BSPs we interviewed, we needed 
to examine the price for a higher end package of services that included 
such items as digital tiers of video service, premium channels, and 
higher end speeds of Internet access. For the 6 markets with BSPs that 
we interviewed, figure 3 shows the average savings a consumer can 
receive by purchasing this particular set of telecommunications 
services in a bundle versus purchasing them individually. The average 
monthly BSP à la carte prices for this bundle of telecommunications 
services in the 6 markets is $136.63. If purchased as a bundle, the 
subscriber is able to receive a discount that would bring the cost for 
this bundle of services down to $117.28. That is, a BSP customer will 
save, on average, about $20, or 14 percent, if they select three 
services as a bundle package rather than buy them individually from the 
BSP. Across the 6 markets with BSPs that we interviewed, the additional 
savings a consumer could receive by purchasing this basket of services 
as a bundle ranged from $11.66 to $28.74 per month.

Figure 3: Average BSP À la carte and Bundle Price for Premium Three-
Service Bundle:

[See PDF for image]

[End of figure]

Consumers Enjoy Lower Rates in Markets with BSPs:

In the 12 markets we reviewed, the entry of a BSP appears to induce 
incumbent cable operators to respond by providing more and better 
services and by reducing rates and offering special deals. Incumbent 
telephone providers have not shown as much of a competitive response to 
BSP entry. The ultimate result of the BSP operations, along with 
incumbents' response, is substantially lower prices for consumers.

Incumbent Cable Operators Responded to BSP Entry by Lowering Prices and 
Improving Services, but Incumbent Telephone Operators Show Less 
Response to BSP Entry:

In the 6 markets we reviewed that had a BSP providing service, 
incumbent cable operators appear to respond competitively to the 
presence of the BSP. Although cable operators told us they generally 
viewed satellite providers as their primary competitors, they indicated 
that BSP competition in individual markets can be a significant factor 
when they develop their business strategies for that market. In 
particular, incumbent cable providers facing competition from a BSP 
told us that they responded to the BSP activity by lowering rates or 
offering special deals or packages and, in some cases by providing more 
local content and advanced services. For example:

* Almost all of the incumbent cable operators we contacted said they 
lowered their cable and high-speed Internet prices in the markets where 
a BSP was operating in order to be more competitive. Moreover, we found 
that one incumbent cable provider in a BSP market chose to offer 
discounts to subscribers who purchased both cable and high-speed 
Internet service, thus enabling it to compete directly with the BSP's 
packaged offerings. In this market, the incumbent cable operator priced 
a package combining cable and high-speed Internet services at a 45 
percent discount when compared with the same package that the cable 
operator offered in the non-BSP matched market.

* Two incumbent cable operators also said that exclusive programming 
helps them to differentiate themselves from the BSP. For example, one 
incumbent cable operator said that they respond to BSP entry in a 
number of ways, including providing more local programming and advanced 
services. Another cable operator told us that its provision of local 
high school sports games, a community-focused talk show, and city 
council meetings provides an advantage over the BSP. However, the 
incumbent cable provider said that it provided this programming before 
the BSP's entry into the market.

* Some incumbent cable providers also responded to BSP competition by 
improving their customer service. For example, one cable operator noted 
that its company initiated door-to-door visits to customers to ensure 
good picture reception and answer customer questions. Similarly, on the 
basis of the information we gathered from local franchising 
authorities, it appeared that in some cases customer satisfaction with 
the incumbent cable providers improved after the BSP entered the 
market.

The incumbent telephone companies that we interviewed had not generally 
taken steps to respond to the BSP presence in their markets. Incumbent 
telephone providers told us that their primary competition comes from 
providers other than BSPs. The telephone companies varied in terms of 
which other providers they viewed as providing the most competition to 
their services, but this list of important competitors included a 
variety of provider types, such as long-distance telephone providers, 
wireless carriers, and Internet-based providers of telephony services.

Incumbent local telephone providers we spoke with told us that they do 
not perceive BSPs as a significant source of competition because the 
BSPs have a very small presence focused only in scattered markets, and 
because they face greater sources of competition, such as wireless and 
long distance providers.[Footnote 7] For example, these providers 
generally did not lower prices or enhance their services in markets 
where BSPs provided telephone service. However, the incumbent telephone 
providers told us that their ability to respond to BSP competition was 
limited by federal and state laws and regulations that they view as 
restrictive.[Footnote 8] Regarding the high-speed Internet market, 
incumbent telephone providers also noted that they did not view BSPs as 
important competitors. Instead, telephone companies told us that their 
most important competitors in the high-speed Internet market are 
incumbent cable television providers. Moreover, they noted that, in 
their opinion, cable operators were likely to remain dominant in the 
high-speed Internet market. In fact, one incumbent local phone provider 
said that it reduced prices for high-speed Internet service to compete 
with cable operators' cable modem service--not because of competition 
from BSPs.

Consumers Benefited from Lower Prices for Telecommunications Services 
in the 6 Markets With BSPs That We Reviewed:

Rates were generally lower for the subscription television, high-speed 
Internet, and local telephone services in the 6 markets we examined 
with a BSP present than in the 6 markets that did not have BSP 
competition. However, the extent to which prices were lower in a BSP 
markets compared to its "matched market" varied considerably across 
markets and services. For example, in 1 BSP market, the monthly rate 
for cable television service was 41 percent lower compared with the 
matched market, and in 2 other BSP locations, cable rates were more 
than 30 percent lower when compared with their matched markets. On the 
other hand, in 1 market, the price for cable television service was 3 
percent higher in the BSP market than it was in the matched market. 
Also, we found that rates for high-speed Internet service were more 
than 20 percent lower in the 3 BSP markets compared each of their 
matched markets, but for the other 3 market-pairs, high-speed Internet 
rates were roughly the same across BSP markets and their matched 
markets. The extent to which rates were lower for one local phone line 
in BSP markets compared to their matched market varied considerably: 
rates were 4 to 33 percent lower in 5 of the 6 markets with a BSP we 
reviewed, and the rates for local telephone service were the same in 1 
of the matched-pair markets we reviewed. See figure 4 and appendix II 
for more information on pricing patterns between market-pairs.

