oversight

Telecommunications: Issues Related to Competition and Subscriber Rates in the Cable Television Industry

Published by the Government Accountability Office on 2003-10-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to the Chairman, Committee on
               Commerce, Science, and
               Transportation, U.S. Senate


October 2003
               TELECOMMUNICATIONS

               Issues Related to
               Competition and
               Subscriber Rates in
               the Cable Television
               Industry




GAO-04-8

                                                October 2003


                                                TELECOMMUNICATIONS

                                                Issues Related to Competition and
Highlights of GAO-04-8, a report to             Subscriber Rates in the Cable Television
Senator John McCain, Chairman,
Committee on Commerce, Science, and             Industry
Transportation, U.S. Senate




Over 70 million American                        Competition leads to lower cable rates and improved quality. Competition
households receive television                   from a wire-based company is limited to very few markets. However, where
service from a cable television                 available, cable rates are substantially lower (by 15 percent) than in markets
operator. In recent years, rates for            without this competition. Competition from direct broadcast satellite (DBS)
cable service have increased at a               companies is available nationwide, and the recent ability of these companies
faster pace than the general rate of
inflation. GAO agreed to (1)
                                                to provide local broadcast stations has enabled them to gain more
examine the impact of competition               customers. In markets where DBS companies provide local broadcast
on cable rates and service, (2)                 stations, cable operators improve the quality of their service.
assess the reliability of information
contained in the Federal                        FCC’s cable rate report does not appear to provide a reliable source of
Communications Commission’s                     information on the cost factors underlying cable rate increases or on the
(FCC) annual cable rate report, (3)             effects of competition. GAO found that cable operators did not complete
examine the causes of recent cable              FCC’s survey in a consistent manner, primarily because the survey lacked
rate increases, (4) assess the                  clear guidance. In particular, GAO found that 84 of the 100 franchises it
impact of ownership affiliations in             surveyed did not provide a complete or accurate accounting of their cost
the cable industry, (5) discuss why             changes for the year. Also, GAO found that FCC does not initiate updates or
cable operators group networks
into tiers, and (6) discuss options
                                                revisions to its classification of competitive and noncompetitive areas.
to address factors that could be                Thus, FCC’s classifications might not reflect current conditions.
contributing to cable rate
increases.                                      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
GAO recommends that the                         infrastructures, which generally permit additional channels, digital service,
Chairman of the FCC
                                                and broadband Internet access.
• 	 take immediate steps to im­
    prove the cable rate survey and
• 	 review the commission’s                     Some concerns exist that ownership affiliations might indirectly influence
    process for maintaining the                 cable rates. Broadcasters and cable operators own many cable networks.
    status of effective competition.            GAO found that cable networks affiliated with these companies are more
                                                likely to be carried by cable operators than nonaffiliated networks.
In commenting on GAO’s report,                  However, cable networks affiliated with broadcasters or cable operators do
FCC agreed to make changes to its               not receive higher license fees, which are payments from cable operators to
annual cable rate survey, but FCC               networks, than nonaffiliated networks.
questioned, on a cost/benefit basis,
the utility of revising its process to          Technological, economic, and contractual factors explain the practice of
keep the status of effective
                                                grouping networks into tiers, thereby limiting the flexibility that subscribers
competition up to date. GAO
believes that FCC should examine                have to choose only the networks that they want to receive. An à la carte
whether cost-effective alternative              approach would facilitate more subscriber choice but require additional
processes could help provide the                technology and customer service. Additionally, cable networks could lose
Congress with more accurate                     advertising revenue. As a result, some subscribers’ bills might decline but
information.                                    others might increase.
www.gao.gov/cgi-bin/getrpt?GAO-04-8.
                                                Certain options for addressing cable rates have been put forth. Although
To view the full product, including the scope   reregulation of cable rates is one option, promoting competition could
and methodology, click on the link above.       influence cable rates through the market process. Policies to bring about
For more information, contact Mark Goldstein
at (202) 512-2834 or goldsteinm@gao.gov.
                                                lower cable rates could have other effects that would need to be considered.
Contents 



Letter           
                                                                            1
                 Results in Brief 
                                                           3
                 Background
                                                                  7
                 Competition Leads to Lower Cable Rates and Improved Quality 

                   and Service among Cable Operators 
                                        9
                 Concerns Exist about the Reliability of FCC’s Data for Cable 

                   Operator Cost Factors and Effective Competition 
                        12
                 A Variety of Factors Contribute to Cable Rate Increases 
                  20
                 Some View Ownership Affiliations as an Important Indirect 

                   Influence on Cable Rates
                                                27
                 Several Factors Generally Lead Cable Operators to Offer Large 

                   Tiers of Networks Instead of Providing À La Carte or Minitier 

                   Service                                                                  
30
                 Industry Participants Have Cited Certain Options That May
                   Address Factors Contributing to Rising Cable Rates 
                     39
                 Conclusions                                                                44
                                                                                            

                 Recommendations for Executive Action 
                                     45
                 Agency Comments and Our Evaluation
                                        46

Appendix I       Scope and Methodology                                                      48



Appendix II      GAO Survey of Cable Franchises                                             51



Appendix III 	   GAO’s Modifications to FCC’s Competition
                 Classification                                                             54



Appendix IV      Cable-Satellite Model                                                      56 

                 Definitions and Sources for Variables                                      56

                 Estimation Methodology and Results                                         57


Appendix V       Cable Network Carriage Model                                               63 

