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

United States General Accounting Office:

GAO:

October 2003:

Telecommunications:

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

GAO-04-8:

GAO Highlights:

Highlights of GAO-04-8, a report to Senator John McCain, Chairman, 
Committee on Commerce, Science, and Transportation, U.S. Senate 

Why GAO Did This Study:

Over 70 million American households receive television service from a 
cable television operator. In recent years, rates for cable service 
have increased at a faster pace than the general rate of inflation. 
GAO agreed to (1) examine the impact of competition on cable rates and 
service, (2) assess the reliability of information contained in the 
Federal Communications Commissions (FCC) annual cable rate report, 
(3) examine the causes of recent cable rate increases, (4) assess the 
impact of ownership affiliations in the cable industry, (5) discuss 
why cable operators group networks into tiers, and (6) discuss options 
to address factors that could be contributing to cable rate 
increases. 

What GAO Found:

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

FCCs cable rate report does not appear to provide a reliable source 
of information on the cost factors underlying cable rate increases or 
on the effects of competition. GAO found that cable operators did not 
complete FCCs survey in a consistent manner, primarily because the 
survey lacked clear guidance. In particular, GAO found that 84 of the 
100 franchises it surveyed did not provide a complete or accurate 
accounting of their cost changes for the year. Also, GAO found that 
FCC does not initiate updates or revisions to its classification of 
competitive and noncompetitive areas. Thus, FCCs classifications 
might not reflect current conditions.

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

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

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

Certain options for addressing cable rates have been put forth. 
Although reregulation of cable rates is one option, promoting 
competition could influence cable rates through the market process. 
Policies to bring about lower cable rates could have other effects 
that would need to be considered. 

What GAO Recommends:

GAO recommends that the Chairman of the FCC

* take immediate steps to im-prove the cable rate survey and 
* review the commissions process for maintaining the status of 
effective competition.

In commenting on GAOs report, FCC agreed to make changes to its 
annual cable rate survey, but FCC questioned, on a cost/benefit basis, 
the utility of revising its process to keep the status of effective 
competition up to date. GAO believes that FCC should examine whether 
cost-effective alternative processes could help provide the Congress 
with more accurate information.

www.gao.gov/cgi-bin/getrpt?GAO-04-8.

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

[End of section]

Contents:

Letter:

Results in Brief:

Background:

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

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

A Variety of Factors Contribute to Cable Rate Increases:

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

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

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

Conclusions:

Recommendations for Executive Action:

Agency Comments and Our Evaluation:

Appendix I: Scope and Methodology:

Appendix II: GAO Survey of Cable Franchises:

Appendix III: GAO's Modifications to FCC's Competition Classification:

Appendix IV: Cable-Satellite Model:

Definitions and Sources for Variables:

Estimation Methodology and Results:

Appendix V: Cable Network Carriage Model:

Set-up of Our Cable Network Carriage Model:

Data Sources and Descriptive Statistics:

Estimation Methodology and Results:

Alternative Specification:

Appendix VI: Comments from the Federal Communications Commission:

GAO Comments:

Appendix VII: Comments from Industry Participants:

American Cable Association:

Consumer Federation of America:

Consumers Union:

National Association of Broadcasters:

National Association of Telecommunications Officers and Advisors:

National Broadcasting Company:

National Cable and Telecommunications Association:

News Corporation:

Satellite Broadcasting and Communications Association:

Viacom:

Walt Disney Company:

Appendix VIII: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Staff Acknowledgments:

Tables:

Table 1: Definition and Source for Variables:

Table 2: Descriptive Statistics:

Table 3: Three-Stage Least Squares Model Results:

Table 4: Definitions and Sources of Variables:

Table 5: Descriptive Statistics:

Table 6: Logistic Model Results:

Table 7: Logistic Model Results:

Figures:

Figure 1: Section of FCC's 2002 Cable Rate Survey Covering Cable 
Franchises' Rate and Cost Changes:

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

Figure 3: Average Monthly License Fees per Subscriber--Sports 
Programming Networks v. Nonsports Networks, 1999 - 2002:

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

Figure 5: Cable Industry Infrastructure Expenditures, 1996 - 2002:

Figure 6: Ownership Affiliation of the 90 Most Carried Cable Networks:

Figure 7: Percentage of Cable Network Advertising Revenue Compared with 
License Fee Revenues for 79 Cable Networks, 1999 - 2002:

Abbreviations:

ACA: American Cable Association: 

BLS: Bureau of Labor Statistics:  

CPI: consumer price index:  

DBS: direct broadcast satellite:  

FCC: Federal Communications Commission:  

LEC: local exchange carrier:  

MMDS: multichannel multipoint distribution service:  

MSA: metropolitan statistical area:  

MSO: multiple system operator:  

NATOA: National Association of Telecommunications 
Officers and Advisors 

NBCNational Broadcasting Company 

NCTANational 
Cable and Telecommunications Association 

YESYankees Entertainment and 
Sports Network:

United States General Accounting Office:

Washington, DC 20548:

October 24, 2003:

The Honorable John McCain 
Chairman, Committee on Commerce, Science, and Transportation 
United States Senate:

Dear Mr. Chairman:

In recent years, cable television has become a major component of the 
American entertainment industry--today more than 70 million households 
receive their television service through a subscription to a cable 
television operator. As the industry has developed, it has been 
affected by regulatory and economic changes. Since 1992, the industry 
has undergone rate reregulation and then in 1999, partial deregulation. 
Additionally, competition to cable operators has emerged erratically. 
Companies emerged in some areas to challenge cable operators, only to 
halt expansion or discontinue service altogether. Conversely, 
competition from direct broadcast satellite (DBS) operators (such as 
DIRECTV and EchoStar)--which did not exist a decade ago--has emerged 
and grown rapidly in recent years. Nevertheless, cable rates continue 
to increase at a faster pace than the general rate of inflation.

You asked us to review several issues related to recent increases in 
cable rates and the competitiveness of the subscription video industry-
-an industry that includes cable television, satellite service 
(including DBS operators), and other technologies that deliver video 
services to customers' homes. We agreed to (1) examine the impact of 
competition in the subscription video industry on cable rates and 
service; (2) assess the reliability of the information contained in the 
Federal Communications Commission's (FCC) annual cable rate report on 
the cost factors underlying cable rate increases, FCC's current 
classification of cable franchises regarding whether they face 
effective competition, and FCC's related findings on the effect of 
competition; (3) examine the causes of recent cable rate increases; (4) 
assess whether ownership of cable networks (such as CNN and ESPN) may 
indirectly affect cable rates through such ownership's influence on 
cable network license fees or the carriage of cable networks; (5) 
discuss why cable operators group networks into tiers, rather than 
package networks so that customers can purchase only those networks 
they wish to receive; and (6) discuss options to address factors that 
could be contributing to cable rate increases.

To respond to the first objective on the impact of competition on cable 
rates and service, we used an empirical model (our cable-satellite 
model) that we previously developed that examines the effect of 
competition on cable rates and service.[Footnote 1] Using data from 
2001, the model considers the effect of various factors on cable rates, 
the number of cable subscribers, the number of channels that cable 
operators provide to subscribers, and DBS penetration rates for areas 
throughout the United States. We further developed the model to more 
explicitly examine whether varied forms of competition have 
differential effects on cable rates. We also discussed the degree and 
impact of competition in the subscription video industry with an array 
of industry stakeholders and experts (see below).

For the second objective on the reliability of data in FCC's annual 
cable rate report, we randomly sampled 100 of approximately 750 cable 
franchises that responded to FCC's 2002 cable rate survey.[Footnote 2] 
We designed this sample to be representative of the universe of 
franchises that responded to FCC's survey. Using a telephone survey 
(our cable franchise survey), we asked these franchises a series of 
questions about how they completed a portion of FCC's survey that 
addresses cost factors underlying annual cable rate changes (see app. 
II). We also examined FCC's process for classifying cable franchises 
regarding whether they face effective competition, a term defined by 
statute (see app. III).

For the third, fourth, fifth, and sixth objectives addressing the 
causes of recent cable rate increases, the impact of ownership 
affiliations, why cable operators group networks into tiers, and 
possible options for addressing factors that may be contributing to 
rate increases, we interviewed officials and obtained documents and 
data from FCC and the Bureau of Labor Statistics. We also interviewed 
officials from several trade associations and other organizations: the 
National Cable and Telecommunications Association (NCTA), Consumers 
Union, the National Association of Broadcasters, the National 
Association of Telecommunications Officers and Advisors, the American 
Cable Association, the National Cable Television Cooperative, three 
major sports leagues, and the Cable Television Advertising Bureau. We 
also conducted semistructured interviews with a variety of companies: 
11 cable operators, one DBS operator, four broadcast networks (such as 
ABC and NBC), 15 cable networks (such as CNN and ESPN), and 
representatives of five financial analysis firms. Furthermore, we used 
data on cable network revenues and programming expenses that we 
acquired from Kagan World Media, which is a private communications 
research firm that specializes in cable industry data. We used these 
data to develop models that examine whether ownership of cable networks 
by broadcasters or by cable operators influences (1) the level of 
license fee (our cable license fee model) or (2) the likelihood that 
the network will be carried (our cable network carriage model).

We conducted our review from December 2002 through September 2003 in 
accordance with generally accepted government auditing standards. For 
additional information on our scope and methodology, see appendix I.

Results in Brief:

Competition from wire-based and DBS operators leads to lower cable 
rates and improved quality and service among cable operators. 
Competition from a wire-based provider--that is, a competitor using a 
wire technology, such as a second cable operator, a local telephone 
company, or an electric utility--is limited to very few markets. 
However, in those markets where this competition is present, cable 
rates are significantly lower--by about 15 percent--than cable rates in 
similar markets without wire-based competition. Since 1999, when DBS 
operators acquired the legal right to provide local broadcast stations 
(such as affiliates of ABC, CBS, Fox, and NBC), these companies have 
emerged as important competitors to cable operators. In particular, in 
areas where subscribers can receive local broadcast stations from both 
primary DBS operators, the DBS penetration rate--that is, the 
percentage of households that subscribe to satellite service--is 
approximately 40 percent higher than in areas where subscribers cannot 
receive local broadcast stations from both primary DBS operators. In 
addition, the DBS provision of local broadcast stations has induced 
cable operators to improve the quality of their service by providing 
their subscribers with approximately 5 percent additional cable 
networks.

FCC's cable rate report may not provide reliable information on the 
factors underlying recent cable rate increases or on the effect of 
competition. In particular, cable franchises responding to FCC's 2002 
survey did not complete in a consistent manner the section pertaining 
to the factors underlying cable rate increases primarily because of a 
lack of clear guidance; 73 of 100 cable franchises whom we spoke with 
said that the instructions included with FCC's survey were 
insufficient. These inconsistencies may have led to unreliable 
information in FCC's report on the relative importance of factors 
underlying recent cable rate increases. For example, we spoke with 83 
franchises that reported zero for infrastructure investment to FCC, 33 
of these franchises told us that they had incurred costs for such 
investments, thereby implying that they understated the contribution of 
infrastructure investment to their cable rate increases. Overall, we 
found that 84 of the 100 franchises we surveyed did not provide a 
complete or accurate accounting of their cost changes for the year. 
Regarding the effect of competition, because FCC's process does not 
provide for updates or revisions to the competitive classification of 
cable franchises unless specifically requested to do so, FCC's 
classifications of cable franchises as having (or not having) effective 
competition on the basis of the statutory definition do not always 
accurately reflect current competitive conditions. In our analysis of 
the impact of wire-based competition, we checked the current status of 
competition in each franchise. The changes we made as a result of this 
process may explain, in part, the differential findings regarding the 
impact of wire-based competition reported by FCC, which found a nearly 
7 percent reduction in cable rates, and our finding of a 15 percent 
reduction in cable rates. Because the Congress and FCC use this 
information in their monitoring and oversight of the cable industry, 
the lack of reliable information in FCC's report on these two issues--
factors underlying cable rate increases and the effect of competition-
-may compromise the ability of the Congress and FCC to fulfill these 
roles. Additionally, the potential for this information to be used in 
debate regarding important policy issues, such as media consolidation, 
also necessitates reliable information in FCC's report. To improve the 
quality and usefulness of the data FCC collects annually on cable 
television rates and competition in the subscription video industry, we 
recommend that the Chairman of FCC take steps to improve the 
reliability, consistency, and relevance of information on rates and 
competition in the subscription video industry.

Several key factors--including programming costs and infrastructure 
investments--are putting upward pressure on cable rates. Programming 
costs incurred by cable operators have risen considerably--on average 
by as much as 34 percent--in the last 3 years, and, in particular, 
programming costs associated with cable networks showing sporting 
events have risen even more--on average by 59 percent--during the same 
time frame. The cable industry has also spent billions of dollars in 
upgrading its infrastructure to enable new services, such as digital 
channels and broadband Internet access. While these upgrades benefit 
cable subscribers by expanding the number of cable networks available 
and improving picture quality, some of this benefit accrues to 
subscribers who purchase new, advanced services, such as broadband 
Internet access. Additionally, cable operators have increased spending 
on customer service, which typically is now available 24 hours a day, 7 
days a week. For the 9 cable operators[Footnote 3] that provided 
financial information to us, we found that programming expenses and 
infrastructure investment appear to be the primary cost factors that 
have been increasing in recent years.[Footnote 4]

Several industry representatives whom we spoke with believe that 
certain factors related to the nature of ownership affiliations may 
also indirectly influence cable rates through their influence on cable 
operators' choice of which cable networks to carry and the cost to the 
cable operator for the right to carry the networks. We did not find 
that ownership affiliations between cable networks (such as CNN and 
ESPN) and broadcasters (such as NBC and CBS) or between cable networks 
and cable operators (such as Time Warner and Cablevision) are 
associated with the level of license fees--that is, the fees cable 
operators pay to carry cable networks. However, we did find that both 
forms of ownership affiliations are associated with the likelihood that 
a cable operator would carry a cable network. Holding constant certain 
other factors that might influence the likelihood of a cable network 
being carried by a cable operator--such as the popularity of the 
network or the type of programming the network carries--we found that 
operators were more likely to carry cable networks that were majority-
owned by either cable operators or by broadcasters than to carry other 
cable networks. Moreover, cable operators were substantially more 
likely to carry cable networks that they directly own than to carry 
cable networks owned by other cable operators, broadcasters, or others.

Currently, technological, contractual, and economic factors lead cable 
operators to sell large numbers of networks on tiers. On average, a 
basic tier of service includes about 25 channels, including local 
broadcast stations, and the next tier provides, on average, 36 
additional channels, including such popular cable networks as CNN and 
ESPN. Because subscribers must buy all of the networks offered on a 
tier that they choose to purchase, they have little choice regarding 
the individual networks they receive. Greater subscriber choice might 
be provided if cable operators used an  la carte system, wherein 
subscribers would receive and pay for only the networks they want to 
watch. But, an  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  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  la carte service, consumers' 
purchasing patterns, and whether certain niche networks would cease to 
exist with  la carte service--make it difficult to ascertain how many 
consumers would be better off and how many would be made worse off 
under an  la carte approach. Creating a separate tier for sports 
channels may be viable because this genre of programming has a loyal 
base of customers. However, sports leagues may be reluctant to have 
sporting events appear on cable networks that are placed on a separate 
sports tier because the programming would not be widely available.