In some cases, the lowest price in the market with a BSP was the BSP 
price, however, in other cases, the lowest price was the incumbent's 
price. Specifically, in the 6 markets with a BSP, the BSP price was 
lowest for cable television in 4 markets, the BSP price was lowest for 
high-speed Internet in 2 markets, and the BSP price was lowest for 
local telephone service in 5 markets.

Figure 4: Extent to Which Rates For Telecommunications Services Were 
Lower in the 6 Markets with BSP Competition When Compared with Each BSP 
Markets' Matched-Pair:

[See PDF for image]

Note: For markets with a BSP, we used the lowest price that could have 
been offered by the incumbent provider or by the BSP. In markets 
without a BSP, the lowest price is that offered by the incumbent 
provider.

[End of figure]

It is possible that some of the differences in pricing we observed are 
caused by factors other than the presence of a BSP in certain markets. 
For example, our earlier study on cable pricing included an econometric 
model that showed that several factors, such as the number of cable 
channels, direct broadcast satellite penetration, and population 
density, influence cable prices. We attempted to minimize the influence 
that other factors would have on price differences across markets by 
choosing case-study markets and matched-pair markets that had certain 
similarities. Because the number of channels is known to be an 
important influence on cable rates, we examined channel line-ups of 
each of the 12 providers. Our analysis showed that the provider with 
the best price in the markets with a BSP also offered more channels 
than the provider in their matched market in 4 of the 6 cases and 
offered the same number of channels in the other two matched-pair 
markets. This indicates that the number of channels is not a cause of 
lower prices in markets with BSPs. See appendix I for a discussion of 
our methods and appendix II for a more complete listing of the channel 
line-up analysis.

BSPs Consider Specific Demographic, Geographic, and Local Government 
Factors When Deciding Which Markets to Enter:

The BSPs we analyzed considered a variety of factors when determining 
which markets to enter. These considerations were directly tied to the 
ability to enter a market quickly and to further their business 
strategy of selling multiple services to most of their subscribers. The 
primary factors considered regarding market selection fell into the 
following three categories: demographic factors, geographic factors, 
and factors related to the local governments in the communities of 
interest.

Demographic Factors Were Considered in Market Selection:

Three primary demographic factors were considered by the BSPs we 
interviewed when deciding which markets to enter and provide service. 
In particular, the size of the city, the level of income of residents, 
and the level of computer use among residents were primary determinants 
of market selection. Despite the commonality in the factors considered, 
there was some variation in how BSPs considered each of these 
demographic factors.

All 6 of the BSPs we interviewed mentioned the size of the market as a 
key factor that they considered in market selection. Only 1 BSP focused 
its business development toward larger cities. This company was the 
first to take the approach of competing with an incumbent by offering 
bundled service packages; thus this BSP believed that in order to 
attract adequate venture capital, it was important to focus its 
operations in major markets. This BSP also told us that it believed a 
large-city focus would have the benefit of enabling the company to 
rapidly gain subscribers in high-density corridors where a greater 
number of customers could be served with a given amount of 
infrastructure deployed. This BSP further noted that a downside of 
entering large markets was that construction in larger cities is 
significantly harder and more costly than in smaller cities, which made 
it difficult to meet an aggressive construction schedule. In fact, this 
BSP was unable to meet the 4-year construction deadline that was 
mandated by its franchise agreement.

Five BSPs built new infrastructure in medium and smaller cities. They 
told us that they took this approach, in part, because they recognized 
how difficult it would be to meet construction requirements in a large 
city. These BSPs also said that a benefit of entering a smaller city is 
that incumbent cable operators are less likely to vigorously compete 
with them as would likely, in their view, be the case if they entered a 
major city. Representatives from 3 BSPs also told us that they enter 
smaller markets because they may be able to leverage customers' 
dissatisfaction with the incumbent--which they believe tend to be more 
of an issue in smaller markets. Similarly, 3 of the BSPs told us that 
small and medium markets tend to have old networks, and this provided 
an opportunity for the entrant with an upgraded system to successfully 
compete for subscribers.[Footnote 9] Representatives from the 5 BSPs 
also noted that entering smaller sized cities allows them to better 
target markets with favorable demographics, rather than have to serve 
the wide array of residents that would live in a larger market.

Four of the 6 BSPs we spoke with stated that the average household 
income in a market was a key criterion in their decisions about what 
markets to enter. However, BSPs took various approaches regarding what 
income levels they were targeting. For example, 2 BSPs told us that 
they choose to enter markets with high-income level populations because 
these subscribers are more likely to take two or more 
telecommunications services. On the other hand, the other 2 BSPs look 
more for markets with a balance of varied income levels. 
Representatives of these companies told us that a mix of income levels 
among subscribers helps to ensure that each of the communications 
services offered by the company has a target audience. In fact, 1 BSP 
stated that higher level income subscribers may be most likely to 
subscribe to broadband service, but middle income subscribers may be 
most likely to subscribe to subscription television service.

Two of the 6 BSPs noted that high levels of computer use and Internet 
connections among residents of a community are factors they consider 
when determining what markets to enter because high-speed Internet 
service has a high profit margin. In particular, these BSPs told us 
that they selected markets with a high number of college students 
because the academic environment has a large amount of computer 
ownership and Internet use.

Geographic Factors Were Considered in Market Selection:

We found that BSPs consider certain geographic factors when deciding 
which markets to enter and provide services. In particular, BSPs looked 
for markets that were in close proximity to other markets that were 
served by a parent company or in proximity to other key facilities, 
such as the BSP headquarters or network, or other needed 
infrastructure.