                 Set-up of Our Cable Network Carriage Model                                 63

                 Data Sources and Descriptive Statistics                                    64

                 Estimation Methodology and Results                                         66

                 Alternative Specification                                                  68




                 Page i                                      GAO-04-8 Cable Television Industry
Appendix VI 	   Comments from the Federal Communications
                Commission                                                                70
                GAO Comments                                                              76

Appendix VII    Comments from Industry Participants                                       80
                American Cable Association 
                                              80
                Consumer Federation of America 
                                          80
                Consumers Union 
                                                         81
                National Association of Broadcasters 
                                    82
                National Association of Telecommunications Officers and Advisors 
        82
                National Broadcasting Company 
                                           83
                National Cable and Telecommunications Association 
                       84
                News Corporation 
                                                        85
                Satellite Broadcasting and Communications Association 
                   86
                Viacom
                                                                   86
                Walt Disney Company 
                                                     86

Appendix VIII   GAO Contacts and Staff Acknowledgments                                    88
                GAO Contacts                                                              88
                Staff Acknowledgments                                                     88


Tables
                Table 1: Definition and Source for Variables                              56
                Table 2: Descriptive Statistics                                           58
                Table 3: Three-Stage Least Squares Model Results                          59
                Table 4: Definitions and Sources of Variables                             65
                Table 5: Descriptive Statistics                                           66
                Table 6: Logistic Model Results                                           67
                Table 7: Logistic Model Results                                           69


Figures
                Figure 1: Section of FCC’s 2002 Cable Rate Survey Covering Cable
                         Franchises’ Rate and Cost Changes                                13
                Figure 2: Change in the General and Cable Television Consumer
                         Price Indexes, 1997 – 2002                                       21




                Page ii                                    GAO-04-8 Cable Television Industry
Figure 3: Average Monthly License Fees per Subscriber—Sports
         Programming Networks v. Nonsports Networks, 1999 –
         2002                                                                             23
Figure 4: Expenditures by 79 Cable Networks to Produce
         Programming, 1999 – 2002                                                         24
Figure 5: Cable Industry Infrastructure Expenditures, 1996 – 2002                         26
Figure 6: Ownership Affiliation of the 90 Most Carried Cable
         Networks                                                                         28
Figure 7: Percentage of Cable Network Advertising Revenue
         Compared with License Fee Revenues for 79 Cable
         Networks, 1999 – 2002                                                            35




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
NBC              National Broadcasting Company
NCTA             National Cable and Telecommunications Association
YES              Yankees Entertainment and Sports Network




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Page iii                                              GAO-04-8 Cable Television Industry
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.


                                   Page 1                                        GAO-04-8 Cable Television Industry
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.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.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



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.




Page 2                                                GAO-04-8 Cable Television Industry
                     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.


                     Competition from wire-based and DBS operators leads to lower cable
Results in Brief 
   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


                     Page 3                                       GAO-04-8 Cable Television Industry
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


Page 4                                       GAO-04-8 Cable Television Industry
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
operators3 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.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



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.




Page 5                                                 GAO-04-8 Cable Television Industry
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



Page 6                                       GAO-04-8 Cable Television Industry
             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.


             Cable television emerged in the late 1940s to fill a need for television
Background   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


             Page 7                                        GAO-04-8 Cable Television Industry
township or county.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.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.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.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


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.




Page 8                                                 GAO-04-8 Cable Television Industry
                            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.


                            Today, wire-based competition—that is, competition from a provider using
Competition Leads to        a wire technology, such as a local telephone company or an electric
Lower Cable Rates           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
and Improved Quality        wire-based video operators. However, in those markets where this
and Service among           competition is present, cable rates are significantly lower—by about 15
                            percent—than cable rates in similar markets without wire-based
Cable Operators             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   Although the Telecommunications Act of 1996 sought to increase wire-
Limited but, Where          based competition, few customers have a choice among companies
Available, Has a            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
Downward Impact on          effective competition based on the presence of a wire-based competitor.9
Cable Rates                 Our interviews with 11 cable operators and five financial analysis firms



                            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).




                            Page 9                                             GAO-04-8 Cable Television Industry
                          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.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.11


DBS Has Become an         In recent years, DBS has become the primary competitor to cable
Important Competitor to   operators in the subscription video industry. As of June 2002, about 18
Cable Operators           million households—roughly 20 percent of the total video subscribers—
                          were served by DBS. Most cable operators that we interviewed described
Nationwide                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



                          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.




                          Page 10                                                GAO-04-8 Cable Television Industry
signals of over-the-air broadcast stations, such as affiliates of ABC, CBS,
Fox, and NBC—via satellite to their customers.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.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.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.




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.




Page 11                                                  GAO-04-8 Cable Television Industry
                         Responses to our cable franchise survey suggest that certain issues
Concerns Exist about     undermine the reliability of information in FCC’s cable rate report, which
the Reliability of       provides information on cable rates and competition in the subscription
                         video industry. In particular, we found that respondents did not fill out
FCC’s Data for Cable     FCC’s survey on factors underlying cable rate increases in a consistent
Operator Cost Factors    manner. Additionally, FCC’s designations of franchise areas as having (or
                         not having) effective competition do not always accurately reflect current
and Effective            competitive conditions. For determinations of effective competition that
Competition              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      Results of our cable franchise survey indicated considerable variation in
Survey May Lead to       how cable franchises completed the section of FCC’s 2002 cable rate
Inaccuracies in the      survey on which they provide information about the factors underlying
                         recent cable rate increases. Figure 1 shows the actual section of FCC’s
Relative Importance of   survey that franchises completed to provide their cost change information;
Cost Factors             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.




                         Page 12                                        GAO-04-8 Cable Television Industry
Figure 1: Section of FCC’s 2002 Cable Rate Survey Covering Cable Franchises’
Rate and Cost Changes




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.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




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.