Certain options for addressing factors that may be contributing to 
cable rate increases have been put forth. Although reregulation of 
cable rates stands as a possible option, taking steps to promote 
competition would help to reduce cable rates by leveraging the normal 
workings of the marketplace. Specific options include reviewing whether 
modifications to the program access rules would be beneficial, 
promoting wireless competition, and reviewing whether changes to the 
retransmission consent process should be considered. Any options 
designed to help bring down cable rates could have other unintended 
effects that would need to be considered in conjunction with the 
benefits of the lower rates. We are not making any specific 
recommendations regarding the adoption of any of these options.

FCC provided comments on a draft of this report in which they stated 
that the agency is taking steps to redesign their survey questionnaire 
in an attempt to obtain more accurate information. However, FCC 
questioned, on a cost/benefit basis, the utility of adopting a revised 
process to keep the status of effective competition in franchises up to 
date. We believe that providing the Congress with reliable information 
on cable rates and competition is important, and that more accurate 
effective competition designations would help to accomplish this. 
Therefore, we believe that FCC should examine whether cost-effective 
alternative processes exist to enhance the accuracy of its effective 
competition designations. FCC's comments are contained in appendix VI, 
along with our responses to those comments. We also provided a draft of 
this report to several industry participants and other experts for 
their review and comment. The comments we received covered a broad 
range of issues and each groups' comments are summarized in appendix 
VII.

Background:

Cable television emerged in the late 1940s to fill a need for 
television service in areas with poor over-the-air reception, such as 
mountainous or remote areas. By the late 1970s, cable operators began 
to compete more directly with free over-the-air television by providing 
new cable networks, such as HBO (introduced in 1972), Showtime 
(introduced in 1976), and ESPN (introduced in 1979). According to FCC, 
cable's penetration rate--as a percentage of television households--
increased from 14 percent in 1975 to 24 percent in 1980 and to 67 
percent today. Cable television is by far the largest segment of the 
subscription video market, a market that includes cable television, 
satellite service (including DBS operators such as DIRECTV and 
EchoStar), and other technologies that deliver video services to 
customers' homes.

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

At the community level, cable operators obtain a franchise license 
under agreed-upon terms and conditions from a franchising authority, 
such as a township or county.[Footnote 5] During cable's early years, 
franchising authorities regulated many aspects of cable television 
service, including franchise terms and conditions and subscriber rates. 
In 1984, the Congress passed the Cable Communications Policy Act, which 
imposed some limitations on franchising authorities' regulation of 
rates.[Footnote 6] However, 8 years later, in response to increasing 
rates, the Congress passed the Cable Television Consumer Protection and 
Competition Act of 1992. The 1992 Act required FCC to establish 
regulations ensuring reasonable rates for basic service--the lowest 
level of cable service, which includes the local broadcast stations--
unless a cable system has been found to be subject to effective 
competition, which the act defined.[Footnote 7] The act also gave FCC 
the authority to regulate any unreasonable rates for upper tiers (often 
referred to as expanded-basic service), which include cable programming 
provided over and above that provided on the basic tier.[Footnote 8] 
Expanded-basic service typically includes such popular cable networks 
as USA Network, ESPN, and CNN. In anticipation of growing competition 
from satellite and wire-based operators, the Telecommunications Act of 
1996 phased out all regulation of expanded-basic service rates by March 
31, 1999. However, franchising authorities can regulate the basic tier 
of cable service where there is no effective competition.

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

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

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

Today, wire-based competition--that is, competition from a provider 
using a wire technology, such as a local telephone company or an 
electric utility--is limited to very few markets, with cable 
subscribers in about 2 percent of markets having the opportunity to 
choose between two or more wire-based video operators. However, in 
those markets where this competition is present, cable rates are 
significantly lower--by about 15 percent--than cable rates in similar 
markets without wire-based competition, according to our analysis of 
rates in 2001. DBS operators have emerged as a nationwide competitor to 
cable operators. This competition has been facilitated by the 
opportunity to provide local broadcast stations. Competition from DBS 
operators has induced cable operators to lower cable rates slightly, 
and DBS provision of local broadcast channels has induced cable 
operators to improve the quality of their service.

Wire-Based Competition Is Limited but, Where Available, Has a Downward 
Impact on Cable Rates:

Although the Telecommunications Act of 1996 sought to increase wire-
based competition, few customers have a choice among companies 
providing video service via wire-based facilities. In a recent report, 
FCC noted that very few markets--about 2 percent--have been found to 
have effective competition based on the presence of a wire-based 
competitor.[Footnote 9] Our interviews with 11 cable operators and five 
financial analysis firms yielded a similar finding--wire-based 
competition is limited. Local telephone companies are not providing 
widespread competition to cable, and FCC also reported in their 2002 
video competition report that the four largest local telephone 
companies have largely exited the cable market. Also, electric and gas 
utilities--which can use their networks and rights of way to provide 
video services--are only providing competition to cable operators in 
scattered localities. Broadband service providers--a relatively new 
kind of entrant, such as Knology and WideOpenWest--are building new, 
advanced networks to provide a bundle of services (video, voice, and 
high-speed Internet access) and compete with cable operators as well as 
with telephone companies. However, the three largest broadband service 
providers only serve approximately 940,000 subscribers.

Although wire-based competition is limited, in those markets where it 
exists, this competition has a measurable impact. According to our 
cable-satellite model (see app. IV), in 2001, cable rates were 
approximately 15 percent lower in areas where a wire-based competitor 
was present.[Footnote 10] With an average monthly cable rate of 
approximately $34 that year, this implies that subscribers in areas 
with a wire-based competitor had monthly cable rates about $5 lower, on 
average, than subscribers in similar areas without a wire-based 
competitor. Our interviews with cable operators also revealed that 
these companies generally lower rates and/or improve customer service 
where a wire-based competitor is present. For example, 1 cable operator 
told us that it stopped raising rates 3 years ago in one market where a 
wire-based competitor had entered.[Footnote 11]

DBS Has Become an Important Competitor to Cable Operators Nationwide:

In recent years, DBS has become the primary competitor to cable 
operators in the subscription video industry. As of June 2002, about 18 
million households--roughly 20 percent of the total video subscribers-
-were served by DBS. Most cable operators that we interviewed described 
competition from DBS as substantial. The ability of DBS operators to 
compete against cable operators was bolstered in 1999 when they 
acquired the legal right to provide local broadcast stations--that is, 
to offer the signals of over-the-air broadcast stations, such as 
affiliates of ABC, CBS, Fox, and NBC--via satellite to their 
customers.[Footnote 12] On the basis of our cable-satellite model, we 
found that in areas where subscribers can receive local broadcast 
stations from both primary DBS operators, the DBS penetration rate--
that is, the percentage of housing units that have satellite service--
is approximately 40 percent higher than in areas where subscribers 
cannot receive these stations from the DBS operators. In a recent 
report, FCC noted that in 62 of the 210 television markets in the 
United States, at least one DBS operator offered local broadcast 
stations.[Footnote 13] Both EchoStar and DIRECTV continue to roll out 
the provision of local broadcast stations in more markets.

DBS competition is associated with a slight reduction in cable rates as 
well as improved quality and service. In terms of rates, we found that 
a 10 percent higher DBS penetration rate in a franchise area is 
associated with a slight rate reduction--about 15 cents per 
month.[Footnote 14] Also, in areas where both primary DBS operators 
provide local broadcast stations, we found that the cable operators 
offer subscribers approximately 5 percent more cable networks than 
cable operators in areas where this is not the case. These results 
indicate that cable operators are responding to DBS competition and the 
provision of local broadcast stations by lowering rates slightly and 
improving their quality. During our interviews with cable operators, 
most operators told us that they responded to DBS competition through 
one or more of the following strategies: focusing on customer service, 
providing bundles of services to subscribers, and lowering prices and 
providing discounts.

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

Responses to our cable franchise survey suggest that certain issues 
undermine the reliability of information in FCC's cable rate report, 
which provides information on cable rates and competition in the 
subscription video industry. In particular, we found that respondents 
did not fill out FCC's survey on factors underlying cable rate 
increases in a consistent manner. Additionally, FCC's designations of 
franchise areas as having (or not having) effective competition do not 
always accurately reflect current competitive conditions. For 
determinations of effective competition that are based on DBS service, 
local franchising authorities have raised concerns about the industry 
data used to substantiate these filings. Because the Congress and FCC 
use this information in their monitoring and oversight of the cable 
industry, the lack of reliable information in FCC's cable rate report 
may compromise the ability of the Congress and FCC to fulfill these 
roles. Additionally, the potential for this information to be used in 
debates on important policy decisions, such as media consolidation, 
also necessitates reliable information in FCC's report.

Weaknesses in FCC's Survey May Lead to Inaccuracies in the Relative 
Importance of Cost Factors:

Results of our cable franchise survey indicated considerable variation 
in how cable franchises completed the section of FCC's 2002 cable rate 
survey on which they provide information about the factors underlying 
recent cable rate increases. Figure 1 shows the actual section of FCC's 
survey that franchises completed to provide their cost change 
information; see also appendix II for our cable franchise survey. We 
identified two key problems with FCC's survey, as follows: a lack of 
guidance on how the survey was to be completed, and the requirement 
that the sum of the cost and noncost factors equal the change in cable 
rates.

Figure 1: Section of FCC's 2002 Cable Rate Survey Covering Cable 
Franchises' Rate and Cost Changes:

[See PDF for image]

[End of figure]

Our telephone survey with 100 cable franchises indicated that a lack of 
specific guidance regarding this cost change section of the survey 
caused considerable confusion about how to complete the form.[Footnote 
15] Every franchise that we surveyed said it was unclear what FCC 
expected for at least one of the six factors (five cost factors plus a 
noncost factor) listed in figure 1 above, and 73 of the 100 franchises 
said that the instructions were insufficient. In particular, several 
cable representatives we surveyed noted that there were no instructions 
or examples to show how to calculate investment, what types of cost 
elements should go into the "other cost" category, and what FCC meant 
by "non-cost-related factors." This lack of guidance created 
considerable variation in the approaches taken to develop the cost 
factors. For example, although 76 of the franchises left the noncost 
factors answer blank, other franchises included a number to reflect a 
change in profit margin or the need to establish uniform rates across 
franchises.

Our cable franchise survey also indicated that another source of 
confusion for respondents was the requirement that the sum of the 
underlying cost and noncost factors (see fig. 1, lines 52-57) equal the 
change in the franchise's cable rates (see fig. 1, line 51). Because 
the expanded-basic service was deregulated in 1999, it is no longer 
necessary that the cost factors equal the yearly change in cable 
rates.[Footnote 16] FCC officials told us that, cable operators could 
use the noncost factor element to adjust the sum of the factors to 
ensure that they equal the change in annual rates. That is, FCC 
officials suggested that after accounting for all cost factors, any 
difference between the sum of these costs and the rate change--whether 
positive or negative--could be accounted for by the noncost factor. 
However, it appears that this information may not have been clearly 
communicated to the cable franchises. We found that only 10 of the 100 
franchises that we surveyed took this approach and instead, most 
franchises told us that they chose to change their estimate of one or 
more of the cost factors in order to achieve the rate-cost balance. In 
most cases, cable representatives told us that this meant reducing 
other cost factors because most franchises told us that their actual 
annual cost increases for the year covered by the 2002 survey exceeded 
their rate change for expanded basic service.[Footnote 17] In fact, 
most franchises--84 of the 100 franchises we surveyed--did not provide 
a complete or accurate accounting of their cost changes for the 
year.[Footnote 18]

According to FCC's 2002 cable rate report, cable franchises attributed 
65 percent of their rate increases last year to the changes in the cost 
of new and existing programming. Comparatively, investment and other 
cost changes had a lesser role in the rate increases. However, our 
findings regarding how cable franchises responded to FCC's survey on 
these issues indicated that the survey findings may not accurately 
reflect the relative importance of these cost factors. In particular, 
we found that most franchises used real cost data to calculate the 
change in new or existing programming costs. However, franchises often 
understated their estimates for investments and other costs. For 
example, 33 of the 83 respondents who entered zero for infrastructure 
investment, noted in our survey discussions with them that there had 
been costs for such investments that year. Similarly, we found that 64 
franchises entered a zero for the other cost category, even though half 
of these respondents told us during our survey that there were costs in 
that category during that year. Moreover, the investment and other cost 
factors were often used to adjust overall costs to equal the rate 
change for the year--these adjustments most often required downward 
adjustments in these cost factors. As such, an overall accurate picture 
of the relative importance of various cost factors, which may be 
important for FCC and congressional oversight, may not be reflected in 
FCC's data.

FCC's Cable Rate Report Does Not Appear to Provide a Reliable Source of 
Information on the Effect of Competition:

FCC is required by statute to produce an annual report on the 
differences between average cable rates in areas that FCC has found to 
have effective competition compared with those that have not had such a 
finding. FCC reported that on July 1, 2001, competitive operators were 
charging an average monthly rate of $34.93, while noncompetitive 
operators were charging $37.13--a 6.3 percent differential for the 
combined basic and expanded-basic tiers of service and 
equipment.[Footnote 19] In another analysis, FCC looked at a subset of 
those areas that had been found to have effective competition--that is, 
areas in which effective competition had been granted on the basis of 
the existence of a wire-based competitor. Using a regression model, FCC 
found that cable rates were nearly 7 percent lower when such a 
competitor existed. Conversely, as previously mentioned, we found a 
greater impact of wire-based competition using a similar model, that 
is, rates were lower by 15 percent in locations where a wire-based 
competitor was operating, according to our cable-satellite model.

One possible explanation for the difference between FCC's results and 
those of our cable-satellite model may be the differences in the 
criteria used to classify the status of competition. When reporting on 
differences between average rates for locations with and without 
effective competition, FCC is mandated to include in the group defined 
to have effective competition only those franchise areas that have had 
a finding by FCC that is based on the statutory definition of effective 
competition.[Footnote 20] However, FCC's process for implementing this 
mandate may lead to situations in which the effective competition 
designation does not reflect the actual state of competition in the 
current time frame. In particular, key aspects of FCC's process are as 
follows:

* As set forth in FCC's rules, cable franchises are presumed not to 
face effective competition.

* Cable operators can petition FCC for a finding of effective 
competition, which would prohibit the franchising authority from 
regulating the rates for basic-tier service.[Footnote 21] If the cable 
franchise can show that at least one of the statutory criteria for 
effective competition is met, FCC classifies the cable franchise as 
facing effective competition.

* A franchising authority can file a petition for recertification to 
regulate rates for basic-tier service, if it believes that the 
conditions under which effective competition was granted no longer 
exist. If recertification is granted, the franchise will no longer be 
considered to have effective competition.