Officials of 2 BSPs that are subsidiaries of energy companies told us 
that a key factor considered in market selection was proximity to the 
parent company's service area, which they said helps to leverage the 
parent company's name brand, infrastructure, and human capital. For 
example, a BSP representative told us that his BSP chose to enter one 
of the markets we studied because it was close to its parent company, 
and the BSP was thus able to benefit from the parent company's good 
reputation within the community as a power provider. The local 
franchising official in that market agreed that the community's 
positive relationship with the parent power company gave citizens 
confidence in the BSP's proposal and to trust that it would fulfill its 
infrastructure construction requirements. In addition to name 
recognition, another BSP official said that entering cities where the 
parent company has a presence allows the BSP to take advantage of the 
parent company's workforce to assist with the construction of the new 
infrastructure.

Two BSP representatives said that their BSP chose to enter markets on 
the basis of close proximity to their BSPs' headquarters or physical 
network. For example, 1 BSP that we interviewed chose markets that were 
close to the BSP headquarters. Another BSP told us that choosing cities 
in close proximity to its existing physical network was important in 
order to minimize the cost of fiber connecting any new market to the 
company's network. In fact, some markets that this BSP chose not to 
enter were too far from existing infrastructure and would have been 
very costly to connect.

Characteristics of Local Government Were Considered in Market 
Selection:

We found that when deciding which markets to enter, BSPs considered the 
receptivity of local government officials to new entrants. Moreover, 
the degree to which government officials took steps to reduce 
administrative requirements--which BSPs told us could be considerable-
-was a key factor for some BSPs when considering market entry.

Representatives from 5 BSPs indicated that specific markets were 
selected because the city government officials had a positive attitude 
toward competition, were easy to work with, or invited the BSP to 
provide services in their market. Similarly, one BSP told us that they 
avoided entering markets that had local franchising officials who 
showed limited interest in their services.

During our interviews, BSPs mentioned that they needed to overcome a 
variety of administrative issues before market entry. Gaining access to 
rights-of-way, fulfilling costly franchise requirements,[Footnote 10] 
and obtaining access to apartment buildings that have exclusive 
contracts with the incumbent cable operators were a few of the varied 
administrative issues that were mentioned by the BSPs. Representatives 
from 2 BSPs told us that when government officials are welcoming to the 
new entrants, the officials often take steps to mitigate administrative 
costs and requirements. For example, one local franchising authority, 
which was eager to have a BSP offer services in its market, presented a 
franchise agreement with reduced-fee payments for rights-of-way access 
and construction permits. Also, 2 different BSPs told us that the 
timeliness for gaining approvals for various required applications 
often were directly influenced by the receptivity of the regulators. We 
were told that two enthusiastic local franchising authorities took only 
120 days to approve a BSP's application for a franchise. In contrast, 
another BSP told us that it was unable to obtain a franchise after 2 
and 1/2 years of working with a local franchising authority that was 
not receptive to competition, and the BSP did not succeed in entering 
that market.

Five of the 6 case study markets that do not have a BSP competitor had 
companies express interest in entering their cities, but, according to 
local government officials, these companies decided not to enter for 
several reasons. For example, one local official told us that the 
level-playing-field law in his state--which are laws that require any 
new cable franchiser to agree to the same terms and conditions that the 
incumbent cable provider must meet--was a factor in an interested 
competitive cable company's (not 1 of the 6 companies we studied) 
retracting a franchise application.[Footnote 11] Another factor that 
may cause BSPs to choose not to enter a market is the local 
government's lack of administrative resources. Specifically, one local 
official said that the lack of administrative resources to process 
applications quickly caused some BSPs to withdraw their applications 
and seek more receptive markets.

BSPs Are Gaining Market Share, but a Variety of Factors May Hinder 
Their Success:

BSPs are gaining market share in the service markets they have entered, 
with varying success. BSPs we interviewed said that certain factors, 
such as difficulty in gaining access to certain programming, can create 
obstacles to their ability to compete effectively. Moreover, BSPs may 
be finding that these telecommunications markets are more competitive 
than they had expected when they first developed their business 
strategy. Currently, all of the BSPs we interviewed are having problems 
with access to capital and, thus are struggling to continue expanding 
their market presence.

BSPs Are Having Varied Success in Gaining Subscribers:

On the basis of statistics provided by the 6 BSPs we interviewed, these 
companies appear to be having varied success in gaining subscribers for 
their television, local telephone, and high-speed Internet services. 
The 6 BSPs have made significant inroads in gaining market share in the 
three service markets. In particular, for the 6 cities with BSPs we 
interviewed, the average BSP market penetration for subscription 
television service was 25 percent, the average penetration of 
subscribers for local telephone service was 29 percent, and the average 
subscriber penetration for high-speed Internet service was 17 
percent.[Footnote 12] As figure 5 shows, there was substantial 
variation across the companies in the penetration rates for each 
service--ranging from a low of 6 percent penetration for high-speed 
Internet in 1 market to a high of 63 percent penetration in telephone 
service in another market. We found that entering smaller markets may 
be associated with an ability to gain greater market penetration. For 
example, we found that in the 3 smaller markets we examined, the BSPs 
were able to attract a larger share of the potential subscribers--that 
is, to achieve a higher level of penetration--than was the case for 
BSPs that entered the medium and the larger markets included in our 
case study.

Figure 5: Penetration of Subscription Television, High-Speed Internet, 
and Telephone Services for BSPs in Case-Study Markets, June 2003:

[See PDF for image]

[End of figure]

Certain Factors in Local Markets Can Hinder BSPs' Ability to Compete:

All of the BSPs we interviewed noted that various barriers arise that 
can hinder their ability to effectively compete in the markets that 
they have entered. Although a host of issues were mentioned during our 
interviews, the greatest concern surrounded issues related to an 
inability to gain access to certain cable networks, an inability to 
serve certain apartment and condominium complexes, and restrictive 
local regulatory requirements.