Page 13                                            GAO-04-8 Cable Television Industry
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.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.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.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


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.




Page 14                                                GAO-04-8 Cable Television Industry
                            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     FCC is required by statute to produce an annual report on the differences
Does Not Appear to          between average cable rates in areas that FCC has found to have effective
Provide a Reliable Source   competition compared with those that have not had such a finding. FCC
                            reported that on July 1, 2001, competitive operators were charging an
of Information on the       average monthly rate of $34.93, while noncompetitive operators were
Effect of Competition       charging $37.13—a 6.3 percent differential for the combined basic and
                            expanded-basic tiers of service and equipment.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



                            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.




                            Page 15                                                GAO-04-8 Cable Television Industry
     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.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.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



     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.




     Page 16                                                GAO-04-8 Cable Television Industry
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 test22 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.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


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.




Page 17                                                GAO-04-8 Cable Television Industry
                          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            In the last several years, there have been dozens of petitions for a
Information Used in       determination of effective competition based on DBS competition.
Effective Competition     However, the data on subscriber counts by zip code, which are used to
                          make these petitions, are considered proprietary business information by
Filings Has Not Been      DBS companies. DBS providers EchoStar and DIRECTV, as well as big
Independently Validated   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


                          Page 18                                       GAO-04-8 Cable Television Industry
                             the providers.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         FCC’s annual cable rate report provides an important source of
Information May              information about the cable industry. This report provides an extensive
Compromise Monitoring        analysis of the cable industry, including such important factors as cable
                             rates, factors underlying changes in cable rates, and provision of advanced
and Oversight of the Cable   services (such as cable modem Internet access). FCC’s findings provide
Industry                     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.



                             24
                              The provision of DBS data for effective competition has recently been transferred to the
                             Satellite Broadcasting and Communications Association.




                             Page 19                                               GAO-04-8 Cable Television Industry
                            During the preceding 5 years, cable rates have increased approximately 40
A Variety of Factors        percent—well in excess of the approximately 12 percent increase in the
Contribute to Cable         general rate of inflation. We found that a number of factors contributed to
                            the increase in cable rates. These factors include increased expenditures
Rate Increases              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     FCC data indicate that the average monthly rate subscribers are charged
Have Increased Rapidly,     for the combined basic and expanded-basic tiers of service rose from
Far Outpacing the General   $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
Rate of Inflation           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.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



                            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.




                            Page 20                                               GAO-04-8 Cable Television Industry
                             view cable networks has increased, cable rates, adjusted for this
                             additional viewing, have actually declined.26

                             Figure 2: Change in the General and Cable Television Consumer Price Indexes,
                             1997 – 2002




Increases in Expenditures    As discussed in the previous section, one important factor contributing to
on Cable Programming         higher cable rates is cable operators’ increased costs to purchase
Contribute to Higher Cable   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
Rates                        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


                             26
                              See Wildman, S.S. Assessing Quality-Adjusted Changes in the Real Price of Basic Cable
                             Service. Michigan State University: September 10, 2003.




                             Page 21                                             GAO-04-8 Cable Television Industry
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 2002.27 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 2002.28
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.




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.




Page 22                                                  GAO-04-8 Cable Television Industry
Figure 3: Average Monthly License Fees per Subscriber—Sports Programming
Networks v. Nonsports Networks, 1999 – 2002




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 rights29 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



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.




Page 23                                                GAO-04-8 Cable Television Industry
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.30

Figure 4: Expenditures by 79 Cable Networks to Produce Programming, 1999 – 2002




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


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.




Page 24                                                 GAO-04-8 Cable Television Industry
                          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.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     In addition to higher programming costs, the cable industry has incurred
Appear to Contribute to   other increased costs. For example, according to industry sources, the
Higher Rates for Cable    cable industry spent over $75 billion between 1996 and 2002 to upgrade its
                          infrastructure by replacing degraded coaxial cable with fiber optics and
Service                   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.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




                          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.




                          Page 25                                                 GAO-04-8 Cable Television Industry
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




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.




Page 26                                           GAO-04-8 Cable Television Industry
Programming Expenses      On the basis of financial data from 9 cable operators, we found that
and Infrastructure        annual subscriber video-based revenues—that is, revenues from basic,
Investment Appear to Be   expanded-basic, and digital tiers; pay-per-view; installation charges; and
                          other revenues such as equipment rental—increased approximately $79
Primary Contributors to   per subscriber from 1999 to 2002. By 2002, revenues per subscriber
Cable Rate Increases      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.


                          Several industry representatives and experts we interviewed told us that
Some View                 they believe ownership affiliation may also influence the cost of
Ownership                 programming and thus, indirectly, the rates for cable service. We found
                          that there are two primary ownership relationships that some believe
Affiliations as an        influence the cost of cable programming: relationships between cable
Important Indirect        networks and cable operators, and relationships between cable networks
                          and broadcasters. To understand the nature of these ownership
Influence on Cable        relationships, we analyzed the ownership of 90 cable networks that are
Rates                     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.33 For example, cable operators have ownership interests of at


                          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.




                          Page 27                                               GAO-04-8 Cable Television Industry
least 50 percent in such widely distributed cable networks as TBS, TNT,
CNN, AMC, and the Cartoon Network.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




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


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-




34
 Only 3 of the large cable operators are majority owners of national cable networks.




Page 28                                                     GAO-04-8 Cable Television Industry
owned by broadcasters or cable operators.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.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.




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.




Page 29                                                 GAO-04-8 Cable Television Industry
                           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.