Our analysis of FCC's classification of cable franchises regarding 
effective competition revealed that FCC's process for maintaining this 
classification--namely, their reliance on external parties to file for 
changes in the classification--may lead to some classifications of the 
competitive status of franchises that do not reflect current 
conditions. Using data from FCC's 2002 cable rate survey, we conducted 
several tests to determine whether information contained in franchises' 
survey information--which was filed with FCC in mid-2002--was 
consistent with the classification of effective competition for the 
franchise in FCC's records. We found some discrepancies. We 
subsequently interviewed officials from local franchising authorities 
in a number of areas with seemingly inconsistent information to further 
investigate the nature of the discrepancies.

Of 86 franchises in FCC's 2002 survey classified as satisfying the low-
penetration test[Footnote 22] for effective competition, we found that 
48 franchises reported current information to FCC that indicate, on the 
basis of our calculations, the penetration rate exceeded the 30 percent 
threshold.[Footnote 23] We spoke with officials from three local 
franchising authorities in areas having a low-penetration 
classification and found the following: a Maryland franchise with a 
current penetration rate of 75 percent, a Virginia franchise with a 
penetration rate of 76 percent, and a California franchise with a 
penetration rate of 97 percent. In the aforementioned franchise areas, 
the local officials told us that they did not know why the franchise 
was classified as low penetration. However, our review of FCC filings 
found that the cable operators in those franchise areas had filed for 
and received an effective competition finding that was based on the 
low-penetration test in the years between 1994 and 1997. Because there 
had never been a petition by the franchise authority to be recertified 
to regulate basic cable rates, the franchise area remained designated 
as having low penetration.

Under the statute, local franchising authorities do not have the 
authority to regulate cable rates in franchises found to have effective 
competition. Therefore, a franchise should not simultaneously be listed 
as facing effective competition and having regulation of basic rates. 
Of 262 franchises in FCC's survey classified as facing effective 
competition, 40 also reported that the franchising authority regulated 
their basic service rates. For example, FCC survey data include one 
franchise each in three states--New Jersey, Kentucky, and California--
that were identified as facing effective competition and also as 
subject to rate regulation. Officials from the franchising authorities 
in New Jersey and Kentucky told us that they indeed regulate the basic 
service tier, and that no competitor was present. The official in 
Kentucky said that the discrepancy could be the result of a wire-based 
competitor that was granted a franchise but has yet to enter the market 
due to a lawsuit filed by the incumbent cable operator attempting to 
block the competitor's entry. The official in New Jersey said there is 
no competition in the area and the discrepancy may be attributed to the 
fact that two cable operators hold franchise agreements in the 
community, but do not compete against each other because each serves a 
different area of the community. According to an official in the 
California franchise, the franchise is not regulated--implying that the 
cable operator incorrectly answered FCC's question. However, the 
official also told us that there is no competition in the area--that 
is, while two cable operators hold franchise agreements, they do not 
compete against each other. We also found one franchise each in two 
states--Texas and Illinois--that were identified as facing effective 
competition and also reporting that they are subject to rate 
regulation. The official in the Texas franchise said that the 
discrepancy may be attributed to the fact that the incumbent cable 
operator filed for a finding of effective competition, but a finding 
has not yet been granted. According to a local franchising authority 
official in the Illinois franchise, the discrepancy could be a result 
of a wire-based competitor that expressed an interest in entering the 
market, but never did.

When the information contained in FCC's database on effective 
competition conflicts with a cable operator's response on the annual 
survey, FCC uses the information in their database for the purpose of 
its analysis of the differences in prices in areas with and without 
effective competition. We found that the survey responses on effective 
competition were not in accord with FCC's files for 24 percent of all 
franchises--or 165 franchises--in its 2002 survey.

DBS Subscriber Information Used in Effective Competition Filings Has 
Not Been Independently Validated:

In the last several years, there have been dozens of petitions for a 
determination of effective competition based on DBS competition. 
However, the data on subscriber counts by zip code, which are used to 
make these petitions, are considered proprietary business information 
by DBS companies. DBS providers EchoStar and DIRECTV, as well as big 
dish satellite provider Motorola, have agreed to make their individual 
market data available to SkyTRENDS--a market research and reporting 
firm for the satellite industry--which aggregates the information 
across the providers.[Footnote 24] SkyTRENDS subsequently makes the 
aggregated data available to cable operators for the purpose of making 
filings for effective competition to FCC. Although FCC has not verified 
the SkyTRENDS data or the method used by SkyTRENDS (and by cable 
operators) to calculate penetration levels at the franchise level, it 
nonetheless accepts SkyTRENDS data for these petitions.

The SkyTRENDS data used to make effective competition petitions that 
are based on DBS competition are generally not available to government 
regulators. According to government regulators and a SkyTRENDS 
official, SkyTRENDS will not provide local franchising authorities with 
the underlying data used to support these filings, unless (in 
accordance with agreements with the satellite providers) the cable 
operator authorizes that dissemination. However, franchising 
authorities do have access to the data provided by cable franchises in 
their submissions for effective competition to FCC. According to FCC 
officials, the agency has not obtained detailed SkyTRENDS data since 
1999. Some local franchise authorities have questioned the accuracy and 
validity of the DBS data and methods used by SkyTRENDS and cable 
operators for developing DBS penetration levels used to support 
effective competition determinations. Nevertheless, FCC has reiterated 
that it finds the SkyTRENDS data reliable for purposes of effective 
competition determinations, and that these data are the only available 
source for determining DBS penetration.

The Lack of Reliable Information May Compromise Monitoring and 
Oversight of the Cable Industry:

FCC's annual cable rate report provides an important source of 
information about the cable industry. This report provides an extensive 
analysis of the cable industry, including such important factors as 
cable rates, factors underlying changes in cable rates, and provision 
of advanced services (such as cable modem Internet access). FCC's 
findings provide the Congress with information relevant to important 
policy decisions, including the regulation of cable rates and/or 
services and media consolidation and the convergence of video, voice, 
and data services. The lack of reliable information in FCC's cable rate 
report may compromise the ability of the Congress to make these 
important policy decisions and of FCC to monitor and provide oversight 
of the cable industry. As such, it is important for FCC's report to 
provide accurate, current, and relevant information about the cable 
industry.

A Variety of Factors Contribute to Cable Rate Increases:

During the preceding 5 years, cable rates have increased approximately 
40 percent--well in excess of the approximately 12 percent increase in 
the general rate of inflation. We found that a number of factors 
contributed to the increase in cable rates. These factors include 
increased expenditures on programming, infrastructure investments, and 
costs associated with customer service. On the basis of data from 9 
cable operators, programming expenses and infrastructure investment 
appear to be the primary cost factors that have been increasing in 
recent years.

Rates for Cable Service Have Increased Rapidly, Far Outpacing the 
General Rate of Inflation:

FCC data indicate that the average monthly rate subscribers are charged 
for the combined basic and expanded-basic tiers of service rose from 
$26.06 in 1997 to $36.47 in 2002--a 40 percent increase over the 5 
years. This rate of increase is much greater than the general rate of 
inflation, as measured by the Consumer Price Index (CPI), which rose 12 
percent over the same period. The CPI cable television subcategory 
index also shows cable rates increasing much faster than inflation, 
although the rise is somewhat less than the rise in rates as reported 
by FCC, likely because the Bureau of Labor Statistics (BLS) calculates 
this index in a way that takes into account the increasing number of 
channels offered over time. As figure 2 shows, the CPI cable television 
subcategory index rose just under 30 percent in the same 5-year time 
frame.

Several cable industry officials told us that the general rate of 
inflation is not an appropriate gauge for evaluating cable rates. In 
particular, these officials told us that a more appropriate comparison 
against which to evaluate the price increases for cable television 
would be other services that have the same kind of cost factors, such 
as other forms of entertainment media and services, which have also 
experienced significant price increases in recent years. Moreover, 
several cable industry representatives told us that on a per-channel 
basis, the increase in cable rates has not been as dramatic because 
cable operators are providing additional cable networks.[Footnote 25] 
However, it is not clear how meaningful cable rates reported on a per-
channel basis are since subscribers cannot purchase cable service on a 
per-channel basis. Alternatively, in a recent analysis, a researcher 
found that because the number of hours subscribers view cable networks 
has increased, cable rates, adjusted for this additional viewing, have 
actually declined.[Footnote 26]

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

[See PDF for image]

[End of figure]

Increases in Expenditures on Cable Programming Contribute to Higher 
Cable Rates:

As discussed in the previous section, one important factor contributing 
to higher cable rates is cable operators' increased costs to purchase 
programming from cable networks. Ten of the 11 cable operators, 8 of 
the 15 cable networks, and all of the financial analysts we interviewed 
told us that higher programming costs contribute to rising cable rates. 
On the basis of financial data supplied to us by 9 cable operators, we 
found that these operators' yearly programming expenses, on a per-
subscriber basis, increased from $122 in 1999 to $180 in 2002--a 48 
percent increase. Using data from Kagan World Media, we found that the 
average fees cable operators must pay to purchase programming (referred 
to as license fees) increased by 34 percent from 1999 to 2002.[Footnote 
27] Although these estimated increases are somewhat different--which 
probably occurs because the data underlying these analyses are from 
different sources--both methods appear to reflect a substantial rise in 
programming expenses over the past few years.

Almost all of the cable operators we interviewed cited sports 
programming as a major contributor to higher programming costs. On the 
basis of our analysis of Kagan World Media data, the average license 
fees for a cable network that shows almost exclusively sports-related 
programming increased by 59 percent in the 3 years between 1999 and 
2002.[Footnote 28] Conversely, for the 72 nonsports networks, the 
average increase in license fees for the same period was approximately 
26 percent. Further, the average license fees for the sports networks 
were substantially higher than the average for other networks. See 
figure 3 for a comparison of the average license fees for sports 
programming networks compared with nonsports networks from 1999 to 
2002.

Figure 3: Average Monthly License Fees per Subscriber--Sports 
Programming Networks v. Nonsports Networks, 1999 - 2002:

[See PDF for image]

[End of figure]

The cable network executives we interviewed cited several reasons for 
increasing programming costs. We were told that competition among 
networks to produce and show content that will attract viewers has 
become more intense. This competition, we were told, has bid up the 
cost of key inputs (such as talented writers and producers) and has 
sparked more investment in programming. Most notably, these executives 
told us that networks today are increasing the amount of original 
content and improving the quality of programming generally. Also, some 
executives cited the increased cost of sports rights[Footnote 29] and 
increased competition among networks for the broadcast rights of 
existing programming (such as syndicated situation comedies). As figure 
4 shows, data from Kagan World Media indicate that of 79 cable networks 
we analyzed, expenditures by these networks to produce programming 
increased from $6.47 billion in 1999 to $8.90 billion in 2002, or by 
about 38 percent.[Footnote 30]

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

[See PDF for image]

[End of figure]

Although programming is a major expense for cable operators, several 
cable network executives we interviewed also pointed out that cable 
operators offset some of the cost of programming through advertising 
revenues. In fact, 3 cable networks with whom we spoke said that they 
believe at least half of the license fees cable operators pay to carry 
their networks are recouped through the sale of the local advertising 
time that cable networks allow the cable operators to sell, which 
typically amounts to 2 minutes per hour. According to industry data, 
cable operators received over $3 billion from the sale of local 
advertising time in recent years. Local advertising dollars account for 
about 7 percent of the total revenues in the 1999 to 2002 time frame 
for the 9 cable operators that supplied us with financial data. For 
these 9 cable operators, gross local advertising revenues--before 
adjusting for the cost of inserting and selling advertising--amounted 
to about $55 per subscriber in 2002 and offset approximately 31 percent 
of their total programming expenses.[Footnote 31] However, we were told 
that only the larger cable operators gain significant revenues from the 
sale of advertising, and that smaller cable operators generally do not 
sell as much local advertising because it is not always cost-effective 
for them to do so. In fact, even the larger cable operators do not sell 
all of the local advertising time that is available to them because 
there are significant costs of selling television ads.

Several Other Factors Appear to Contribute to Higher Rates for Cable 
Service:

In addition to higher programming costs, the cable industry has 
incurred other increased costs. For example, according to industry 
sources, the cable industry spent over $75 billion between 1996 and 
2002 to upgrade its infrastructure by replacing degraded coaxial cable 
with fiber optics and adding digital capabilities (see fig. 5). As a 
result of these expenditures, FCC reported that there have been 
increases in channel capacity; the deployment of digital transmissions; 
and nonvideo services, such as Internet access and telephone 
service.[Footnote 32] Five of the 11 cable operators, 9 of the 15 cable 
networks, and three of the five financial analysts we interviewed said 
investments in system upgrades contributed to increases in consumer 
cable rates. For example, one network with whom we spoke said that the 
major cause of recent cable rate increases is the cable industry's 
capital improvements. Although these upgrades benefit cable subscribers 
by expanding the number of cable networks available and improving 
picture quality, much of the benefit of infrastructure improvements 
accrue to subscribers who purchase new, advanced services, such as 
broadband Internet access. One expert who commented on our report noted 
that there is no need for cable operators to pass on costs associated 
with infrastructure upgrades to subscribers purchasing basic and 
expanded-basic service because, by his calculations, these costs are 
almost fully offset by increases in revenues for digital tier and 
advanced (e.g., cable modem) services.

Figure 5: Cable Industry Infrastructure Expenditures, 1996 - 2002:

[See PDF for image]

[End of figure]

Another factor contributing to higher cable rates is cable operators' 
increased expenditures on customer service. NCTA said that the industry 
is paying more in labor costs because it has sought better-educated and 
more highly trained employees to provide customer support for the new 
services that the cable operators are offering. Additionally, customer 
service is now typically available to cable subscribers 24 hours a day, 
7 days a week. Three of the five financial analysts we interviewed 
agreed that increased customer service costs contributed to increases 
in cable rates, while 5 of the 11 cable operators we interviewed said 
increases in customer service, labor costs, or both contributed to 
higher cable rates.

Programming Expenses and Infrastructure Investment Appear to Be Primary 
Contributors to Cable Rate Increases:

On the basis of financial data from 9 cable operators, we found that 
annual subscriber video-based revenues--that is, revenues from basic, 
expanded-basic, and digital tiers; pay-per-view; installation charges; 
and other revenues such as equipment rental--increased approximately 
$79 per subscriber from 1999 to 2002. By 2002, revenues per subscriber 
averaged $561, or $47 per month. During this same period, programming 
expenses increased approximately $57 per subscriber. Depreciation 
expenses on cable-based property, plant, and equipment--an indicator of 
expenses related to infrastructure investment--increased approximately 
$80 per subscriber during the same period. Although this may indicate 
that the marginal profits for the video business have been declining--
which is consistent with what we were told during our interviews with 
financial analysts--there are two important caveats to this conclusion. 
First, depreciation expenses (and therefore infrastructure investment) 
represent a joint (or common) expense for both video-based and 
Internet-based services. Because these expenses are associated with 
more than one service, it is unclear how much of this cost should be 
attributed to video-based services. Second, cable operators are 
enjoying increased revenues from these nonvideo sources. For example, 
revenues from Internet-based services increased approximately $74 per 
subscriber during the same period. Thus, even if video profit margins 
have been in decline, this does not imply that overall profitability of 
cable operators has declined.