Program Access Concerns:

In 4 markets, BSP officials said they have experienced problems 
obtaining certain cable networks--such as regional sports, weather, and 
local informational channels--that the incumbent cable provider of that 
market owns or holds exclusive rights to within that market. Of the 4 
BSPs that expressed concern with program access, 2 specifically told us 
that they were unable to gain access to regional sports networks 
because the incumbent cable provider, which owned that network, 
provided the network to its own facilities terrestrially--that is, not 
via a satellite.[Footnote 13] Similarly, the third BSP stated that it 
could not obtain access to a popular local news network because the 
incumbent cable provider partially owned it. The incumbent, however, 
explained that FCC ruled that program exclusivity in this case was in 
the public interest and therefore FCC granted it an exemption to the 
program access rules. The last BSP stated that even though the 
incumbent cable provider had not produced a local sports network, it 
still could not obtain access because the incumbent had secured an 
exclusive deal with the producers of that network. The BSP was able to 
gain access to that cable network only after the network was sold from 
one owner to another.

While 4 of the BSPs said they had a problem with program access, only 
two cable operators we spoke with said that they were aware of program 
access issues in the markets we reviewed. Moreover, one incumbent cable 
provider told us that producing or having access to exclusive content 
can be a good marketing strategy for it and that without the ability to 
develop exclusive content, the incentive to produce innovative 
programming is minimized. Regarding the market where an incumbent cable 
provider had exclusive rights to certain programming, the incumbent's 
view was that it created the concept for the programming package and 
the BSP was unwilling to make such a commitment on an unproven product.

Multiple Dwelling Units:

Three of the BSPs we interviewed expressed concern about being 
prevented from providing service to large segments of the population 
that live in apartments or condominiums, which are generally referred 
to as "multiple dwelling units." We were told that owners of multiple 
dwelling units often enter into exclusive contracts with one cable 
provider, thereby limiting a competitor's access to that building. 
Also, even when BSPs have gained access into a building, we were told 
that the building owners may not allow them to lay additional wires 
because of the associated costs and disruptions. In fact, 1 BSP we 
spoke with estimated that it could not provide service to 20 percent of 
subscribers in 1 of our case-study markets because of problems gaining 
access to multiple dwelling units. The incumbent cable operators we 
interviewed said that in some cases they had exclusive contracts to 
serve multiple dwelling units. However, in 3 of the markets, these 
providers noted that the BSPs also had exclusive contracts with some 
multiple dwelling units.

Recently, FCC reviewed issues related to access by telecommunications 
companies to multiple dwelling units. In a January 2003 order, FCC did 
not establish federal access requirements or preempt state regulation 
of these matters.[Footnote 14] Likewise, FCC continued to permit 
exclusive or perpetual contracts for subscription television service in 
multiple dwelling units because, according to FCC, it found that it was 
not clear that there are anticompetitive effects from exclusive and 
perpetual contracts, and, as such, FCC could not support government 
intervention in privately negotiated contracts.

Burdensome Franchise Requirements:

Some of the BSPs also told us that certain franchise requirements can 
be burdensome. As we previously noted, BSPs told us that the 
administrative requirements of local jurisdictions can influence the 
markets they enter, but we were also told that these requirements could 
affect how quickly they can begin providing service in markets they 
have chosen to enter. For example, we were told that required 
construction time frames often burden new entrants, even though these 
rules are generally designed to create a "level playing field" by 
ensuring that new providers must meet all of the same requirements that 
incumbent providers have had to meet. These construction rules can 
require extensive capital, reprioritization of the business plan, or 
the provision of service in areas that are not economic to serve. In 
some cases, BSPs have changed their legal status in order to avoid 
costly and labor-intensive construction requirements.[Footnote 15] One 
BSP noted that the incumbents effectively receive a longer build-out 
schedule because they were able to grow with the communities they 
serve.

BSPs May Have Underestimated the Level of Competition in 
Telecommunications Markets:

One of the most significant factors that may hinder the BSP's marketing 
success is that the communications markets BSPs seek to serve may be 
more competitive today than these providers envisioned when they first 
developed their plans. We found that BSPs avoid markets where another 
new wire-based operator had entered the market, but this avoidance does 
not ensure that there are not other new competitors providing service 
in the three service markets.[Footnote 16] For example:

* Regarding subscription television service, direct broadcast satellite 
service (such as DIRECTV or EchoStar) service is available nationwide 
and, thus, represents a second and third formidable competitor in every 
market that a BSP may choose to enter. As the number of direct 
broadcast satellite subscribers continues to grow, it will be even 
harder for the BSPs to achieve the penetration rates that are necessary 
for profitability.[Footnote 17]

* Competition in the market for local telephone service has been 
emerging. Incumbent local telephone companies noted that consumers are 
increasingly turning to mobile telephones as their sole telephone line 
in lieu of a wire line connection. If more consumers replace their wire 
line telephone service with wireless service (which is not 
traditionally provided by BSPs), such action will also have the effect 
of decreasing the number of potential subscribers to which BSPs can 
market their services. Also, incumbent local telephone providers view 
the large established cable operators as their primary competitive 
threat in the future. In fact, some established cable operators are 
increasingly providing telephone service in markets around the country.

* In the high-speed Internet market, BSPs already compete against cable 
and local telephone providers. In addition, new platforms for the 
provision of Internet service may erode the market for all wire-based 
companies. For example, one incumbent local telephone company noted 
that the presence of a large university that provides free high-speed 
Internet service to its students and faculty reduces its potential 
high-speed Internet market. Other new means of Internet access, such as 
through wireless modes, are also becoming more widely available.

BSPs Serving the Markets We Reviewed Are Now Struggling to Obtain 
Adequate Access to Capital:

The BSPs we spoke with gained financial capital to construct their 
infrastructure and operate their business in a variety of ways. Two 
BSPs that are providing services in the markets we reviewed were wholly 
owned subsidiaries of large power companies and were able to receive 
all of their investment capital from their parent company. Two other 
BSPs providing service in the markets we reviewed are, or had been, 
part of larger telecommunications companies and received their startup 
financing from these parent companies. The remaining BSPs serving 
markets we reviewed were funded through venture capital or a mixture of 
venture capital and money obtained through a partnership with an energy 
company.