                           Most cable operators with whom we spoke provide subscribers with
Several Factors            similar tiers of networks, typically the basic and expanded-basic tiers,
Generally Lead Cable       which provide subscribers with little choice regarding the specific
                           networks they purchase. Adopting an à la carte approach, where
Operators to Offer         subscribers could choose to pay for only those networks they desire,
Large Tiers of             would provide consumers with more individual choice, but could require
                           additional technology and impose additional costs on both cable operators
Networks Instead of        and subscribers. Additionally, this approach could alter the current
Providing À La Carte       business model of the cable network industry wherein cable networks
or Minitier Service        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       The 11 cable operators that we interviewed adopt very similar strategies
Offer Similar Bundles of   for bundling networks into tiers of service. These cable operators offer
Networks                   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


                           Page 30                                       GAO-04-8 Cable Television Industry
                            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.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      The manner in which cable networks are currently packaged has raised
Lack of Subscriber Choice   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.38




                            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.




                            Page 31                                                 GAO-04-8 Cable Television Industry
An À La Carte Network       If cable operators were to offer all networks on an à la carte basis—that is,
Offering Could Impose       if consumers could select the individual networks they wish to purchase—
Costs on Cable              additional technology upgrades would be necessary in the near term. In
                            particular, subscribers would need to have an addressable converter box
Subscribers and Operators   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.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


                            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.




                            Page 32                                             GAO-04-8 Cable Television Industry
                           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       Even if cable operators desired to offer customers a wider variety of
Specify Placement on the   bundles of services or even à la carte service, most contracts negotiated
Basic or Expanded-Basic    between cable networks and cable operators prohibit these alternatives.
                           All 11 cable operators and four of five financial analysts that we
Tier                       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


                           Page 33                                      GAO-04-8 Cable Television Industry
                             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     If cable subscribers were allowed to choose networks on an à la carte
of the Cable Network         basis, the economics of the cable network industry could be altered, and,
Market Are a Constraint to   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
an À La Carte Approach       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.




                             Page 34                                        GAO-04-8 Cable Television Industry
Figure 7: Percentage of Cable Network Advertising Revenue Compared with
License Fee Revenues for 79 Cable Networks, 1999 – 2002




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


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



Page 35                                                    GAO-04-8 Cable Television Industry
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



Page 36                                      GAO-04-8 Cable Television Industry
                            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   Another alternative to the à la carte approach that has been discussed is a
of Service Is More          move to minitiers, under which subscribers would choose small tiers of
Feasible, but Economic      programming that are grouped by genre (such as sports, news and
                            information, and general entertainment). Although industry
and Technological           representatives told us that this approach might be more viable than an à
Constraints Would Also      la carte approach, we were also told that all of the issues associated with
Apply                       an à la carte regime would also apply to minitiers. Representatives of 8 of


                            Page 37                                      GAO-04-8 Cable Television Industry
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.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


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.




Page 38                                             GAO-04-8 Cable Television Industry
                         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.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.42


                         In recent years, there has been concern about the rapidity of cable rate
Industry Participants    increases. As we previously noted, cable rates have risen by about 40
Have Cited Certain       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
Options That May         been put forth. These approaches can be grouped into the following two
Address Factors          main categories: (1) the control of rates through regulation and (2) the
                         promotion of lower rates through market mechanisms, such as through
Contributing to Rising   greater competition.
Cable Rates
                         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



                         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.




                         Page 39                                                  GAO-04-8 Cable Television Industry
     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



     Page 40                                      GAO-04-8 Cable Television Industry
     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.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.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.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.46 DBS companies


     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.



     Page 41                                               GAO-04-8 Cable Television Industry
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.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




47
 Satellite Broadcasting and Communications Association v. FCC, 275 3d 337 (4th Cir.
2001) cert. Denied 536 U.S. 922 (2002).




Page 42                                            GAO-04-8 Cable Television Industry
payment or some other form of compensation in exchange for the cable
operator’s right to carry broadcast networks.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.



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.




Page 43                                                 GAO-04-8 Cable Television Industry
              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.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.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.


              In the last decade, the subscription video industry has undergone dramatic
Conclusions   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


              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.




              Page 44                                              GAO-04-8 Cable Television Industry
                       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.

                       To improve the quality and usefulness of the data that FCC collects on
Recommendations for    cable television rates and competition in the subscription video industry,
Executive Action       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.




                       Page 45                                      GAO-04-8 Cable Television Industry
                       We provided a draft of this report to FCC for comment. FCC had two key
Agency Comments 
      comments on the draft report. First, FCC stated that they are taking steps
and Our Evaluation 
   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.




                       Page 46                                        GAO-04-8 Cable Television Industry
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 





Page 47                                      GAO-04-8 Cable Television Industry
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.1 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.




              1
               See U.S. General Accounting Office, Telecommunications: Issues in Providing Cable and
              Satellite Television Services, GAO-03-130 (Washington, D.C.: Oct. 15, 2002).




              Page 48                                            GAO-04-8 Cable Television Industry
     Appendix I: Scope and Methodology




     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



     Page 49                                       GAO-04-8 Cable Television Industry
     Appendix I: Scope and Methodology




     provided the financial and operating data we sought. We also acquired
     data from Kagan World Media,2 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.3

•	    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.




     2
     Kagan World Media, Economics of Basic Cable Networks 2003 (Carmel, CA: 2003).
     3
      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.




     Page 50                                              GAO-04-8 Cable Television Industry
Appendix II: GAO Survey of Cable Franchises 





              Page 51           GAO-04-8 Cable Television Industry
Appendix II: GAO Survey of Cable Franchises




Page 52                                       GAO-04-8 Cable Television Industry
Appendix II: GAO Survey of Cable Franchises




Page 53                                       GAO-04-8 Cable Television Industry
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
              2001.1 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.