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

Several industry representatives and experts we interviewed told us 
that they believe ownership affiliation may also influence the cost of 
programming and thus, indirectly, the rates for cable service. We found 
that there are two primary ownership relationships that some believe 
influence the cost of cable programming: relationships between cable 
networks and cable operators, and relationships between cable networks 
and broadcasters. To understand the nature of these ownership 
relationships, we analyzed the ownership of 90 cable networks that are 
carried most frequently on cable operators' basic or expanded-basic 
tier (see fig. 6). Of these 90 cable networks, we found that 
approximately 19 percent were majority-owned (i.e., at least 50 percent 
owned) by a cable operator.[Footnote 33] For example, cable operators 
have ownership interests of at least 50 percent in such widely 
distributed cable networks as TBS, TNT, CNN, AMC, and the Cartoon 
Network.[Footnote 34] We also found that approximately 43 percent of 
the 90 networks were majority-owned by a broadcaster. For example, 
broadcasters have ownership interests of at least 50 percent in such 
widely distributed cable networks as ESPN, FX, MSNBC, and MTV. The 
remaining 38 percent of the networks are not majority-owned by 
broadcasters or cable operators.

Figure 6: Ownership Affiliation of the 90 Most Carried Cable Networks:

[See PDF for image]

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

[End of figure]

Despite the view held by some industry representatives with whom we 
spoke that license fees for cable networks owned by either cable 
operators or broadcasters tend to be higher than fees for other cable 
networks, we did not find this to be the case. In particular, we found 
that cable networks that have an ownership affiliation with a 
broadcaster did not have, on average, higher license fees (i.e., the 
fee the cable operator pays to the cable network) than cable networks 
that were not majority-owned by broadcasters or cable 
operators.[Footnote 35] We did find that license fees were 
statistically higher for cable networks owned by cable operators than 
was the case for cable networks that were not majority-owned by 
broadcasters or cable operators. However, when using a regression 
analysis (our cable license fee model) to hold constant other factors 
that could influence the level of the license fee, we found that 
ownership affiliations--with broadcasters or with cable operators--had 
no influence on cable networks' license fees.[Footnote 36] We did find 
that networks with higher advertising revenues per subscriber (a proxy 
for popularity) and sports networks received higher license fees.

Industry representatives we interviewed also told us that cable 
networks owned by cable operators or broadcasters are more likely to be 
carried by cable operators than other cable networks. There was a 
particular concern expressed to us regarding retransmission consent 
agreements. These agreements often include, as part of the agreement 
between cable operators and broadcasters for the right of the cable 
operator to carry the broadcast station, a simultaneous agreement to 
carry one or more broadcast-owned cable networks. Many representatives 
from cable operators and several independent (nonbroadcast) cable 
networks told us that because the terms of retransmission consent 
agreements often include carriage of broadcast-owned cable networks, 
cable operators sometimes carry networks they might otherwise not have 
carried, and this practice can make it difficult for independent cable 
networks to be carried by cable operators. Alternatively, 
representatives of the broadcast networks told us that, to their 
knowledge, cable networks had not been dropped nor were independent 
cable networks unable to be carried by cable operators because of 
retransmission consent agreements. Further, these representatives told 
us that they accept cash payment for carriage of the broadcast station, 
but that cable operators prefer to carry broadcast-owned cable networks 
in lieu of a cash payment.

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

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

Most cable operators with whom we spoke provide subscribers with 
similar tiers of networks, typically the basic and expanded-basic 
tiers, which provide subscribers with little choice regarding the 
specific networks they purchase. Adopting an  la carte approach, where 
subscribers could choose to pay for only those networks they desire, 
would provide consumers with more individual choice, but could require 
additional technology and impose additional costs on both cable 
operators and subscribers. Additionally, this approach could alter the 
current business model of the cable network industry wherein cable 
networks obtain roughly half of their overall revenues from 
advertising. A move to an  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  la carte service, 
consumers' purchasing patterns, and whether certain niche networks 
would cease to exist with  la carte service--make it difficult to 
ascertain how many consumers would be better off and how many would be 
made worse off under an  la carte approach. Creating a greater number 
of smaller tiers could cause many of the same technological and 
economic concerns as an  la carte approach.

Most Cable Operators Offer Similar Bundles of Networks:

The 11 cable operators that we interviewed adopt very similar 
strategies for bundling networks into tiers of service. These cable 
operators offer their subscribers the following tiers of service: basic 
tier (11 operators), expanded-basic tier (11 operators), digital tier 
(11 operators), and premium services (7 operators). Five of the 11 
cable operators offer the same or similar tiers of service to 
subscribers in all their franchise areas. The remaining 6 cable 
operators offer different tiers of service among their franchise areas; 
we were told that these differences are generally the result of the 
cable operators acquiring franchises with different tiering strategies.

Using data from FCC's 2002 cable rate survey, we also examined the 
networks included in the basic, expanded-basic, and digital tiers of 
service. With basic tier service, subscribers receive, on average, 
approximately 25 channels, which include the local broadcast 
stations.[Footnote 37] The expanded-basic tier provides, on average, an 
additional 36 channels. With a digital tier, subscribers receive, on 
average, 104 channels. In general, to have access to the most widely 
distributed cable networks--such as ESPN, TNT, and CNN--most 
subscribers must purchase the expanded-basic tier of service.

Concerns Exist about a Lack of Subscriber Choice:

The manner in which cable networks are currently packaged has raised 
concern among policy makers and consumer advocates about the lack of 
consumer choice in selecting the programming they receive. Under the 
current approach, it is likely that many subscribers are receiving 
cable networks that they do not watch. In fact, a 2000 Nielsen Media 
Research Report indicated that households receiving more than 70 
networks only watch, on average, about 17 of these networks. The 
current approach has sparked calls for more flexibility in the manner 
that subscribers receive cable service, including the option of  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  la carte approach because they believe it will 
mitigate the ability of broadcast networks to gain carriage agreements 
for their cable networks through the retransmission consent 
process.[Footnote 38]

An  La Carte Network Offering Could Impose Costs on Cable Subscribers 
and Operators:

If cable operators were to offer all networks on an  la carte basis--
that is, if consumers could select the individual networks they wish to 
purchase--additional technology upgrades would be necessary in the near 
term. In particular, subscribers would need to have an addressable 
converter box on every television set attached to the cable system. 
Today, the networks included on the basic and expanded-basic tiers are 
usually transmitted throughout the cable system in an unscrambled 
fashion. Because most televisions in operation today are cable ready, a 
cable wire can usually be connected directly into the television and 
the subscriber can view all of the networks on those tiers. An 
addressable converter box--which serves to unscramble any scrambled 
networks--is only needed if the subscriber chooses to purchase networks 
that the cable operator transmits in a scrambled fashion, as is usually 
the case for networks placed on digital tiers, certain premium movie 
channels, and pay-per-view channels.[Footnote 39]

If all networks were offered on an  la carte basis, cable operators 
would need to scramble all of the networks they transmit to ensure that 
subscribers are unable to view networks they are not paying to receive. 
Under such a scenario, addressable converter boxes, which enable the 
operator to send messages from the cable facility to the box to 
indicate which networks the subscriber is purchasing and thus allowed 
to watch, would need to be connected to all television sets attached to 
the cable system. The addressable converter box would unscramble the 
signals of the networks that the subscriber has agreed to purchase. The 
need for an addressable converter box deployment could be costly. 
According to FCC's 2002 survey data, of the franchises that responded 
to the survey and provided cost data on addressable converter boxes, 
the average monthly rental price for a box is approximately $4.39. For 
homes that have multiple television sets, the expense for these boxes 
could add up--the extra cost for a home that needs to add three 
addressable converter boxes would be about $13.17 a month at current 
prices.

Although cable operators have been placing addressable converter boxes 
in the homes of customers who subscribe to scrambled networks, many 
homes do not currently have addressable converter boxes or do not have 
them on all of the television sets attached to the cable system. For 
example, a representative of 1 cable operator we interviewed indicated 
that most of its subscribers do not have addressable converter boxes. A 
representative of another cable operator stated that only 40 percent of 
its subscribers have addressable converter boxes. Conversely, 1 
operator told us that nearly three out of four of its subscribers do 
have at least one addressable converter box in place, and that the 
number of homes with a box will only continue to increase. Addressable 
converter boxes are becoming more commonly deployed as more customers 
subscribe to digital tiers. Since cable operators may move toward 
having a greater portion of their networks provided on a digital tier 
in the future, these boxes will need to be deployed in greater numbers. 
Moreover, consumer electronic manufacturers have recently submitted 
plans to FCC regarding specifications for new television sets that will 
effectively have the functionality of an addressable box within the 
television set. Once most customers have addressable converter boxes or 
these new televisions in place, the technical difficulties of an  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  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  la carte regime. One cable network 
representative we interviewed indicated that an  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  la carte programming could have its subscribers choosing 
all different numbers of networks, which would mean that subscribers 
would be spending much longer periods of times on the telephone with 
customer service staff.

Cable Networks Often Specify Placement on the Basic or Expanded-Basic 
Tier:

Even if cable operators desired to offer customers a wider variety of 
bundles of services or even  la carte service, most contracts 
negotiated between cable networks and cable operators prohibit these 
alternatives. All 11 cable operators and four of five financial 
analysts that we interviewed told us that program contracts generally 
specify the tier that the network must appear on, or the contract 
establishes a threshold percentage of subscribers that must be able to 
see a network--which effectively requires the same tier placements. For 
example, one individual responsible for negotiating program contracts 
for cable operators noted that all of the top 40 to 50 networks specify 
that their networks appear on either the basic or expanded-basic tier. 
We also reviewed sample contracts for 2 cable networks, one contract 
specified that the network appear on the basic or expanded-basic tier 
and the other contract specified "the most widely subscribed level of 
service." We were told that cable networks include these provisions in 
their contracts because their business models are developed on the 
basis of a wide distribution of their network.

Economic Characteristics of the Cable Network Market Are a Constraint 
to an  La Carte Approach:

If cable subscribers were allowed to choose networks on an  la carte 
basis, the economics of the cable network industry could be altered, 
and, if this were to occur, it is possible that cable rates could 
actually increase for some consumers. In particular, we found that 
cable networks earn much of their revenue from the sale of advertising 
that airs during their programming. For example, 3 of the 15 cable 
network representatives we interviewed indicated that they receive 
approximately 60 percent of their revenue from advertising. Our 
analysis of information on 79 networks from Kagan World Media indicates 
that these cable networks received nearly half of their revenue from 
advertising in 2002. The majority of the remaining revenue is derived 
from the license fees that cable operators pay to networks for the 
right to carry their signals. Figure 7 provides a breakdown of the 
relationship in recent years between advertising revenues and license 
fee revenues on the basis of data from Kagan.

Figure 7: Percentage of Cable Network Advertising Revenue Compared with 
License Fee Revenues for 79 Cable Networks, 1999 - 2002:

[See PDF for image]

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

[End of figure]

To receive the maximum revenue possible from advertisers, cable 
networks strive to be on cable operators' most widely distributed 
tiers. In other words, advertisers will pay more to place an 
advertisement on a network that will be viewed, or have the potential 
to be viewed, by the greatest number of people. According to cable 
network representatives we interviewed, any movement of networks from 
the most widely distributed tiers to an  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  la carte system, the cost burden of cable television would 
become less reliant on advertising revenues and much more reliant on 
license fees that would likely be passed on to consumers. For example, 
one cable network representative estimated that to compensate for the 
loss of advertising revenue in an  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  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  la carte 
system. The cable networks that we interviewed generally told us that 
they believe that an  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  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  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  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  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  la carte 
system. A number of the cable networks indicated that launching a new 
network under an  la carte system would be very difficult. Similarly, 
according to NCTA, an  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  la carte system resulted 
in limited subscribers and decreased advertising revenue, several 
networks said the quality of programming available might be adversely 
impacted.

The manner in which an  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  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  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  la carte approach. These factors 
include how cable operators would price their services under an  la 
carte system; the distribution of consumers' purchasing patterns; 
whether niche networks would cease to exist, and, if so, how many would 
exit the industry; and consumers' true valuation of networks they 
typically do not watch.

Creating Additional Tiers of Service Is More Feasible, but Economic and 
Technological Constraints Would Also Apply:

Another alternative to the  la carte approach that has been discussed 
is a move to minitiers, under which subscribers would choose small 
tiers of programming that are grouped by genre (such as sports, news 
and information, and general entertainment). Although industry 
representatives told us that this approach might be more viable than an 
 la carte approach, we were also told that all of the issues 
associated with an  la carte regime would also apply to minitiers. 
Representatives of 8 of the 15 cable networks we interviewed indicated 
that the creation of additional tiers would be a disadvantage to the 
cable industry. Four cable network representatives stated that 
increasing the number of tiers would result in the same outcome as an  
la carte system: a decline in cable network advertising revenue that 
would force networks to increase their license fees to cable operators, 
which would result in higher cable rates. Six of the 11 cable operators 
we interviewed also noted that a minitier approach would also require 
more deployment of addressable converter boxes. Finally, a 
representative of 1 cable operator told us that after experimenting 
with genre tiers in the past, the operator determined that this was not 
a successful strategy. This representative stated that subscribers felt 
the cable operator was forcing them to buy many tiers, since a typical 
household wanted to see one or more networks in several of the tiers.

However, officials representing 5 of the 11 cable operators we 
interviewed indicated that the tier concept might be viable in the case 
of sports programming. A representative of 1 cable operator indicated 
that a sports tier would be appropriate because sport fans are loyal 
customers and the cost of sports programming is very high. A 
representative of another cable operator noted that creating a sports 
tier should be an option, but that other types of programming would not 
work on separate tiers. Recently, several regional sports networks have 
been placed on sports-only tiers in the New York City metropolitan 
area.[Footnote 40]

Alternatively, representatives from two major sports leagues and a 
sports network do not believe that a sports-only tier is necessary, and 
some of these representatives did not believe such a tier would be 
viable. One important objective of the major sports leagues is to 
obtain the widest distribution of their games as possible. Therefore, 
many games appear either on broadcast television or on cable networks 
carried on the basic or expanded-basic tier. To ensure this wide 
distribution of their games, the major sports leagues include 
provisions in their contracts with cable networks that specify carriage 
of their games on a tier with broad distribution. A representative of a 
sports network said that if their network were offered on a sports-only 
tier, the nature of the network would change. In fact, representatives 
of the three leagues with whom we spoke said that if sports networks 
were on a sports-only tier, the leagues would not want to sell the 
right to carry certain events on those networks since it would likely 
not be available to most viewers.[Footnote 41] One of these three 
representatives said that under this scenario, sports-only networks 
might cease to exist and any sports on cable would only be placed on 
general entertainment networks that provide variety programming--
similar to broadcast networks. Finally, representatives from two of the 
sports leagues and a sports network said that there is no reason to 
believe that removing the sports networks from the expanded-basic tier 
would result in any substantial reduction in the rate for expanded-
basic tier cable service. When two cable operators in the New York City 
metropolitan area moved regional sports networks to a separate tier, 
these companies lowered the expanded-basic cable rate by only 50 cents 
to a dollar.[Footnote 42]

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

In recent years, there has been concern about the rapidity of cable 
rate increases. As we previously noted, cable rates have risen by about 
40 percent in the last 5 years, far outstripping increases in the 
general rate of inflation. Several approaches for addressing the rise 
in cable rates have been put forth. These approaches can be grouped 
into the following two main categories: (1) the control of rates 
through regulation and (2) the promotion of lower rates through market 
mechanisms, such as through greater competition.