Despite these sources of capital in the early stages of their business, 
the 6 BSPs we interviewed are currently experiencing some level of 
financial problems. In particular, they told us that their difficulty 
in obtaining access to necessary capital is threatening their ability 
to construct their networks and market their services. None of the 6 
BSPs we studied are aggressively expanding their operations. Two of the 
BSPs are still completing construction within their current markets in 
order to comply with their agreed-upon schedule, but another BSP was 
currently unable to complete construction. Beyond their current 
markets, all of the BSPs we reviewed have had to put expansion plans on 
hold until the market conditions improve. Additionally, 2 BSPs told us 
that they do not have enough capital to advertise their service 
offerings to their current base of potential subscribers, and 1 BSP 
reorganized through a Chapter 11 bankruptcy proceeding.[Footnote 18] 
BSPs told us that, to a large extent, these financial problems are the 
result of the economic problems that have affected the entire 
telecommunications sector.

Conclusions:

Although our study indicates that there are measurable consumer 
benefits in markets with BSPs compared with markets without such 
competition, the degree to which the BSP model is replicable throughout 
a broader set of markets remains unclear. For example, the majority of 
BSPs we spoke with stated that they avoid entering large metropolitan 
cities because they believe serving such markets might prove difficult. 
Moreover, even in the markets that they have successfully entered, the 
companies are struggling to achieve their key business targets. As a 
result, nationwide, BSPs serve only about 1 percent of the subscription 
television market and even less of the local telephone market, although 
BSPs do serve about 2 percent of all high-speed Internet subscribers. 
Nevertheless, at this time, with the telecommunications sector 
struggling to recover from diminished capital investments, it is 
difficult to determine the long-term prospects for success of BSPs as 
new telecommunications providers. The problems BSPs face may be 
mitigated as the current economic downturn of the telecommunications 
sector subsides, but the long-term viability of these providers is not 
clear.

Agency Comments:

We provided a draft of this report to the Federal Communications 
Commission and the Antitrust Division of the Department of Justice for 
their review and comment. The Department of Justice did not provide 
comments on this report. The FCC provided technical comments that we 
incorporated.

Industry Association Comments and Our Evaluation:

We also invited representatives from the Broadband Service Provider 
Association (BSPA), the National Association of Telecommunications 
Officers and Advisors (NATOA), the National Cable & Telecommunications 
Association (NCTA), and the United States Telecom Association (USTA) to 
review and comment on a draft of this report. The USTA did not provide 
any comments. The BSPA and NATOA provided some comments that we 
incorporated as appropriate.

NCTA officials provided extensive comments on the draft. These 
officials expressed concern with certain summary statistics on price 
differences in BSP markets compared with markets without BSPs that 
appeared in the draft of this report that they reviewed. We modified 
the presentation of the data on these price differences. In particular, 
rather than providing summary statistics on price differences across 
the markets with BSPs compared to the markets without BSPs, we provide 
information on the price difference between each BSP market and its 
match. Additionally, NCTA made the following points:

* NCTA officials note that a case study of 6 markets with and 6 markets 
without a BSP competitor is a very small sample of the roughly 10,000 
cable systems in operation in the United States. They view the study as 
thus having no statistical significance. In particular, NCTA official 
express concern that our draft "implies vastly broader conclusions 
regarding the effect of BSPs on cable pricing than are warranted by the 
limited case studies." They also note that, as we reported, the larger 
pricing differences were found for the 3 smaller city-pair case 
studies, while smaller price differences were found in the medium and 
larger city pairs. The officials stated that, as such, for the larger 
percentage of subscribers covered by the study, the differences were 
much smaller.

GAO response: We agree that our approach in this report--a case study 
analysis--is not generalizable to the universe of cable systems. We 
have stated this several times in the report, and have added more 
discussion of this in response to NCTA's comments. However, as stated 
in the report, our BSP sample represents more than 20 percent of the 
households nationwide that are in areas where BSPs currently offer the 
three-service package. Given the caveats we place on our own work, we 
do not believe that our conclusions imply a broader interpretation than 
is warranted.

* NCTA officials note their concern that just 4 months after we 
released a report on cable pricing that was based on an econometric 
analysis, we would provide new information on cable pricing in 
competitive and noncompetitive markets that are based on a different 
methodology.

GAO response: We do not believe there is a problem in conducting a 
second study on cable rates and competition that analyzes the issue 
using an alternative methodology. The two studies used different data 
and different methods to examine an overlapping issue. The fundamental 
findings of both studies were similar, but the specifics were 
different--as would be expected given the different methods used. While 
our October 2003 study examined the issue of cable rates broadly, the 
current study focuses on 12 markets and compares rates in the 6 with a 
BSP to the 6 without such a competitor. The findings from this study 
relate to those 12 markets.

* NCTA officials note that the reported pricing differences between 
markets with BSPs and those without BSPs could be misinterpreted as 
implying that BSP entry engenders a substantial price response by 
incumbent providers, when in fact, for cable pricing, the BSP (not the 
incumbent) offered the lower price in the BSP market in 4 out of the 6 
case-study markets. Moreover, NCTA officials note that to the extent 
that incumbents are responding to competition, this response may be to 
competition from DBS providers, rather than competition from BSPs.

GAO response: We agree with NCTA that price differences in cable rates 
across the BSP markets compared to those without a BSP do not 
necessarily mean that the incumbent providers lowered their prices 
entirely in response to BSP entry. We added some discussion in the 
report to clarify this point. Also, we note in the report that 
incumbent cable providers told us that their most important competitors 
are the two DBS providers. However, almost all of the incumbent cable 
providers also told us that when faced with wire-based competitors in 
particular local markets, they tend to lower their prices.

* NCTA officials also note that any observed price difference between 
markets with and without BSPs could be related to other factors not 
controlled for by the case-study analysis. For example, they noted that 
the number of channels in a cable system's line up is a key factor that 
may drive pricing differences across locations and providers.