              1
               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.




              Page 54                                              GAO-04-8 Cable Television Industry
Appendix III: GAO’s Modifications to FCC’s
Competition Classification




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.”2




2
 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).




Page 55                                          GAO-04-8 Cable Television Industry
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.1


                                              Table 1 includes a list of all the variables included in our model, with the
Definitions and 	                             definition and source identified for each variable.
Sources for Variables

Table 1: Definition and Source for Variables

 Variable                        Definition                                                                      Source
 Cable price                     The monthly rate charged for the Basic Service Tier, Cable Programming          FCC 2001 Cable Rate
                                 Service Tier, and rental of a converter box and remote control.                 Survey
 Number of subscribers           The number of subscribers to the Basic Service Tier and Cable                   FCC 2001 Cable Rate
                                 Programming Service Tier.                                                       Survey
 Number of channels              The number of channels provided with the Basic Service Tier and Cable           FCC 2001 Cable Rate
                                 Programming Service Tier (the most commonly purchased tier).                    Survey
 Direct broadcast satellite      The fraction of housing units in a cable franchise area that have satellite     SkyREPORT
 (DBS) penetration rate          service.
 DBS provision of local stations A binary variable that equals 1 if both DBS operators offer local broadcast     National Association of
                                 stations in the cable franchise area.                                           Broadcasters
 Television market size          The number of television households in the market.                              Neilsen Media Research
 Horizontal concentration	       A binary variable that equals 1 if 1 of the 10 largest national multiple        FCC 2001 Cable Rate
                                 system operators (MSO) provides service in the franchise area.                  Survey
 Vertical relationship           A binary variable that equals 1 if the cable operator is affiliated with an     FCC 2001 Cable Rate
                                 MSO that has an ownership interest in a national or regional video              Survey and 2001 Annual
                                 programming service.                                                            Video Report
 Presence of a wire-based        A binary variable that equals 1 if a second wireline company provides           FCC 2001 Cable Rate
 competitor 	                    cable service (including, for example, a local exchange telephone carrier       Survey and GAO
                                 offering video services) in the franchise area.                                 analysis




                                              1
                                              See GAO-03-130.




                                              Page 56                                                GAO-04-8 Cable Television Industry
                                               Appendix IV: Cable-Satellite Model




 Variable                         Definition                                                                       Source
 Presence of multichannel         A binary variable that equals 1 if a company provides cable service via          FCC 2001 Cable Rate
 multipoint distribution system   MMDS technology in the franchise area.                                           Survey and GAO
 (MMDS) competitor                                                                                                 analysis
 Average wage	                    The average weekly wage for telecommunications equipment installers              Bureau of Labor
                                  and repairers in the state where the cable franchise is located.                 Statistics
 Population density               The ratio of population to square miles in the franchise area.                   U.S. Census Bureau
 Number of broadcast stations     The number of over-the-air broadcast stations in the television market.          BIA MEDIA AccessPro
 Urbanization 	                   The percentage of the county’s population that is classified as urban by the U.S. Census Bureau
                                  U.S. Census Bureau.
 Age of cable franchise	          The number of years between when the cable franchise began operation             FCC Master List of
                                  and 2001.                                                                        Cable Franchises
 Homes passed by cable            The number of homes passed by the cable system that serves the                   FCC 2001 Cable Rate
 system                           franchise area, including homes outside of the franchise area.                   Survey
 Median per-capita income         The median per-capita income in the franchise area.                              U.S. Census Bureau
 System megahertz                 The capacity, measured in megahertz, of the cable system that serves the         FCC 2001 Cable Rate
                                  franchise area.                                                                  Survey
 Percentage of multiple           The percentage of housing units accounted for by structures with five or         U.S. Census Bureau
 dwelling units                   more housing units.
 Nonmetropolitan areas            A binary variable that equals 1 if the franchise area is outside of a            U.S. Census Bureau
                                  metropolitan statistical area (MSA).
 Angle (or “elevation”) of        The angle relative to the ground that a DBS subscriber must mount the            Web pages of DIRECTV
 satellite dish                   satellite dish to “see” the satellite.                                           and EchoStar
 Regulation                       A binary variable that equals 1 if the cable franchise is subject to regulation FCC 2001 Cable Rate
                                  of the rate charged for the Basic Service Tier.                                 Survey
Source: GAO (2003).



                                               We employed the three-stage least squares method to estimate our model.2
Estimation                                     Table 2 includes the descriptive statistics for the variables included in our
Methodology and                                model, and table 3 includes the estimation results for each of the four
                                               structural equations. All of the variables, except dummy variables,3 are
Results                                        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




                                               2
                                                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.
                                               3
                                                A dummy variable takes a value of 1 if a certain characteristic is present and a value of 0
                                               otherwise.




                                               Page 57                                               GAO-04-8 Cable Television Industry
                                         Appendix IV: Cable-Satellite Model




                                         independent, or explanatory, variable.4 The coefficients on the dummy
                                         variables are elasticities in decimal form.