Some consumer groups have pointed to the lack of competition as 
evidence that reregulation needs to be considered. One representative 
of a consumer group noted that regulation might be the only alternative 
to mitigate increasing cable rates and cable operators' market power. 
For example, one consumer group has recommended, among a variety of 
options, returning authority to reregulate cable rates to local and 
state governments. However, some experts expressed concerns about cable 
regulation after the 1992 Act. First, some academic critics believe 
that cable regulation lowered the quality of programming, discouraged 
investment in new facilities, and imposed administrative burdens on the 
industry and regulators. Second, according to these same critics, there 
is no strong evidence that cable rates were significantly constrained 
during that regulated era. Finally, regulation today could be 
considerably more complex than it was 11 years ago. Today, video 
providers use varied platforms (cable, DBS) to provide an array of 
communication services, including video service, Internet access, and 
video on demand. A regulatory scheme would need to consider which 
services and providers to regulate, and how to allocate the common 
costs of a communications network in a regulatory context across the 
various services provided.

Alternatively, taking steps to promote competition could help to reduce 
or slow the growth of cable rates by leveraging the normal workings of 
the marketplace. In those few local markets where a second wire-based 
provider exists, we found that cable rates are about 15 percent lower 
than local markets without this competition. Moreover, even though the 
influence of DBS on cable rates is minor, our current finding--in 
contrast to our earlier study and earlier studies by FCC that did not 
find such an effect--is that the presence of DBS does help to lower 
cable rates slightly. This may indicate that as more households 
subscribe to DBS service, cable operators will ultimately respond by 
reducing rates. Below, we discuss options that have been suggested for 
addressing the cable rate issue. We note that in this overview, we are 
neither making any specific recommendations regarding the adoption of 
any of these options, nor suggesting that this list is a necessarily 
comprehensive review of possible options.

Program access issues. The 1992 Act includes provisions aimed at, among 
other things, enhancing competition in the subscription video industry. 
As required by the act, FCC developed rules--commonly referred to as 
the program access rules--which were designed in part to ensure that 
cable networks that have ownership relationships with cable operators 
(i.e., vertically integrated cable operators) generally make their 
satellite-delivered programming available to competitors. Since 1992, 
some entering companies and consumer groups have stated that current 
program access rules are not broad enough to provide assurances that 
entrants can obtain necessary programming. In particular:

* Some have expressed concern that the law is too narrow because it 
applies only to the satellite-delivered programming of vertically 
integrated cable operators. In recent years, some regional cable 
networks owned by cable operators have been delivered to their cable 
facilities through wires--that is, they are not satellite delivered. 
When this is the case, the cable operator need not make the programming 
available to competitors. Additionally, although it is not clear how 
widespread this practice is in local markets across the country, a 
recent report by a consumer group raised concerns that it could become 
more prominent at a national level.[Footnote 43] Although questions 
have been raised about this issue--which has come to be called the 
terrestrial loophole--FCC has pointed out that the statue is specific 
in that the program access rules apply only to satellite-delivered 
programming.

* Although the program access rules generally prohibit exclusive 
contracts for programming of vertically integrated cable operators, 
these rules do not prohibit exclusive contracts between a cable 
operator and an independent cable network.[Footnote 44] Some operators 
entering the market believe that some programming may not be available 
to them because large incumbent cable operators have secured such 
exclusive arrangements.

Given these concerns, some have suggested that changes in the statutory 
program access provisions might enhance the ability of other providers 
to compete with the incumbent cable operators. However, others have 
noted that altering these provisions could reduce the incentive for 
companies to develop innovative programming. That is, we were told that 
companies may have less incentive to invest in certain new programming 
if they are not able to market that programming through their own 
distribution channels on an exclusive basis.[Footnote 45]

Promoting wireless competition. The medium used to provide video 
services over wireless platforms--radio spectrum--is a scarce and 
congested resource. DBS operators have stated that they are currently 
not able to provide local broadcast stations in all 210 television 
markets in the United States because they do not have adequate spectrum 
to do so while still providing a wide variety of national 
networks.[Footnote 46] DBS companies gained the right to provide these 
local stations in 1999, and this has been important in enabling them to 
compete more effectively with locally based cable operators. However, 
as part of the so-called carry one, carry all provisions, these 
companies are required to provide all local broadcast stations in 
markets where they provide any of those stations. According to 
executives at the two primary DBS companies, if DBS companies only 
provided the local stations that they view as desired by their 
subscribers, they might more quickly provide local broadcast stations 
in more markets, thereby rendering DBS a more effective competitor to 
cable. However, any modifications to the DBS carry one, carry all rules 
would need to be examined in the context of why those rules were put 
into place--that is, to ensure that all broadcast stations are 
available in markets where DBS providers choose to provide local 
stations. In fact, a U.S. Court of Appeals found that certain 
government interests promoted by the carry one, carry all provisions 
applicable to DBS providers are sufficient to justify this requirement 
under a First Amendment analysis.[Footnote 47] Additionally, any review 
of these rules would need to take into account how they relate to other 
similar requirements, including, for example, must-carry requirements 
for the cable industry as well as how must carry will be applied to 
cable and DBS in the coming digital age. As with many complex policy 
issues, balancing what are often conflicting considerations is very 
complex.

Retransmission consent issues. In the 1992 Act, the Congress created a 
mechanism, known as retransmission consent, through which local 
broadcast station owners (such as local ABC, CBS, Fox, and NBC 
stations) could receive compensation from cable operators in return for 
the right to carry their broadcast stations. Prior to the 1992 Act, 
cable operators could retransmit local broadcast stations without 
approval of the broadcasters and without compensation. As cable 
operators began to carry more cable networks that competed with 
broadcast networks for viewers and associated advertising revenues, 
broadcasters argued that it was important for them to be able to 
receive compensation for retransmission of their stations. The 
retransmission consent provisions included in the 1992 Act allow local 
broadcast stations and cable operators to negotiate for payment or some 
other form of compensation in exchange for the cable operator's right 
to carry broadcast networks.[Footnote 48]

Today, few retransmission consent agreements include cash payment for 
carriage of the local broadcast station; rather, agreements between 
some large broadcast groups and cable operators generally include 
provisions for carriage of broadcaster-owned cable networks. We were 
told that, after the passage of the 1992 Act, the cable industry 
indicated its reluctance to pay for carriage of local broadcast 
stations--which they had previously been carrying free of charge. The 
negotiations for retransmission consent at that time quickly turned to 
examining carriage of broadcaster-owned cable networks as compensation 
for the right to carry the local broadcast station. Both the Congress 
and FCC had indicated that carriage of broadcast-owned cable networks 
would be a possible way for broadcasters to receive compensation for 
carriage of broadcasters' over-the-air stations. A variety of parties 
with whom we spoke mentioned specific broadcast-owned cable networks 
(such as ESPN2 and MSNBC) that were launched as part of retransmission 
consent agreements during the 1990s.

One concern that was expressed to us regarding retransmission consent 
relates to its influence on the carriage decisions of cable operators. 
In particular, many representatives from cable operators and several 
independent (nonbroadcast) cable networks told us that because the 
terms of retransmission agreements often include the carriage of 
broadcast-owned cable networks, cable operators sometimes carry 
networks they otherwise might not have carried. Several of the cable 
networks we spoke with noted that this practice can make it difficult 
for independent cable networks to gain carriage, particularly in the 
case of new networks. Alternatively, representatives of the broadcast 
networks told us that they did not believe that cable networks had been 
dropped or that independent cable networks could not gain carriage 
because of retransmission consent agreements. Further, these 
representatives told us that they accept cash payment for carriage of 
the broadcast signal, but that cable operators tend to prefer carriage 
options in lieu of a cash payment. Broadcast executives also told us 
that the retransmission process has been very important in preserving 
free over-the-air television.

Several of the industry representatives with whom we met also expressed 
concern that ownership relationships between broadcast networks and 
cable networks could lead to higher cable rates for consumers. Although 
we did not find that license fees are higher when such an ownership 
relationship exists, we did find that cable networks owned by broadcast 
networks are more likely to be carried on cable systems than networks 
not owned by broadcasters or by cable operators.[Footnote 49] (See app. 
V for a discussion of our carriage model). As such, the influence of 
retransmission consent on consumer rates is not clear, since these 
rates could be affected by the carriage patterns.

Certain parties with whom we met advocated the removal of the 
retransmission consent provisions and told us that this may have the 
effect of lowering cable rates.[Footnote 50] However, other parties 
have stated that such provisions serve to enable television stations to 
obtain a fair return for the retransmitted content they provide--which 
they believe was not the case prior to 1992. Moreover, these industry 
representatives noted that retransmission rules help to ensure the 
continued availability of free television for all Americans. Currently, 
there is a petition pending before FCC that asks for a review of the 
impact of retransmission consent.

Conclusions:

In the last decade, the subscription video industry has undergone 
dramatic changes. The regulatory and competitive environments have both 
evolved; cable rates have been regulated and later partially 
deregulated; and limited wire-based competition has been supplanted by 
nationwide competition from satellite-based companies. It appears that 
this evolution has created problems for FCC's monitoring and reporting 
on the industry. As mandated by the Congress, FCC prepares a yearly 
report on cable rates in the United States. But, aspects of how 
information for the report is collected--such as the cost factors 
underlying cable rate increases--are closely associated with the 
earlier, regulated era of the cable industry. For example, information 
on cost changes underlying cable rate increases are reported to FCC on 
a survey form that requires the cost factors and rate changes to 
balance. Because rates and costs need not balance in an unregulated 
environment, cable franchise representatives filing out the form made 
accommodations in their answers that may have compromised the accuracy 
of the cost data they were reporting. Similarly, maintaining current 
information on the effective competition status of cable operators 
under FCC's current process has proven difficult. Some expected 
competitors have emerged but did not fully deploy their networks and, 
in some cases, discontinued service altogether, and DBS companies--
which were not yet providing service in 1992--have thrived, but 
information on their market participation is not readily available on a 
local level. We found that because FCC's current process does not 
provide for updates to the status of effective competition, some 
designations do not appear to reflect current competitive conditions.

In the face of the rapid evolution of the subscription video industry, 
it remains important for accurate, current, and relevant information to 
be available to the Congress and FCC. Both the Congress and FCC monitor 
and provide oversight of this industry, for which FCC's report can 
serve as an important input. Additionally, FCC's report can provide 
information relevant to the Congress, as it considers important policy 
decisions, including the regulation of cable rates and/or services, 
media consolidation, and the convergence of video, voice, and data 
services. Lacking reliable information, the Congress and FCC face the 
challenge of performing monitoring and oversight, as well as making 
important policy decisions, without the benefit of important price, 
cost, and competition information. As such, it is important for FCC's 
report to provide accurate, current, and relevant information about the 
cable industry.

Recommendations for Executive Action:

To improve the quality and usefulness of the data that FCC collects on 
cable television rates and competition in the subscription video 
industry, we recommend that the Chairman of the FCC take the following 
actions:

* take immediate steps to improve the cable rates survey by (1) 
including more detailed, standardized instructions and examples for how 
to calculate the cost changes that the cable operators experienced in 
the previous year and (2) eliminating the requirement for the cost 
increases to sum to the change in rates and:

* review the commission's process for maintaining the status of 
effective competition among franchises in order to keep these 
designations more up to date.

Agency Comments and Our Evaluation:

We provided a draft of this report to FCC for comment. FCC had two key 
comments on the draft report. First, FCC stated that they are taking 
steps to redesign their survey questionnaire in an attempt to obtain 
more accurate information. Second, FCC questioned on a cost/benefit 
basis the utility of adopting a revised process to keep the status of 
effective competition in franchises up to date. We believe that 
providing the Congress with reliable information on cable rates and 
competition is important, and that improving the accuracy of effective 
competition designations would help to accomplish this. We recognize 
that there are costs associated with FCC's cable price survey, and we 
recommend that FCC examine whether cost-effective alternative processes 
exist that would enhance the accuracy of its effective competition 
designations. FCC's comments are contained in appendix VI, along with 
our responses to those comments.

We also provided a draft of this report to several industry 
participants and other experts for their review and comment. In 
particular, we provided the draft to representatives of Consumers 
Union, the Consumer Federation of America, the American Cable 
Association, the National Association of Telecommunications Officers 
and Advisors, the National Association of Broadcasters, the National 
Cable and Telecommunications Association, the Satellite Broadcasting 
and Communications Association, Walt Disney Company, the National 
Broadcasting Company, Viacom, and the News Corporation. The comments 
received covered a broad range of issues and each groups' comments are 
summarized in appendix VII. In addition, these groups provided 
clarifications to the draft report. As appropriate, we made changes in 
our report that are based on the broad comments summarized in appendix 
VII as well as the technical clarification provided to us by these 
parties.

As agreed with your office, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 30 days 
after the date of this letter. At that time, we will send copies to 
interested congressional committees; the Chairman, FCC; and other 
interested parties. We will also make copies available to others upon 
request. In addition, this report will be available at no cost on the 
GAO Web site at http://www.gao.gov.

If you or your staff have any questions concerning this report, please 
contact me on (202) 512-6670 or at goldsteinm@gao.gov. Key contacts and 
major contributors to this report are listed in appendix VIII.

Sincerely yours,

Mark L. Goldstein: 

Director, Physical Infrastructure Issues:

Signed by Mark L. Goldstein: 

[End of section]

Appendix I: Scope and Methodology:

To respond to the first objective of this report--examine the impact of 
competition on cable rates--we used an empirical model (our cable-
satellite model) that we previously developed that examines the effect 
of competition on cable rates and services.[Footnote 51] Using data 
from the Federal Communications Commission's (FCC) 2001 cable rate 
survey, the model considers the effect of various factors on cable 
rates, the number of cable subscribers, the number of channels that 
cable operators provide to subscribers, and direct broadcast satellite 
(DBS) penetration rates for areas throughout the United States. We 
further developed the model to more explicitly examine whether varied 
forms of competition--such as wire-based, DBS, multipoint multichannel 
distribution systems (MMDS) competition--have differential effects on 
cable rates. See appendix IV for a further discussion of this model. In 
addition, we spoke with an array of industry stakeholders and experts 
(see below) to gain further insights on these issues.