GAO response: We agree with NCTA's point that some of the differences 
in cable rates across our case study locations with a BSP as compared 
to those without such a provider could be caused by factors other than 
the presence of the BSP. We have added language to that effect in the 
report. However, after receiving NCTA's comments, we also examined the 
number of channels provided in the case study markets--which NCTA 
specifically cited as a possible cause of rate differences--and found a 
similar number of channels available in the markets with a BSP when 
compared to its matched market. Moreover, when we asked incumbent cable 
operators why their prices differed across the markets in our sample, 
they usually cited the presence of the BSP as the primary cause.

* NCTA officials note that the draft report did not adequately address 
the possibility that in markets with BSPs, prices are uneconomically 
low and are unsustainable. That is, they noted that the low prices 
available in markets with BSPs may be of a transitory nature only. The 
officials noted that this seems particularly possible in light of the 
fact that we found that all BSPs interviewed in the course of the study 
were facing various degrees of financial difficulty. NCTA officials 
also said that we did not fully describe the extent of financial 
problems currently experienced by the BSPs.

GAO response: We did not evaluate the long-term sustainability of the 
BSPs in the markets we reviewed. However, to address this to some 
extent, we only selected markets where the BSP had been in operation 
for at least a year.

* NCTA officials note that they believe that BSPs have overstated 
claims that certain local conditions (e.g., related to program access 
concerns, multiple dwelling unit access, and local franchising 
conditions) may hinder BSPs' ability to compete.

GAO response: We did not evaluate BSPs' concerns about the effect of 
local market conditions on their entry and success. Similarly, we did 
not evaluate the veracity of incumbent providers' statements on these 
issues. In this section of the report, we are simply reporting the 
views of these providers.

As agreed with your offices, unless you publicly release 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 provide 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 charge on the 
GAO Web site at [Hyperlink, http://www.gao.gov]. If you have any 
questions about this report, please contact me at (202) 512-2834 or 
[Hyperlink, goldsteinm@gao.gov]. Key contacts and major contributors 
to this report are listed in appendix IV.

Signed by:

Mark L. Goldstein: 
Director, Physical Infrastructure Issues:

[End of section]

Appendixes: 

Appendix I: Scope and Methodology:

We employed a case-study approach in gathering information in 
responding to our four objectives. In particular, this report provides 
information on (1) BSPs' business strategy; (2) the impact of BSPs' 
market entry on incumbent cable and telephone companies' market 
behavior and consumer prices of subscription television, high-speed 
Internet, and local telephone services; (3) the key factors BSPs 
consider when making decisions about which local markets to enter; and 
(4) the success of BSPs in attaining subscribership and any key factors 
that may limit their success. The case study consisted of 6 matched 
pairs of cities (12 total) that shared certain key traits except that 1 
city in each pair has a BSP providing service and the other does not.

In selecting the cities with BSPs, we considered several factors. We 
selected cities in various parts of the country with BSPs that met some 
basic criteria. To be considered for selection in our case study, a BSP 
had to provide subscription television, local telephone, and high-speed 
Internet services in the city for more than 1 year; had to have 
constructed its own network (rather than having purchased an existing 
network); and had to have a network that was nearly completed. We also 
analyzed population data to ensure that our case study included markets 
of varying sizes. We selected 3 small cities (with populations under 
100,000), 2 medium-sized cities (with populations of 100,000 to 
200,000) and 1 large city (with a population over 200,000). The 6 
cities chosen for the case studies represented more than 20 percent of 
the households to which BSPs currently offer the three-service package. 
See appendix III for a detailed listing of the BSPs and areas of 
service.

To choose cities without BSPs for our analysis, we matched the 6 BSP 
cities with cities that were similar in terms of size and demographics. 
Where possible, we matched each BSP city with a city that did not have 
a BSP in the same state to avoid any possible differences caused by 
state laws or regulations and to help ensure reasonably similar 
demographic characteristics across the city-pairs. However, in the case 
of the only large city in our sample of BSP cities we selected a city 
in another state--Seattle--to match with Boston because there was no 
city in Massachusetts with similar size and demographics, and no other 
large cities had extensive BSP presence.[Footnote 19] Each city-pair 
also has the same incumbent local telephone and cable television 
providers, although in one case two incumbent telephone companies 
served different parts of a city.

We conducted semistructured interviews with a variety of industry and 
local government participants for each of the selected markets. Our 
interviews included questions about telecommunications competition in 
each city, the price of telecommunications services, and the factors 
that favor or discourage competition in each city. We interviewed the 
BSPs (in the 6 cities where they existed), the incumbent cable 
companies, the incumbent telephone companies, the local franchising 
authorities, and the public utility commissions. Table 1 provides the 
details of the cities we chose and the primary companies and local 
representatives we interviewed. In addition, we interviewed officials 
from the BSPA and the Mid-American Regional Council (a support 
organization for local governments).

Table 1: Case-Study Cities and Industry and Local Government 
Participants:

State: Kansas; 
Type of market: With BSP: Lenexa; 
Type of market: Without BSP: Prairie Village; 
BSP: Everest; 
Incumbent telephone: SBC; 
Incumbent cable: Time Warner; 
Local franchising authority: Lenexa, Prairie Village; 
State telecommunications regulator: Kansas Corporation Commission.

State: Texas; 
Type of market: With BSP: Waco; 
Type of market: Without BSP: Beaumont; 
BSP: Grande; 
Incumbent telephone: SBC; 
Incumbent cable: Time Warner; 
Local franchising authority: Waco, Beaumont; 
State telecommunications regulator: Texas Public Utility Commission.

State: Minnesota; 
Type of market: With BSP: St. Cloud; 
Type of market: Without BSP: Rochester; 
BSP: Astound; 
Incumbent telephone: Qwest; 
Incumbent cable: Charter; 
Local franchising authority: St. Cloud, Rochester; 
State telecommunications regulator: Minnesota Public Utilities 
Commission.

State: South Dakota; 
Type of market: With BSP: Yankton; 
Type of market: Without BSP: Vermillion; 
BSP: Prairie Wave; 
Incumbent telephone: Qwest; 
Incumbent cable: Mediacom; 
Local franchising authority: Yankton, Vermillion; 
State telecommunications regulator: South Dakota Public Utilities 
Commission.