Table 2: Descriptive Statistics

 Variable                                       Mean        Standard deviation            Minimum value            Maximum value
 Cable price                                    36.15                          5.02                  14.00                    47.84
 Cable price per channel                           0.66                        0.19                   0.30                      1.80
 Cable subscribers                         21,460.68                   43,673.73                      4.00              302,964.00
 Cable channels                                 58.17                         14.06                  10.00                    99.00
 DBS penetration                                15.91                       11.31                     1.59                    63.64
 DBS provision of local stations                   0.52                        0.50                   0.00                      1.00
 Regulation                                        0.36                        0.48                   0.00                      1.00
 Number of broadcast stations                   12.00                          5.64                   1.00                    25.00
 Median income                             43,965.25                   16,202.17                13,529.00               139,997.00
 Horizontal concentration                          0.85                        0.36                   0.00                      1.00
 Vertical relationship                             0.55                        0.50                   0.00                      1.00
 Presence of wire-based competitor                 0.16                        0.37                   0.00                      1.00
 Presence of MMDS competitor                       0.01                        0.10                   0.00                      1.00
 Nonmetropolitan areas                             0.25                        0.43                   0.00                      1.00
 Urbanization                                   73.53                         28.12                   0.00                   100.00
 Percentage of multiple dwelling units          14.38                         13.70                   0.00                    98.12
 Age of cable franchise                         24.11                          9.52                   2.00                    50.00
 Homes passed by cable system             181,024.81                  235,085.38                     30.00             1,260,734.00
 Cable system megahertz                        638.98                     172.13                    216.00                   870.00
 Television market households                1,459.89                   1,664.50                     50.00                 7,301.00
 Population density                          2,888.92                   7,144.36                      2.25                87,139.78
 State-level wages                             788.91                     102.28                    575.38                 1,045.58
 Dish angle or elevation                        40.29                          6.67                  27.19                    57.28
Source: GAO (2003).




                                         4
                                          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.




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                                       Appendix IV: Cable-Satellite Model




Table 3: Three-Stage Least Squares Model Results

                                  Cable prices        Cable subscribers         Cable channels          DBS penetration
Variable                             equation                  equation               equation                equation
Cable price per channel                                           -1.5368                                          0.7839
                                                                           a
                                                                [0.0001]                                         [0.0001]a
Cable subscribers                      0.0079                                           0.0603
                                      [0.3938]                                        [0.0001]a
Cable channels                         0.2428
                                      [0.0001]a
DBS penetration                        -0.0441                    -2.2403              -0.0174
                                      [0.0898]c                 [0.0001]a              [0.5933]
DBS provision of local                 -0.0063                    0.4276                0.0527                     0.3386
stations                              [0.7285]                  [0.0800]c             [0.0408]b                  [0.0001]
                                                                                                                            a



Regulation                             -0.0213
                                      [0.1157]
Number of broadcast                                               0.5896
stations                                                        [0.0081]a
Median income                                                     -0.3772               0.0672                     0.1903
                                                                            c                    a
                                                                [0.0813]              [0.0032]                   [0.0023]a
Horizontal concentration               0.0528
                                      [0.0006]a
Vertical relationship                  -0.0051                                         -0.0335
                                      [0.6682]                                        [0.0351]b
Presence of wire-based                 -0.1636                    -1.2766               0.0339                    -0.3797
competitor                            [0.0001]   a
                                                                [0.0001]
                                                                           a
                                                                                       [0.1832]                  [0.0001]a
Presence of MMDS                       0.0420                     -0.2247               0.0426                    -0.1350
competitor                            [0.3697]                   [0.7350]              [0.5391]                  [0.4596]
Nonmetropolitan areas                                                                                              0.4456
                                                                                                                 [0.0001]a
Urbanization                                                      0.0541
                                                                 [0.5117]
Percentage of multiple                                                                 -0.0228                    -0.2162
dwelling units                                                                        [0.0261]b                  [0.0001]a
Age of cable franchise                                            0.3027                                          -0.1778
                                                                           b
                                                                [0.0463]                                         [0.0001]a
Homes passed by cable                                             0.2918
system                                                          [0.0001]a




                                       Page 59                                       GAO-04-8 Cable Television Industry
                                Appendix IV: Cable-Satellite Model




                           Cable prices              Cable subscribers           Cable channels                DBS penetration
 Variable                     equation                        equation                 equation                      equation
 Cable system megahertz                                                                    0.5038                      -0.0434
                                                                                         [0.0001]a                     [0.5304]
 Television market              0.0072                             -0.2902                -0.0023                      -0.1195
 households                    [0.3639]                           [0.0670]c               [0.8489]                    [0.0001]a
 Population density             -0.0120
                               [0.0256]b
 State-level wages              0.0392
                               [0.3676]
 Dish angle or elevation                                                                                                0.6028
                                                                                                                      [0.0001]a
 Intercept                      2.4077                            14.1843                 -0.3218                       0.5324
                                          a                                  a
                               [0.0001]                           [0.0001]                [0.3259]                     [0.5601]
 Sample size                           705                                 705                 705                         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.


                                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. 5 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




                                5
                                 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.




                                Page 60                                                 GAO-04-8 Cable Television Industry
Appendix IV: Cable-Satellite Model




associated with a 15 cent reduction in cable rates.6 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.7

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.



6
 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.
7
 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.




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Appendix IV: Cable-Satellite Model




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.




Page 62                                     GAO-04-8 Cable Television Industry
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.


                      A cable operator will carry a cable network if, on the margin, the network
Set-up of Our Cable   increases the operator’s profit or increases its profits more than an
Network Carriage      alternative cable network. Cable operators receive revenue associated
                      with cable networks from both subscriber fees and local advertising.
Model                 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.1 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




                      1
                       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.




                      Page 63                                                GAO-04-8 Cable Television Industry
                              Appendix V: Cable Network Carriage Model




                              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.