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

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

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

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

* We solicited the 11 cable operators we interviewed to gather 
financial and operating data and reviewed relevant Securities and 
Exchange Commission filings for these operators. Nine of the 11 cable 
operators provided the financial and operating data we sought. We also 
acquired data from Kagan World Media,[Footnote 52] which is a private 
communications research firm that specializes in the cable industry. 
These data provided us with revenue and programming expenses for over 
75 cable networks.[Footnote 53]

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

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

[End of section]

Appendix II GAO Survey of Cable Franchises:

[See PDF for image]

[End of section]

Appendix III: GAO's Modifications to FCC's Competition Classification:

To determine the status of competition from a wire-based competitor for 
our cable-satellite model, we took steps to review the accuracy of 
FCC's classification of effective competition for the cable franchises 
surveyed in 2001--the year of data used in our model. For those cases 
in which a finding of effective competition had been made because of 
the presence of a local exchange carrier (LEC) or a competitive 
overbuilder, we took steps to determine if that competition was still 
present as of 2001. For cases without a designation of effective 
competition, we checked to see if there was a possible LEC or 
overbuilder operating in the areas. This process was only designed to 
check the status of competition other than that provided by DBS. This 
is because we did not rely on FCC's competitive classifications related 
to DBS because information on DBS for our model was obtained from a 
different source, and we did not use FCC's classification at all in 
that case.

Our sample contained 705 cable franchises, of which 133 had been found 
to face effective competition from a LEC or overbuilder, and 572 had 
not. In most cases in which a finding of effective competition had been 
made (95 of the 133), we found evidence that, in fact, a nonsatellite 
provider was competing with the incumbent cable provider. In the other 
38 cases, we found evidence suggesting that a nonsatellite provider was 
not present in 2001.[Footnote 54] To make these determinations, we used 
various sources of information, including FCC's master list of cable 
franchises. We noted that if there were competitive cable franchises, 
we would expect to find two franchises operated by different companies 
in the same geographic area. If, for example, we found only one 
operating franchise in an area but that franchise was listed as having 
effective competition, we investigated further. Also, if we found two 
franchises operating in an area that were classified as having 
effective competition, but both were operated by the same company, we 
also investigated further. Also, in some cases, we made attempts to 
determine if the nonsatellite competitor was operating as an MMDS, 
which is sometimes referred to as wireless cable. This further 
investigation usually involved Web research and information obtained 
through contacts with local franchising authorities. In those instances 
for which we were able to gather information indicating that an 
incumbent cable provider that once faced a nonsatellite competitor no 
longer did in 2001, we defined our nonsatellite competition variable 
accordingly.

To check whether franchise areas without a designation of effective 
competition might have nonetheless faced nonsatellite competition in 
2001, we used lists of service areas of cable overbuilders and compared 
these areas with the list of sampled franchises. We also examined FCC's 
master franchise list for areas in which more than one company appeared 
to operate an active franchise. We investigated these lists further by 
calling local franchising authorities to determine whether those 
franchise areas were geographically distinct or whether this pattern 
could represent competition. We also attempted to identify areas where 
wireless cable companies provided video service and whether any of 
those areas overlapped sampled franchises. In all, we found a number of 
cases where a nonsatellite provider appeared to be offering service in 
areas where no filings for effective competition had been made. In 
these cases, we defined our variable to reflect this competition. Of 
the 572 franchises without a designation of effective competition, we 
found that 28 were facing some form of nonsatellite competition in 
2001.

Finally, we made a distinction between those franchises that were found 
to face effective competition because of the availability of MMDS 
versus areas with a wire-based overbuilder. We separated these kinds of 
competition into distinct variables under the assumption that they may 
have a differential effect on cable operators. We believed that this 
might be the case because many MMDS providers have been modifying their 
business plans and placing less emphasis on their video businesses. For 
example, FCC noted that "MMDS has never become a significant competitor 
in the market for the delivery of video programming, rather many MMDS 
providers are focusing on data transmission rather than video 
service."[Footnote 55]

[End of section]

Appendix IV: Cable-Satellite Model:

This appendix provides a brief description of our model of cable-
satellite competition. With this model, we estimate the influence of 
wire-based, MMDS, and DBS competition, along with other variables, on 
cable prices and services through a system of structural equations in 
which certain variables that may be simultaneously determined are 
estimated jointly. The model includes equations for cable prices, the 
number of cable subscribers, the number of cable channels, and the DBS 
penetration rate. Our October 2002 report provides a more detailed 
discussion of the data sources, our process for merging various data 
into a single dataset, and the specification of our model.[Footnote 56]

Definitions and Sources for Variables:

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

Table 1: Definition and Source for Variables:

Variable: Cable price; Definition: The monthly rate charged for the 
Basic Service Tier, Cable Programming Service Tier, and rental of a 
converter box and remote control;  Source: FCC 2001 Cable Rate Survey.

Variable: Number of subscribers; Definition: The number of subscribers 
to the Basic Service Tier and Cable Programming Service Tier;  Source: 
FCC 2001 Cable Rate Survey.

Variable: Number of channels; Definition: The number of channels 
provided with the Basic Service Tier and Cable Programming Service Tier 
(the most commonly purchased tier);  Source: FCC 2001 Cable Rate 
Survey.

Variable: Direct broadcast satellite (DBS) penetration rate; 
Definition: The fraction of housing units in a cable franchise area 
that have satellite service;  Source: SkyREPORT.

Variable: DBS provision of local stations; Definition: A binary 
variable that equals 1 if both DBS operators offer local broadcast 
stations in the cable franchise area;  Source: National Association of 
Broadcasters.

Variable: Television market size; Definition: The number of television 
households in the market;  Source: Neilsen Media Research.

Variable: Horizontal concentration; Definition: A binary variable that 
equals 1 if 1 of the 10 largest national multiple system operators 
(MSO) provides service in the franchise area;  Source: FCC 2001 Cable 
Rate Survey.

Variable: Vertical relationship; Definition: A binary variable that 
equals 1 if the cable operator is affiliated with an MSO that has an 
ownership interest in a national or regional video programming 
service;  Source: FCC 2001 Cable Rate Survey and 2001 Annual Video 
Report.

Variable: Presence of a wire-based competitor; Definition: A binary 
variable that equals 1 if a second wireline company provides cable 
service (including, for example, a local exchange telephone carrier 
offering video services) in the franchise area;  Source: FCC 2001 Cable 
Rate Survey and GAO analysis.

Variable: Presence of multichannel multipoint distribution system 
(MMDS) competitor; Definition: A binary variable that equals 1 if a 
company provides cable service via MMDS technology in the franchise 
area;  Source: FCC 2001 Cable Rate Survey and GAO analysis.

Variable: Average wage; Definition: The average weekly wage for 
telecommunications equipment installers and repairers in the state 
where the cable franchise is located;  Source: Bureau of Labor 
Statistics.

Variable: Population density; Definition: The ratio of population to 
square miles in the franchise area;  Source: U.S. Census Bureau.

Variable: Number of broadcast stations; Definition: The number of over-
the-air broadcast stations in the television market;  Source: BIA MEDIA 
AccessPro.

Variable: Urbanization; Definition: The percentage of the county's 
population that is classified as urban by the U.S. Census Bureau;  
Source: U.S. Census Bureau.

Variable: Age of cable franchise; Definition: The number of years 
between when the cable franchise began operation and 2001;  Source: FCC 
Master List of Cable Franchises.

Variable: Homes passed by cable system; Definition: The number of homes 
passed by the cable system that serves the franchise area, including 
homes outside of the franchise area;  Source: FCC 2001 Cable Rate 
Survey.

Variable: Median per-capita income; Definition: The median per-capita 
income in the franchise area;  Source: U.S. Census Bureau.

Variable: System megahertz; Definition: The capacity, measured in 
megahertz, of the cable system that serves the franchise area;  Source: 
FCC 2001 Cable Rate Survey.

Variable: Percentage of multiple dwelling units; Definition: The 
percentage of housing units accounted for by structures with five or 
more housing units;  Source: U.S. Census Bureau.

Variable: Nonmetropolitan areas; Definition: A binary variable that 
equals 1 if the franchise area is outside of a metropolitan statistical 
area (MSA);  Source: U.S. Census Bureau.

Variable: Angle (or "elevation") of satellite dish; Definition: The 
angle relative to the ground that a DBS subscriber must mount the 
satellite dish to "see" the satellite;  Source: Web pages of DIRECTV 
and EchoStar.

Variable: Regulation; Definition: A binary variable that equals 1 if 
the cable franchise is subject to regulation of the rate charged for 
the Basic Service Tier;  Source: FCC 2001 Cable Rate Survey.

Source: GAO (2003).

[End of table]

Estimation Methodology and Results:

We employed the three-stage least squares method to estimate our 
model.[Footnote 57] Table 2 includes the descriptive statistics for the 
variables included in our model, and table 3 includes the estimation 
results for each of the four structural equations. All of the 
variables, except dummy variables,[Footnote 58] are expressed in 
natural logarithmic form, so coefficients can be interpreted as 
elasticities--which is the percentage change in the value of the 
dependent variable associated with a 1 percent change in the value of 
an independent, or explanatory, variable.[Footnote 59] The coefficients 
on the dummy variables are elasticities in decimal form.

Table 2: Descriptive Statistics:


Variable: Cable price; Mean: 36.15; Standard deviation: 5.02; Minimum 
value: 14.00; Maximum value: 47.84.

Variable: Cable price per channel; Mean: 0.66; Standard deviation: 
0.19; Minimum value: 0.30; Maximum value: 1.80.

Variable: Cable subscribers; Mean: 21,460.68; Standard deviation: 
43,673.73; Minimum value: 4.00; Maximum value: 302,964.00.

Variable: Cable channels; Mean: 58.17; Standard deviation: 14.06; 
Minimum value: 10.00; Maximum value: 99.00.

Variable: DBS penetration; Mean: 15.91; Standard deviation: 11.31; 
Minimum value: 1.59; Maximum value: 63.64.

Variable: DBS provision of local stations; Mean: 0.52; Standard 
deviation: 0.50; Minimum value: 0.00; Maximum value: 1.00.

Variable: Regulation; Mean: 0.36; Standard deviation: 0.48; Minimum 
value: 0.00; Maximum value: 1.00.

Variable: Number of broadcast stations; Mean: 12.00; Standard 
deviation: 5.64; Minimum value: 1.00; Maximum value: 25.00.

Variable: Median income; Mean: 43,965.25; Standard deviation: 
16,202.17; Minimum value: 13,529.00; Maximum value: 139,997.00.

Variable: Horizontal concentration; Mean: 0.85; Standard deviation: 
0.36; Minimum value: 0.00; Maximum value: 1.00.

Variable: Vertical relationship; Mean: 0.55; Standard deviation: 0.50; 
Minimum value: 0.00; Maximum value: 1.00.

Variable: Presence of wire-based competitor; Mean: 0.16; Standard 
deviation: 0.37; Minimum value: 0.00; Maximum value: 1.00.

Variable: Presence of MMDS competitor; Mean: 0.01; Standard deviation: 
0.10; Minimum value: 0.00; Maximum value: 1.00.

Variable: Nonmetropolitan areas; Mean: 0.25; Standard deviation: 0.43; 
Minimum value: 0.00; Maximum value: 1.00.

Variable: Urbanization; Mean: 73.53; Standard deviation: 28.12; Minimum 
value: 0.00; Maximum value: 100.00.

Variable: Percentage of multiple dwelling units; Mean: 14.38; Standard 
deviation: 13.70; Minimum value: 0.00; Maximum value: 98.12.

Variable: Age of cable franchise; Mean: 24.11; Standard deviation: 
9.52; Minimum value: 2.00; Maximum value: 50.00.

Variable: Homes passed by cable system; Mean: 181,024.81; Standard 
deviation: 235,085.38; Minimum value: 30.00; Maximum value: 
1,260,734.00.

Variable: Cable system megahertz; Mean: 638.98; Standard deviation: 
172.13; Minimum value: 216.00; Maximum value: 870.00.

Variable: Television market households; Mean: 1,459.89; Standard 
deviation: 1,664.50; Minimum value: 50.00; Maximum value: 7,301.00.

Variable: Population density; Mean: 2,888.92; Standard deviation: 
7,144.36; Minimum value: 2.25; Maximum value: 87,139.78.

Variable: State-level wages; Mean: 788.91; Standard deviation: 102.28; 
Minimum value: 575.38; Maximum value: 1,045.58.

Variable: Dish angle or elevation; Mean: 40.29; Standard deviation: 
6.67; Minimum value: 27.19; Maximum value: 57.28.

Source: GAO (2003).

[End of table]

Table 3: Three-Stage Least Squares Model Results:

Variable: Cable price per channel; Cable prices equation: [Empty]; 
Cable subscribers equation: -1.5368; [0.0001][A]; Cable channels 
equation: [Empty]; DBS penetration equation: 0.7839; [0.0001][A].

Variable: Cable subscribers; Cable prices equation: 0.0079; [0.3938]; 
Cable subscribers equation: [Empty]; Cable channels equation: 0.0603; 
[0.0001][A]; DBS penetration equation: [Empty].

Variable: Cable channels; Cable prices equation: 0.2428; [0.0001][A]; 
Cable subscribers equation: [Empty]; Cable channels equation: [Empty]; 
DBS penetration equation: [Empty].

Variable: DBS penetration; Cable prices equation: -0.0441; 
[0.0898][C]; Cable subscribers equation: -2.2403; [0.0001][A]; Cable 
channels equation: -0.0174; [0.5933]; DBS penetration equation: 
[Empty].

Variable: DBS provision of local stations; Cable prices equation: -
0.0063; [0.7285]; Cable subscribers equation: 0.4276; [0.0800][C]; 
Cable channels equation: 0.0527; [0.0408][B]; DBS penetration equation: 
0.3386; [0.0001][A].

Variable: Regulation; Cable prices equation: -0.0213; [0.1157]; Cable 
subscribers equation: [Empty]; Cable channels equation: [Empty]; DBS 
penetration equation: [Empty].

Variable: Number of broadcast stations; Cable prices equation: 
[Empty]; Cable subscribers equation: 0.5896; [0.0081][A]; Cable 
channels equation: [Empty]; DBS penetration equation: [Empty].

Variable: Median income; Cable prices equation: [Empty]; Cable 
subscribers equation: -0.3772; [0.0813][C]; Cable channels equation: 
0.0672; [0.0032][A]; DBS penetration equation: 0.1903; [0.0023][A].

Variable: Horizontal concentration; Cable prices equation: 0.0528; 
[0.0006][A]; Cable subscribers equation: [Empty]; Cable channels 
equation: [Empty]; DBS penetration equation: [Empty].

Variable: Vertical relationship; Cable prices equation: -0.0051; 
[0.6682]; Cable subscribers equation: [Empty]; Cable channels equation: 
-0.0335; [0.0351][B]; DBS penetration equation: [Empty].

Variable: Presence of wire-based competitor; Cable prices equation: -
0.1636; [0.0001][A]; Cable subscribers equation: -1.2766; [0.0001][A]; 
Cable channels equation: 0.0339; [0.1832]; DBS penetration equation: -
0.3797; [0.0001][A].