State: Georgia; 
Type of market: With BSP: Augusta; 
Type of market: Without BSP: Savannah; 
BSP: Knology; 
Incumbent telephone: BellSouth; 
Incumbent cable: Comcast; 
Local franchising authority: Augusta, Savannah; 
State telecommunications regulator: Georgia Public Service Commission.

State: Massachusetts & Washington; 
Type of market: With BSP: Boston; 
Type of market: Without BSP: Seattle; 
BSP: RCN; 
Incumbent telephone: Verizon, Qwest; 
Incumbent cable: Comcast; 
Local franchising authority: Boston, Seattle; 
State telecommunications regulator: Massachusetts Department of 
Telecommunications and Energy, Washington Utilities and Transportation 
Commission.

Source: GAO.

[End of table]

Our analysis provides details on the competitive status of markets with 
BSPs. However, because we used a case-study method, our results are not 
generalizable to all markets with such providers. We performed our work 
between May 2003 and December 2003 in accordance with generally 
accepted government auditing standards.

[End of section]

Appendix II: Price and Channel Information in Six Market Pairs:

The following table provides additional data on the price patterns 
between the matched pair markets. The percentage price difference 
between each matched market pair was calculated by subtracting the 
lowest price in the BSP market from the incumbent's price in the non-
BSP market, and then dividing that difference by the incumbent's non-
BSP market price.

Table 2: Price and Channel Information in Six Market Pairs:

Case study market pair: Market pair 1; 
Expanded basic cable television: Percentage monthly rate is lower in 
BSP market: 31%; 
Expanded basic cable television: Number of additional channels in 
BSP market: No difference; 
High-Speed Internet service: Percentage monthly rate is lower in 
BSP market: 29%; 
One local telephone line: Percentage monthly rate is lower in 
BSP market: 7%.

Case study market pair: Market pair 2; 
Expanded basic cable television: Percentage monthly rate is lower in 
BSP market: 32%; 
Expanded basic cable television: Number of additional channels in 
BSP market: No difference; 
High-Speed Internet service: Percentage monthly rate is lower in 
BSP market: 20%; 
One local telephone line: Percentage monthly rate is lower in 
BSP market: 33%.

Case study market pair: Market pair 3; 
Expanded basic cable television: Percentage monthly rate is lower in 
BSP market: 41%; 
Expanded basic cable television: Number of additional channels in 
BSP market: 3; 
High-Speed Internet service: Percentage monthly rate is lower in 
BSP market: 38%; 
One local telephone line: Percentage monthly rate is lower in 
BSP market: No difference.

Case study market pair: Market pair 4; 
Expanded basic cable television: Percentage monthly rate is lower in 
BSP market: 17%; 
Expanded basic cable television: Number of additional channels in 
BSP market: 7; 
High-Speed Internet service: Percentage monthly rate is lower in 
BSP market: 2%; 
One local telephone line: Percentage monthly rate is lower in 
BSP market: 11%.

Case study market pair: Market pair 5; 
Expanded basic cable television: Percentage monthly rate is lower in 
BSP market: 15%; 
Expanded basic cable television: Number of additional channels in 
BSP market: 5; 
High-Speed Internet service: Percentage monthly rate is lower in 
BSP market: No difference; 
One local telephone line: Percentage monthly rate is lower in 
BSP market: 4%.

Case study market pair: Market pair 6; 
Expanded basic cable television: Percentage monthly rate is lower in 
BSP market: -3%; 
Expanded basic cable television: Number of additional channels in 
BSP market: 1; 
High-Speed Internet service: Percentage monthly rate is lower in 
BSP market: No difference; 
One local telephone line: Percentage monthly rate is lower in 
BSP market: 28%. 

Source: GAO.

Note: The difference in numbers of channels was based on the comparison 
of the channels offered by the provider with the lowest price in the 
market with a BSP and the channels offered by the sole wire-based 
provider in the comparison market.

[End of table]

[End of section]

Appendix III: Broadband Service Provider Association Member Markets as 
of February 2003:

Broadband service provider: Altrio; 
Markets under franchise: California: Arcadia; 
Total households under franchise: 19,970; 
Percentage of network constructed[A]: Low.

Broadband service provider: Astound; 
Markets under franchise: Minnesota: St. Cloud; 
California: Concord, Contra Costa County, and 
Walnut Creek; 
Total households under franchise: 119,471; 
Percentage of network constructed[A]: Moderate.

Broadband service provider: Everest; 
Markets under franchise: Kansas: 
Lenexa, Overland Park, Shawnee, and Merriam; Missouri: Kansas City and 
Kearney; 
Total households under franchise: 321,000; 
Percentage of network constructed[A]: Low.

Broadband service provider: Grande; 
Markets under franchise: Texas: 
Austin, San Marcos, Corpus Christi, Midland, Odessa, San Antonio, and 
Waco; 
Total households under franchise: 1,355,419; 
Percentage of network constructed[A]: Low.

Broadband service provider: Hiawatha; 
Markets under franchise: 
Minnesota: Winona; 
Total households under franchise: 12,893; 
Percentage of network constructed[A]: Substantial.
Broadband service provider: Knology; 
Markets under franchise: Alabama: Huntsville and Montgomery; Florida: 
Panama City; Georgia: Augusta and Columbus; South Carolina: 
Charleston; Tennessee: Knoxville; 
Total households under franchise: 628,392; 
Percentage of network constructed[A]: Substantial.

Broadband service provider: Prairie Wave; 
Markets under franchise: Iowa: Lakeside and Storm Lake; Minnesota: 
Luverne, Marshall, Pipestone, Slayton, Tracy, and Worthington; South 
Dakota: Canton, Coleman, Flandreau, Madison, North Sioux City, 
Watertown, and Yankton; 
Total households under franchise: 43,667; 
Percentage of network constructed[A]: Substantial.