                              We required several data elements to build the dataset used to estimate
Data Sources and              this model. The following is a list of our primary data sources. In addition,
Descriptive Statistics        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


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                                            Appendix V: Cable Network Carriage Model




                                            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                     Definition                                                                          Source
 Carry                        A binary variable that equals 1 if the cable network is carried on the basic or     FCC 2002 cable rate
                              expanded-basic tier.                                                                survey
 Age                          2003 minus the launch year of the cable network.                                    Kagan World Media
 Advertising revenue per      The cable network’s advertising revenues divided by the number of                   Kagan World Media
 subscriber                   subscribers that could receive the cable network in 2002.
 News 	                       A binary variable that equals 1 if the cable network primarily delivers news-       GAO analysis
                              related programming.
 Sports 	                     A binary variable that equals 1 if the cable network primarily delivers sports-     GAO analysis
                              related programming.
 Broadcaster affiliation 	    A binary variable that equals 1 if the cable network is affiliated with a           Kagan World Media
                              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.
 Cable affiliation 	          A binary variable that equals 1 if the cable network is affiliated with a cable     Kagan World Media
                              operator (Time Warner, Cablevision, or Comcast).
 Homes passed by cable        The number of households passed by the cable system that serves the                 FCC 2002 cable rate
 system                       franchise, including homes outside of the franchise area.                           survey
 Cable system megahertz 	     The capacity, measured in megahertz, of the cable system that serves the            FCC 2002 cable rate
                              franchise area.                                                                     survey
 Multiple system operator 	   A binary variable that equals 1 if the cable franchise is affiliated with a cable   FCC 2002 cable rate
                              multiple system operator.                                                           survey
 Population between ages 25   The percentage of the population in a franchise area between ages 25 and 65. U.S. Census Bureau
 and 65
 Home ownership 	             The percentage of households in the franchise area residing in owner-               U.S. Census Bureau
                              occupied housing units.
Source: GAO (2003).




                                            Page 65                                                   GAO-04-8 Cable Television Industry
                                      Appendix V: Cable Network Carriage Model




Table 5: Descriptive Statistics

 Variable                                        Mean     Standard deviation          Minimum value          Maximum value
 Carry                                            0.43                    0.50                    0.00                    1.00
 Age                                             10.68                    6.61                    1.00                  27.00
 Advertising revenue per subscriber               1.91                    2.19                    0.00                  10.98
 News                                             0.06                    0.24                    0.00                    1.00
 Sports                                           0.09                    0.28                    0.00                    1.00
 Broadcaster affiliation                          0.25                    0.43                    0.00                    1.00
 Cable affiliation                                0.20                    0.40                    0.00                    1.00
 Homes passed by cable system               178,212.05             244,160.35                    73.00           1,286,698.00
 Cable system megahertz                         672.57                  171.08                 212.00                  870.00
 Multiple system operator                         0.95                    0.23                    0.00                    1.00
 Population between ages 25 and 65               52.09                    2.92                   37.26                  62.94
 Home ownership                                  68.16                   10.02                   19.46                  84.90
Source: GAO (2003).




                                      Because we are estimating a binary choice model—that is, the cable
Estimation                            franchise either carries or does not carry a given cable network—we
Methodology and                       employed the logit method to estimate our reduced-form equation of cable
                                      network carriage.2 We present the estimation results for our reduced-form
Results                               equation in table 6.




                                      2
                                       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.




                                      Page 66                                               GAO-04-8 Cable Television Industry
Appendix V: Cable Network Carriage Model




Table 6: Logistic Model Results

    Variable                                 Parameter estimate and [p-value]
    Age                                                                 0.1558
                                                                                 a
                                                                      [0.0001]
    Advertising revenue per subscriber                                  0.7537
                                                                                 a
                                                                      [0.0001]
    News                                                                0.6769
                                                                      [0.0001]a
    Sports                                                              0.0812
                                                                                 b
                                                                      [0.0472]
    Broadcaster affiliation                                             0.8265
                                                                                 a
                                                                      [0.0001]
    Cable affiliation                                                   0.5817
                                                                                 a
                                                                      [0.0001]
    Homes passed by cable system                                        0.0000
                                                                                 a
                                                                      [0.0011]
    Cable system megahertz                                              0.0029
                                                                                 a
                                                                      [0.0001]
    Population between ages 25 and 65                                   0.0061
                                                                       [0.1191]
    Home ownership                                                      0.0068
                                                                                 a
                                                                      [0.0001]
    Multiple system operator                                            0.3059
                                                                      [0.0001]a
    Intercept                                                          -6.5658
                                                                                 a
                                                                      [0.0001]
    Sample size                                                         55,728
    Rescaled R-square                                                   0.5075
Source: GAO (2003).
a
Significance at the 1 percent level.
b
Significance at the 5 percent level.


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



Page 67                                       GAO-04-8 Cable Television Industry
                Appendix V: Cable Network Carriage Model




                that do not have broadcast ownership.3 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.


                In addition to the above specification, we also considered a narrower
Alternative     definition of cable affiliation. In this specification, a cable network was
Specification   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.




                3
                 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.