Variable: Presence of MMDS competitor; Cable prices equation: 0.0420; 
[0.3697]; Cable subscribers equation: -0.2247; [0.7350]; Cable channels 
equation: 0.0426; [0.5391]; DBS penetration equation: -0.1350; 
[0.4596].

Variable: Nonmetropolitan areas; Cable prices equation: [Empty]; 
Cable subscribers equation: [Empty]; Cable channels equation: [Empty]; 
DBS penetration equation: 0.4456; [0.0001][A].

Variable: Urbanization; Cable prices equation: [Empty]; Cable 
subscribers equation: 0.0541; [0.5117]; Cable channels equation: 
[Empty]; DBS penetration equation: [Empty].

Variable: Percentage of multiple dwelling units; Cable prices 
equation: [Empty]; Cable subscribers equation: [Empty]; Cable channels 
equation: -0.0228; [0.0261][B]; DBS penetration equation: -0.2162; 
[0.0001][A].

Variable: Age of cable franchise; Cable prices equation: [Empty]; 
Cable subscribers equation: 0.3027; [0.0463][B]; Cable channels 
equation: [Empty]; DBS penetration equation: -0.1778; [0.0001][A].

Variable: Homes passed by cable system; Cable prices equation: 
[Empty]; Cable subscribers equation: 0.2918; [0.0001][A]; Cable 
channels equation: [Empty]; DBS penetration equation: [Empty].

Variable: Cable system megahertz; Cable prices equation: [Empty]; 
Cable subscribers equation: [Empty]; Cable channels equation: 0.5038; 
[0.0001][A]; DBS penetration equation: -0.0434; [0.5304].

Variable: Television market households; Cable prices equation: 
0.0072; [0.3639]; Cable subscribers equation: -0.2902; [0.0670][C]; 
Cable channels equation: -0.0023; [0.8489]; DBS penetration equation: -
0.1195; [0.0001][A].

Variable: Population density; Cable prices equation: -0.0120; 
[0.0256][B]; Cable subscribers equation: [Empty]; Cable channels 
equation: [Empty]; DBS penetration equation: [Empty].

Variable: State-level wages; Cable prices equation: 0.0392; [0.3676]; 
Cable subscribers equation: [Empty]; Cable channels equation: [Empty]; 
DBS penetration equation: [Empty].

Variable: Dish angle or elevation; Cable prices equation: [Empty]; 
Cable subscribers equation: [Empty]; Cable channels equation: [Empty]; 
DBS penetration equation: 0.6028; [0.0001][A].

Variable: Intercept; Cable prices equation: 2.4077; [0.0001][A]; 
Cable subscribers equation: 14.1843; [0.0001][A]; Cable channels 
equation: -0.3218; [0.3259]; DBS penetration equation: 0.5324; 
[0.5601].

Variable: Sample size; Cable prices equation: 705; Cable subscribers 
equation: 705; Cable channels equation: 705; DBS penetration equation: 
705.

Source: GAO (2003).

Note: System-weighted R-square: 0.65. P-values are shown in square 
brackets.

[A] Significance at the 1 percent level.

[B] Significance at the 5 percent level.

[C] Significance at the 10 percent level.

[End of table]

We found that competition has an effect on the subscription video 
market. Competition from a second wire-based operator appears to 
significantly lower cable prices--cable prices were approximately 15 
percent lower in areas where a second wire-based operator provides 
service. [Footnote 60] Yet, this competition had no effect on the 
quality of cable service, as measured by the number of channels the 
cable operator provides. Additionally, we found that higher DBS 
penetration rates were associated with a slight reduction in cable 
prices; a 10 percent higher DBS penetration rate was associated with a 
15 cent reduction in cable rates.[Footnote 61] In areas where both DBS 
operators provide local broadcast stations, we found that cable 
operators offer subscribers approximately 5 percent more channels than 
cable operators in areas where both DBS operators do not provide local 
stations. Unlike wire-based and DBS competition, we found that the 
presence of a company providing video service via MMDS technology was 
not associated with a different level of cable rates or number of 
channels provided to subscribers.[Footnote 62]

We found that a variety of other factors affect the level of cable 
prices and the quality of cable service. Cable prices are higher in 
areas where the cable operator provides more channels, indicating that 
some consumers may be willing to pay for additional channels and that 
providing additional channels raises a cable company's costs. We found 
that cable prices were 5 percent higher when the cable operator was 
affiliated with 1 of the 10 largest MSOs. Finally, we found that cable 
operators affiliated with a cable network provided their subscribers 
with 3 percent fewer basic and expanded-basic cable networks than 
similar cable operators unaffiliated with a cable network.

DBS operators' provision of local broadcast stations is associated with 
significantly higher DBS penetration rates. As shown in table 3, our 
model results indicate that in cable franchise areas where these local 
stations are available from both DBS operators, the DBS penetration 
rate is approximately 40 percent higher than in areas where local 
stations are not available via satellite from both DBS operators. This 
finding suggests that in areas where local broadcast stations are 
available from both DBS operators, consumers are more likely to 
subscribe to DBS service; therefore, DBS appears to be more competitive 
with cable than in areas where local stations are not available from 
both DBS operators.

Several additional factors also influence the DBS penetration rate. Our 
model results indicate that the DBS penetration rate is greater in 
nonmetropolitan areas and also tends to increase as the size of the 
television market decreases. Additionally, the DBS penetration rate is 
higher in areas that require a relatively higher angle or elevation at 
which the satellite dish is mounted and is lower in areas where there 
are more multiple dwelling units. These two factors can be associated 
with the need of DBS satellite dishes to "see" the satellite. That is, 
a dish aimed more toward the horizon (as opposed to aimed higher in the 
sky) is more likely to be blocked by a building or foliage, and people 
in multiple dwelling units often have fewer available locations to 
mount their dish.

[End of section]

Appendix V: Cable Network Carriage Model:

This appendix describes our model of cable network carriage that we 
developed to test whether ownership affiliations influence cable 
operators' decisions about what networks they will carry. Specifically, 
we discuss (1) the set-up of our model, (2) the data sources and 
descriptive statistics, (3) the estimation methodology and results, and 
(4) an alternative specification.

Set-up of Our Cable Network Carriage Model:

A cable operator will carry a cable network if, on the margin, the 
network increases the operator's profit or increases its profits more 
than an alternative cable network. Cable operators receive revenue 
associated with cable networks from both subscriber fees and local 
advertising. Therefore, the addition of a popular cable network will 
likely increase the operator's revenues by allowing the operator to 
impose higher monthly cable rates on subscribers and sell additional 
local advertising at higher rates than would be possible with a less 
popular network. At the same time, the cable operator will incur 
programming costs associated with the cable network. Thus, the cable 
operator will balance these various revenue and cost factors when 
deciding whether to carry a given cable network.

In interviews with 11 cable operators, we were told that broadcast 
networks often link carriage of cable networks to retransmission of 
local broadcast stations. In addition to these broadcaster affiliations 
with cable networks, some cable operators are also affiliated with 
cable networks. In fact, several studies have indicated that cable 
ownership of cable networks influences the carriage of cable networks-
-so there is some precedent that ownership, albeit of a different form, 
influences carriage decisions.[Footnote 63] To examine whether these 
ownership affiliations--broadcaster and cable operator ownership of 
cable networks--influence the carriage of cable networks by cable 
franchises, we employed a model that tests whether certain variables 
increase or decrease the probability of a cable network being carried 
on a particular cable franchise. To empirically test these hypotheses, 
we estimated the following. Carriage of a cable network on a cable 
franchise is a function of:

* the age of the cable network,

* the popularity of the cable network as measured by advertising 
revenues per subscriber,

* whether the cable network primarily distributes news-or sports-
related programming,

* whether the cable network is affiliated with a broadcast network or a 
cable operator,

* cable system capacity in terms of megahertz,

* the number of households passed by the cable system,

* the percentage of people in the franchise area between ages 25 and 
65,

* the percentage of households in the franchise area that own their 
homes, and:

* whether the cable franchise is owned by a cable multiple system 
operator.

Data Sources and Descriptive Statistics:

We required several data elements to build the dataset used to estimate 
this model. The following is a list of our primary data sources. In 
addition, we list all of the variables, definitions, and sources in 
table 4 and basic statistical information on all of the variables in 
table 5.

* We obtained data on the carriage of individual cable networks on 
cable franchises from FCC's 2002 survey of cable franchises. FCC's 
survey asked a sample of cable franchises whether the franchise carried 
various cable networks. We used the survey to define a variable 
representing whether a given cable network was carried on either the 
basic or expanded-basic tier. In addition, we used the survey to define 
variables measuring (1) the system megahertz (the capacity of the cable 
system in megahertz), (2) the number of households passed by the cable 
system, (3) the affiliation of the cable franchise with a multiple 
system operator, and (4) the ownership affiliation of the cable 
operator.

* From Kagan World Media, we obtained data on cable networks, including 
(1) the year the cable network launched, (2) the number of cable 
subscribers that received the cable network in 2002, (3) the 
advertising revenue the cable network received in 2002, and (4) the 
ownership affiliation of the cable network.

* We used the most recent data from the U.S. Census Bureau to obtain 
the following demographic information for each franchise area: 
proportion of the population between ages 25 and 65 and the percentage 
of the households that reside in owner-occupied housing.

Table 4: Definitions and Sources of Variables:

Variable: Carry; Definition: A binary variable that equals 1 if the 
cable network is carried on the basic or expanded-basic tier;  Source: 
FCC 2002 cable rate survey.

Variable: Age; Definition: 2003 minus the launch year of the cable 
network;  Source: Kagan World Media.

Variable: Advertising revenue per subscriber; Definition: The cable 
network's advertising revenues divided by the number of subscribers 
that could receive the cable network in 2002;  Source: Kagan World 
Media.

Variable: News; Definition: A binary variable that equals 1 if the 
cable network primarily delivers news-related programming;  Source: GAO 
analysis.

Variable: Sports; Definition: A binary variable that equals 1 if the 
cable network primarily delivers sports-related programming;  Source: 
GAO analysis.

Variable: Broadcaster affiliation; Definition: A binary variable that 
equals 1 if the cable network is affiliated with a broadcast network 
group (Disney/ABC, Viacom/CBS, News Corporation/Fox, General Electric/
NBC, or Scripps), and the cable network began operation in 1992 or 
later;  Source: Kagan World Media.

Variable: Cable affiliation; Definition: A binary variable that equals 
1 if the cable network is affiliated with a cable operator (Time 
Warner, Cablevision, or Comcast);  Source: Kagan World Media.

Variable: Homes passed by cable system; Definition: The number of 
households passed by the cable system that serves the franchise, 
including homes outside of the franchise area;  Source: FCC 2002 cable 
rate survey.

Variable: Cable system megahertz; Definition: The capacity, measured in 
megahertz, of the cable system that serves the franchise area;  Source: 
FCC 2002 cable rate survey.

Variable: Multiple system operator; Definition: A binary variable that 
equals 1 if the cable franchise is affiliated with a cable multiple 
system operator;  Source: FCC 2002 cable rate survey.

Variable: Population between ages 25 and 65; Definition: The percentage 
of the population in a franchise area between ages 25 and 65;  Source: 
U.S. Census Bureau.

Variable: Home ownership; Definition: The percentage of households in 
the franchise area residing in owner-occupied housing units;  Source: 
U.S. Census Bureau.

Source: GAO (2003).

[End of table]

Table 5: Descriptive Statistics:

Variable: Carry; Mean: 0.43; Standard deviation: 0.50; Minimum value: 
0.00; Maximum value: 1.00.

Variable: Age; Mean: 10.68; Standard deviation: 6.61; Minimum value: 
1.00; Maximum value: 27.00.

Variable: Advertising revenue per subscriber; Mean: 1.91; Standard 
deviation: 2.19; Minimum value: 0.00; Maximum value: 10.98.

Variable: News; Mean: 0.06; Standard deviation: 0.24; Minimum value: 
0.00; Maximum value: 1.00.

Variable: Sports; Mean: 0.09; Standard deviation: 0.28; Minimum value: 
0.00; Maximum value: 1.00.

Variable: Broadcaster affiliation; Mean: 0.25; Standard deviation: 
0.43; Minimum value: 0.00; Maximum value: 1.00.

Variable: Cable affiliation; Mean: 0.20; Standard deviation: 0.40; 
Minimum value: 0.00; Maximum value: 1.00.

Variable: Homes passed by cable system; Mean: 178,212.05; Standard 
deviation: 244,160.35; Minimum value: 73.00; Maximum value: 
1,286,698.00.

Variable: Cable system megahertz; Mean: 672.57; Standard deviation: 
171.08; Minimum value: 212.00; Maximum value: 870.00.

Variable: Multiple system operator; Mean: 0.95; Standard deviation: 
0.23; Minimum value: 0.00; Maximum value: 1.00.

Variable: Population between ages 25 and 65; Mean: 52.09; Standard 
deviation: 2.92; Minimum value: 37.26; Maximum value: 62.94.

Variable: Home ownership; Mean: 68.16; Standard deviation: 10.02; 
Minimum value: 19.46; Maximum value: 84.90.

Source: GAO (2003).

[End of table]

Estimation Methodology and Results:

Because we are estimating a binary choice model--that is, the cable 
franchise either carries or does not carry a given cable network--we 
employed the logit method to estimate our reduced-form equation of 
cable network carriage.[Footnote 64] We present the estimation results 
for our reduced-form equation in table 6.

Table 6: Logistic Model Results:

Variable: Age; Parameter estimate and [p-value]: 0.1558; [0.0001][A].

Variable: Advertising revenue per subscriber; Parameter estimate and 
[p-value]: 0.7537; [0.0001][A].

Variable: News; Parameter estimate and [p-value]: 0.6769; [0.0001][A].

Variable: Sports; Parameter estimate and [p-value]: 0.0812; 
[0.0472][B].

Variable: Broadcaster affiliation; Parameter estimate and [p-value]: 
0.8265; [0.0001][A].

Variable: Cable affiliation; Parameter estimate and [p-value]: 0.5817; 
[0.0001][A].

Variable: Homes passed by cable system; Parameter estimate and [p-
value]: 0.0000; [0.0011][A].

Variable: Cable system megahertz; Parameter estimate and [p-value]: 
0.0029; [0.0001][A].

Variable: Population between ages 25 and 65; Parameter estimate and [p-
value]: 0.0061; [0.1191].

Variable: Home ownership; Parameter estimate and [p-value]: 0.0068; 
[0.0001][A].

Variable: Multiple system operator; Parameter estimate and [p-value]: 
0.3059; [0.0001][A].

Variable: Intercept; Parameter estimate and [p-value]: -6.5658; 
[0.0001][A].

Variable: Sample size; Parameter estimate and [p-value]: 55,728.

Variable: Rescaled R-square; Parameter estimate and [p-value]: 0.5075.

Source: GAO (2003).

[A] Significance at the 1 percent level.

[B] Significance at the 5 percent level.