Broadband service provider: RCN; 
Markets under franchise: California: Gardena and San Francisco; 
Illinois: Chicago; New York: New York; Massachusetts: Boston; 
Pennsylvania: Philadelphia; 
Total households under franchise: 4,575,362; 
Percentage of network constructed[A]: Low.

Broadband service provider: Starpower; 
Markets under franchise: Washington, D.C.; 
Total households under franchise: 650,000; 
Percentage of network constructed[A]: Low.

Broadband service provider: Utilicom Networks; 
Markets under franchise: Indiana: Evansville; 
Total households under franchise: 77,000; 
Percentage of network constructed[A]: Substantial.

Broadband service provider: WideOpenWest; 
Markets under franchise: Colorado: Lakewood; 
Total households under franchise: 12,000; 
Percentage of network constructed[A]: Substantial.

Source: BSPA.

Notes: The markets noted in bold were those included in our case study. 
The table only includes markets in which these companies currently 
offer subscription television, local telephone, and high-speed Internet 
services.

Several changes in the membership of BSPA have taken place since we 
selected our case-study markets in early 2003.

[A] Low is less than 25%; Moderate is from 25% to 75%; and Substantial 
is more than 75%.

[End of table]

[End of section]

Appendix IV: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Amy Abramowitz (202) 512-2834 Keith Cunningham (202) 512-2834:

Staff Acknowledgments:

In addition to those named above, Julie Chao, Michael Clements, Andy 
Clinton, David Dornisch, Etana Finkler, Bert Japikse, Sally Moino, and 
Carrie Wilks made key contributions to this report.

(545031):

FOOTNOTES

[1] See U.S. General Accounting Office, TELECOMMUNICATIONS: Issues 
Related to Competition and Subscriber Rates in the Cable Television 
Industry, GAO-04-8 (Washington, D.C.: Oct. 24, 2003).

[2] The Broadband Service Provider Association (BSPA) has 11 members, 6 
of which provide all three services to more than one market. (See app. 
III for a list of BSPs that are members of the BSPA.) For our sample, 
we selected 1 city for each of the providers serving multiple markets.

[3] Cable operators obtain a franchise license under agreed-upon terms 
and conditions from a franchising authority--referred to as a local 
franchising authority--such as a township or county. In some instances, 
the state public utility or public service commission regulates cable 
television service. These franchise agreements govern many aspects of 
cable television service, including access to rights-of-way; the 
schedule for the company to build its infrastructure; and the provision 
of public, educational, and governmental channels. 

[4] Cable networks typically deliver their programming to cable 
operators via satellite. However, if the cable network delivers its 
programming to the affiliated cable operator via a different technology 
(such as a wire), then the program access obligations do not apply.

[5] With high-speed Internet service, subscribers can download material 
sometimes as much as 50 times faster than a dial-up modem. This 
additional capacity allows users to download more material and also 
makes other services, such as streaming video, possible.

[6] In addition to digital subscriber line and cable modem service, 
households can acquire high-speed Internet service from other wire-
based, fiber, and wireless technologies. These technologies serve the 
remaining 10 percent of high-speed Internet customers. 

[7] One incumbent telephone company provided data indicating that 
wireless lines have increased so much in recent years that they now 
surpass the aggregate number of wire-based lines provided by the 
largest telephone companies by as much as 15 million in 2003. By 
contrast, the number of telephone lines served by BSPs number only 
about 540,000. 

[8] For example, all 4 of the incumbent telephone providers we spoke 
with stated that provisions of the 1996 Telecommunications Act force 
them to lease critical network elements to competing entities at 
government-mandated rates that these providers view as being below 
cost.

[9] Three BSPs we interviewed stated that incumbent providers focus 
more attention on their largest markets. As such, the quality of 
infrastructure as well as customer service may, in their view, be lower 
in smaller cities.

[10] Franchise requirements are agreed-upon terms and conditions 
between the local government officials and cable operators, which can 
include provisions such as fees, Public Education and Government 
channels, construction schedules, and customer service requirements. 

[11] According to a recent article, at least 12 states have level-
playing-field laws.

[12] In its comments on a draft of this report, the BSPA noted that an 
additional benefit of BSP entry into markets is greater penetration of 
high-speed Internet access. In particular, BSPA noted that it believes 
that the total high-speed Internet access penetration rate in markets 
with BSPs is at least double that of the national average high-speed 
penetration rate.

[13] As required by the Cable Television Consumer Protection and 
Competition Act of 1992, FCC developed rules designed, in part, to 
ensure that vertically integrated cable operators generally make their 
satellite-delivered programming available to competitors.

[14] See In the Matter of Telecommunications Inside Wiring, 18 F.C.C.R. 
1342 (FCC 1ST order on recon., 2003)

[15] A company that wants to provide subscription television service in 
a community can elect to operate under the "open video system" (OVS) 
provisions of the 1996 Telecommunications Act. An OVS provider may not 
always need to obtain a franchise and as such may not generally face 
specific construction requirements. However, companies with OVS status 
must open portions of their network to competing entities. 

[16] Interestingly, none of the incumbent cable operators we 
interviewed chose to enter other markets to compete against an existing 
incumbent cable company despite the fact that incumbent cable providers 
have extensive know-how, reasonably reliable access to capital, and 
lucrative contracts for programming. These companies' lack of interest 
in competing in new markets may indicate a view that such entry poses a 
difficult business challenge.

[17] However, some BSPs and incumbent cable operators we spoke with 
noted that DBS subscribership is low in some of the markets with BSPs. 
For example, in 4 of the 6 markets with a BSP present, the incumbent 
cable provider or the BSP had data indicating that DBS penetration was 
well below the national average, and as low as 2 percent in 1 market. 
Representatives of the incumbent cable operator said that the low rate 
was due to the greater competition and lower prices in that market.

[18] The BSPA told us in their comments that the bankruptcy proceeding 
was a prepackaged conversion of debt to equity, through which no 
creditors lost money.

[19] Although Boston had the largest presence of a BSP for any large 
city, the BSP operating in Boston has not fully constructed a system.

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