                Page 68                                                 GAO-04-8 Cable Television Industry
Appendix V: Cable Network Carriage Model




Table 7: Logistic Model Results

    Variable                               Parameter estimate and [p-value]
    Age                                                               0.1558
                                                                               a
                                                                    [0.0001]
    Advertising revenue per subscriber                                0.7360
                                                                               a
                                                                    [0.0001]
    News                                                              0.6495
                                                                    [0.0001]a
    Sports                                                            0.1558
                                                                               a
                                                                    [0.0001]
    Broadcaster affiliation                                           0.6877
                                                                               a
                                                                    [0.0001]
    Cable network owned by operator                                   1.4091
                                                                               a
                                                                    [0.0001]
    Homes passed by cable system                                      0.0000
                                                                               b
                                                                    [0.0131]
    Cable system megahertz                                            0.0029
                                                                               a
                                                                    [0.0001]
    Population between ages 25 and 65                                 0.0054
                                                                     [0.1677]
    Home ownership                                                    0.0069
                                                                               a
                                                                    [0.0001]
    Multiple system operator                                          0.2915
                                                                    [0.0001]a
    Intercept                                                        -6.3393
                                                                               a
                                                                    [0.0001]
    Sample size                                                       55,728
    Rescaled R-square                                                 0.5065
Source: GAO (2003). 

a
Significance at the 1 percent level. 

b
Significance at the 5 percent level. 





Page 69                                     GAO-04-8 Cable Television Industry
Appendix VI: Comments from the Federal
Communications Commission

Note: GAO comments
supplementing those in
the report text appear at
the end of this appendix.




See comment 1.




                            Page 70   GAO-04-8 Cable Television Industry
                 Appendix VI: Comments from the Federal
                 Communications Commission




See comment 2.




See comment 1.



See comment 1.

See comment 3.




See comment 1.




See comment 4.




See comment 5.



See comment 6.




                 Page 71                                  GAO-04-8 Cable Television Industry
                 Appendix VI: Comments from the Federal
                 Communications Commission




See comment 7.




See comment 6.




See comment 7.




                 Page 72                                  GAO-04-8 Cable Television Industry
Appendix VI: Comments from the Federal
Communications Commission




Page 73                                  GAO-04-8 Cable Television Industry
                  Appendix VI: Comments from the Federal
                  Communications Commission




See comment 8.




See comment 9.




See comment 10.




                  Page 74                                  GAO-04-8 Cable Television Industry
                  Appendix VI: Comments from the Federal
                  Communications Commission




See comment 10.




                  Page 75 
                                GAO-04-8 Cable Television Industry
               Appendix VI: Comments from the Federal
               Communications Commission




               The following are GAO’s comments on the Federal Communications
               Commission’s letters dated September 24 and October 9, 2003.


               1. 	 In a letter dated September 24, 2003, FCC contended that under the
GAO Comments        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



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Appendix VI: Comments from the Federal
Communications Commission




    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.



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Appendix VI: Comments from the Federal
Communications Commission




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




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Appendix VI: Comments from the Federal
Communications Commission




    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.




Page 79                                         GAO-04-8 Cable Television Industry
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.


                      The American Cable Association (ACA) noted that because we focused
American Cable        much of our analysis on larger cable operators, the report does not
Association           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.


                      A representative of the Consumer Federation of America suggested that
Consumer Federation   the costs associated with infrastructure upgrades were recouped from
of America            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


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                  Appendix VII: Comments from Industry
                  Participants




                  suggested that we include a table reporting the results for the alternative
                  specification, in which we consider cable networks owned by a cable
                  operator.


                  A representative of Consumers Union believes that our finding that cable
Consumers Union   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.




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                        Appendix VII: Comments from Industry
                        Participants




                        National Association of Broadcasters officials identified several issues
National Association    associated with the cable industry. First, they stated that while our report
of Broadcasters         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.


                        The National Association of Telecommunications Officers and Advisors
National Association    (NATOA) noted that the focus of our review was cable rates for the basic
of                      and expanded-basic service tiers, but equipment rental—such as converter
                        boxes—are also rising. NATOA noted that we correctly pointed out that
Telecommunications      the benefits of infrastructure investment may confer largely to subscribers
Officers and Advisors   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



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                        Appendix VII: Comments from Industry
                        Participants




                        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 (NBC) officials suggested that we explain
National Broadcasting   why broadcaster-owned cable networks are more frequently carried than
Company                 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


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                     Appendix VII: Comments from Industry
                     Participants




                     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.


                     The National Cable and Telecommunications Association (NCTA) had
National Cable and   serious concerns about the finding from our econometric model, which
Telecommunications   indicates that cable rates are 15 percent lower in markets with a second
                     wire-based competitor. NCTA officials noted that only about 45 franchise
Association          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.”1

                     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.




                     1
                      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.




                     Page 84                                              GAO-04-8 Cable Television Industry
                   Appendix VII: Comments from Industry
                   Participants




                   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.


                   Regarding programming costs, News Corporation (Fox) officials stated
News Corporation   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


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                           Appendix VII: Comments from Industry
                           Participants




                           than 17 channels. Moreover, they indicated that consumers may not
                           choose to watch the same 17 channels in any given year.


                           The Satellite Broadcasting and Communications Association chose to
Satellite Broadcasting 	   provide no comments.
and Communications
Association
                           Viacom (CBS) chose to provide no comments.
Viacom
                           Walt Disney Company (ABC) officials said that our draft provided
Walt Disney Company 
      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


                           Page 86                                         GAO-04-8 Cable Television Industry
Appendix VII: Comments from Industry
Participants




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.




Page 87                                       GAO-04-8 Cable Television Industry
Appendix VIII: GAO Contacts and Staff
Acknowledgments

                  Amy Abramowitz, (202) 512-2834
GAO Contacts      Michael Clements, (202) 512-2834


                  In addition to those named above, Stephen Brown, Julie Chao, Andy
Staff             Clinton, Keith Cunningham, Michele Fejfar, Sally Moino, Tina Sherman,
Acknowledgments   Wendy Turrene, Mindi Weisenbloom, and Carrie Wilks made key
                  contributions to this report




(545024)
                  Page 88                                     GAO-04-8 Cable Television Industry
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