[End of table]

Our model results indicate that ownership affiliation does influence 
the carriage of cable networks, as both broadcaster affiliation and 
cable operator affiliation are associated with a greater probability of 
a cable network being carried on a cable franchise. When calculated at 
the mean values for all of the variables in the model, cable networks 
affiliated with broadcast networks are 46 percent more likely to be 
carried than networks that do not have broadcast ownership.[Footnote 
65] Similarly, when calculated at mean values for all of the variables 
included in the model, cable networks affiliated with a cable operator 
are 31 percent more likely to be carried on a cable franchise than 
noncable-affiliated networks.

The remaining variables generally had the expected impact on the 
likelihood of a cable network being carried on a cable franchise. 
Popular networks--as represented by high levels of advertising revenues 
per subscriber--and news-and sports-related networks were more likely 
to be carried on franchises than less popular networks and networks 
primarily delivering other program genres. Also, cable franchises with 
larger capacity were more likely to carry any given cable network, and 
franchises with a high percentage of people residing in owner-occupied 
housing were also more likely to carry any given network.

Alternative Specification:

In addition to the above specification, we also considered a narrower 
definition of cable affiliation. In this specification, a cable network 
was only considered to be cable affiliated if the cable operator that 
owned the cable network also owned the cable franchise. For example, a 
cable network owned by Comcast would be considered cable affiliated 
when it appeared on a Comcast cable franchise, but not on another cable 
company's franchise, such as a Time Warner franchise. In this 
specification, cable networks affiliated with a cable operator are 64 
percent more likely to be carried on the affiliated cable franchise 
than a nonaffiliated cable network. Cable networks affiliated with 
broadcast networks remain more likely to be carried than cable networks 
not affiliated with broadcasters. We present the estimation results for 
this alternative specification in table 7.

Table 7: Logistic Model Results:

Variable: Age; Parameter estimate and [p-value]: 0.1558; [0.0001][A].

Variable: Advertising revenue per subscriber; Parameter estimate and 
[p-value]: 0.7360; [0.0001][A].

Variable: News; Parameter estimate and [p-value]: 0.6495; [0.0001][A].

Variable: Sports; Parameter estimate and [p-value]: 0.1558; 
[0.0001][A].

Variable: Broadcaster affiliation; Parameter estimate and [p-value]: 
0.6877; [0.0001][A].

Variable: Cable network owned by operator; Parameter estimate and [p-
value]: 1.4091; [0.0001][A].

Variable: Homes passed by cable system; Parameter estimate and [p-
value]: 0.0000; [0.0131][B].

Variable: Cable system megahertz; Parameter estimate and [p-value]: 
0.0029; [0.0001][A].

Variable: Population between ages 25 and 65; Parameter estimate and [p-
value]: 0.0054; [0.1677].

Variable: Home ownership; Parameter estimate and [p-value]: 0.0069; 
[0.0001][A].

Variable: Multiple system operator; Parameter estimate and [p-value]: 
0.2915; [0.0001][A].

Variable: Intercept; Parameter estimate and [p-value]: -6.3393; 
[0.0001][A].

Variable: Sample size; Parameter estimate and [p-value]: 55,728.

Variable: Rescaled R-square; Parameter estimate and [p-value]: 0.5065.

Source: GAO (2003).

[A] Significance at the 1 percent level.

[B] Significance at the 5 percent level.


[End of table]

[End of section]

Appendix VI: Comments from the Federal Communications Commission:

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

Federal Communications Commission Washington, D.C. 20554:

September 24, 2003:

Mr. Mark Goldstein:

Acting Director, Physical Infrastructure Issues 
United States General Accounting Office 
Washington, DC 20548:

Dear Mr. Goldstein:

Thank you for the opportunity to review GAO's draft report entitled 
Telecommunications: Issues Related to Competition and Subscriber Rates 
in the Cable Television Industry (GAO-04-8). It is my understanding 
that your staff has met with Commission staff and has received data, 
comments, and assistance from them.

There are two primary areas of the draft report that are seriously 
misleading and upon which we would like to comment. The first relates 
to the statutory framework that the Commission is legally obligated to 
adhere to in making effective competition determinations. The second 
relates to the Commission's use of estimates provided by cable 
operators to determine the relative importance of factors that explain 
cable television rate increases.

The GAO Report states that the "FCC's designations of franchise areas 
as having (or not having) effective competition do not always 
accurately reflect current competitive conditions and, in the case of 
effective competition based on DBS service, FCC has not sought to 
validate the industry data used to substantiate these filings." Our 
Annual Price Survey is not an independent inquiry into competitive 
conditions, but rather a statutorily defined survey based on a legal 
framework --adopted by Congress --which specifies the definition of 
effective competition and the administrative process through which 
cable operators file petitions seeking findings of effective 
competition.

The rate regulation provisions enacted by Congress require 
participation by the local franchising authorities (LFAs) to work 
effectively. An LFA may regulate basic rate increases if the local 
cable system is not subject to effective competition. An LFA must be 
certified to regulate basic rates, if it would like to do so. A cable 
operator seeking effective competition status files a petition with the 
Commission providing data to demonstrate that it meets one of the four 
statutory tests for effective competition. The cable operator is 
required to serve its petition on the LFA, which provides an 
opportunity for the LFA to oppose the petition and provide 
countervailing evidence for Commission review.

In making determinations of effective competition, the statutory 
process allows the Commission to rely on data from external sources, 
for example DBS penetration data from SkyTRENDS. Because copies of the 
petitions for determination of effective competition filings --
including 
copies of the full SkyTRENDS reports for the relevant communities --are 
available to the LFAs under the statutory framework, the LFAs have an 
opportunity to file objections in the effective competition proceedings 
if they believe the data are inaccurate. No LFA has ever made a serious 
charge that the SkyTRENDS data were not sufficiently accurate for these 
purposes; nor are we aware of a better source for such data.

If circumstances change and the criteria for "effective competition" as 
defined by our governing statute are no longer present, the statute 
provides LFAs have an opportunity to file for recertification, but they 
are under no obligation to do so. If an LFA chooses not to file for 
recertification, the Commission has no legal basis upon which to act to 
change a cable operator's effective competition status for purposes of 
rate regulation. In situations where a cable operator has met the 
definition of effective competition and a finding to that effect has 
been made, the cable operator has no obligation under the statute to 
inform the LFA or the Commission of changed circumstances. In addition, 
there may be situations in which LFAs may be aware of changed 
circumstances and for various reasons choose not to file for 
recertification.

The statutory framework establishes no mechanism --other than 
recertification by the LFA --for the Commission to become cognizant of 
changes in competitive conditions. Further, as a practical matter, the 
Commission does not have the resources that would be needed to monitor 
the entire cable industry and update designations of effective 
competition on a rolling basis. Indeed, even if the FCC were to do so 
based on some independent authority, it is not clear that this 
information could be used in an annual cable rate survey. The 
Commission is required to report annually on cable rates, comparing 
cable systems subject to "effective competition" with those not subject 
to "effective competition" as defined in the statute. Even if the 
Commission could determine changes in competitive status, the law would 
require that we continue to report cable rates pursuant to the legal 
definition of effective competition. Thus, to the extent the report 
suggests that the FCC should update periodically its view of the 
competitive situation in individual franchise areas, such an effort 
would not only be ultra vires and beyond the limits of the Commission's 
resources, it ultimately would not provide the data needed to fulfill 
our legal obligation to report on cable industry prices.

By making ad hoc determinations of competitive status based on current 
market conditions and using an econometric model, GAO found a 15% 
differential in cable rates between wire-based competitors and 
noncompetitive operators. In the 2002 Price Survey Report, also using 
an econometric model, the Commission found a 7% differential between 
wire-based competitors and noncompetitive operators. The GAO report may 
be misleading in this regard because it draws a comparison between 
these two percentages even though they were estimated based on two 
different sets of competitive cable operators. As mentioned in the 
report, GAO sought to determine the current status of competition in 
each franchise. The Commission, on the other hand, followed the 
statutory framework and included only those operators where a finding 
of effective competition has been made.[NOTE 1]:

With respect to the Commission's use of estimates to explain rate 
increases, the GAO report suggests that our Price Survey Report may not 
provide "a reliable source of information" on the factors that underlie 
recent cable rate increases because the cable operators participating 
in our survey did not respond to these questions in a consistent 
manner. The report further observes that many cable operators 
responding to our survey may have underestimated the importance of 
certain factors, and by so doing, would have overestimated the 
importance of programming costs as a factor contributing to rate 
increases.

We acknowledge in our 2002 Price Survey Report that the responses to 
these particular questions may not have the same degree of accuracy as, 
for example, the responses to questions regarding monthly rates. We 
also observe that because the survey requires the factors to equal the 
amount of the rate increases that are being explained, if one or more 
factors are underestimated, then the remaining factors will be 
overestimated. Despite these shortcomings, we provided the estimates 
because we believed that, on balance, they provide information that 
helps put the changes in rates in perspective with reported cost 
increases. It is instructive to note that GAO's findings, which were 
arrived at through an independent survey, appear to corroborate the 
estimates provided in our Price Survey Report. For example, we reported 
that cable operators attributed 65.8% of their rate increases for 2002 
to increases in programming costs. Using information in GAO's report, 
we can calculate that your survey finds that programming cost increases 
would explain about 60% of rate increases for 2002. [NOTE 2] Although 
these results differ by approximately 5.8 percentage points, on 
balance, our estimates provide useful information that helps put the 
change in rates in perspective and are consistent with your findings.

Finally, based on discussions with GAO staff, we have redesigned our 
survey questionnaire for 2003 to eliminate questions that rely on 
estimates and to substitute other questions for which we believe cable 
operators can provide more accurate information. We also provide more 
complete explanations for these questions in our 2003 questionnaire, as 
recommended by the GAO.

We very much appreciate the opportunity to review and comment on this 
draft report, and thank GAO staff for their helpful suggestions that we 
are incorporating in our next Price Survey questionnaire.

Sincerely,

Signed for: 

Andrew S. Fishel 
Managing Director:

[See PDF for image]

[End of figure]

Federal Communications Commission Washington, D.C. 20554:

October 9, 2003:

Mr. Mark Goldstein:

Acting Director, Physical Infrastructure Issues United States General 
Accounting Office Washington, DC 20548:

Dear Mr. Goldstein:

This is in response to our discussion regarding the Commission's 
statutory authority to modify its findings of effective competition or 
establish new procedures to account for changed circumstances with 
respect to effective competition adjudications in particular local 
franchise areas ("LFAs").

Pursuant to Section 623 of the Communications Act, the Commission is 
authorized to make findings of effective competition and has 
established rules to do so. In accordance with the authority granted to 
the Commission in Section 623, the procedure for making a decision as 
to the presence or absence of effective competition is necessarily an 
adjudicatory one. As currently promulgated, the Commission's rules do 
not contemplate a reassessment of an effective competition 
adjudication, except through the LFA recertification procedure. The 
Communications Act neither explicitly authorizes the Commission to, nor 
prohibits the Commission from, revising its rules to limit the duration 
of such findings or require a cable operator to periodically certify 
that it continues to meet the specific standard which was the basis of 
its grant of effective competition status. In today's increasingly 
competitive environment and from a cost/benefit perspective, however, 
we seriously question the utility of such an approach for several 
reasons.

First, based upon our experience, it is unlikely that such a mechanism 
would significantly change our findings with respect to the comparison 
of rates charged by competitive and noncompetitive cable operators. We 
have examined various combinations of competitive operators and at the 
possibility of reformulating the competitive list in various ways and 
find that the end result would be an almost negligible change in the 
average rate found for the competitive group.

In this regard, we note that there are other considerations and issues 
that must be taken into account in the context of our price survey and 
effective competition findings. Although the Commission could possibly 
modify the procedural rules associated with findings of effective 
competition, it is not clear that it could, for purposes of comparing 
the rates of competitive and noncompetitive operators, by-pass the due 
process requirements involved in order to properly evaluate those 
communities that have never been the subject of an effective 
competition finding. In other words, shifting from a comparison that is 
based on the legal status of the communities in question as is done 
now, to a comparison based on an updated review of only those 
communities subject to a previous adjudication would not appear to 
improve the overall process. This would 
particularly appear to be the case where the level of competition is 
increasing year-to-year so that the number of communities reverting to 
a non-competitive status is likely to be limited and the number of 
communities facing effective competition for the first time is likely 
to be significant. Any attempt to reevaluate the effective competition 
findings formally while looking at the lack of effective competition 
situations informally would involve mixing two entirely different types 
of decision making. Such an effort also would increase the level of 
resources that would have to be devoted to the price survey process 
without necessarily improving the value of the work product 
significantly.

Second, it appears that the under the new procedures you suggest we 
would only reexamine those cable systems determined to face effective 
competition, a process that does not address the very large number of 
"noncompetitive" cable systems where the conditions for "effective 
competition" are actually present but there has been no formal 
determination. For example, DBS penetration has reached an average of 
15% or more (the threshold for a finding of effective competition) in 
at least 40 states, suggesting that there are many cable systems in 
those states that would meet the "effective competition" test should a 
petition come before us. There are more than 33,400 franchise areas 
registered with the Commission. In order to update our list of 
"noncompetitive" operators for current circumstances, we would have to 
review virtually all of those franchise areas for the current status of 
competition. This would represent a burden that would be significantly 
beyond our resources. Moreover, as we have noted in previous 
discussions, the data necessary for this exercise is not readily 
available to us.

Third, many effective competition decisions, particularly those 
involving LEC competition pursuant to Section 623(l)(1)(D), are not 
objectively clear cut such that parties could reliably certify or 
recertify the existence or non-existence of effective competition 
periodically. By their very nature, LEC effective competition decisions 
are not reducible to neat equations by which cable operators can 
periodically self-certify. Decisions under the LEC test often turn on 
Commission value judgments based on variables such as build-out 
schedules, performance bonds, incumbent response and lack of obstacles 
to construction. It would be extraordinarily difficult for the 
Commission to rely on an operator's decision to certify that the 
circumstances underlying a LEC adjudication are unchanged. Only through 
the adjudicatory process can the decisional import of such factors be 
determined, i.e., the process intended by Congress as reflected in the 
statutory scheme.

We appreciate the opportunity to engage in this dialog.


Signed by: 

w. Kenneth Ferree 
Chief, Media Bureau:

NOTES: 

[1] Although both GAO and the Commission use simultaneous equation 
models estimated via three-stage least squares, GAO uses a different 
set of explanatory variables than the Commission. This could explain 
some of the difference between GAO's and the Commission's findings. In 
addition, we believe that multicollinearity is present among the 
explanatory variables included in the GAO model, i.e., the explanatory 
variables influence each other as well as the variables being 
explained. This makes the GAO model sensitive to even small changes in 
the choice of explanatory variables, i.e., a small change in the list 
of variables selected as explanatory variables will result in a large 
change in the result. This also could explain why some of the 
estimates in the GAO model are statistically not significant and have 
the opposite sign from that which would be intuitively expected.

[2] The GAO report observes that for the nine operators included in 
GAO's survey (which covers 62% of all cable subscribers) annual 
programming expenses on a per subscriber basis increased from $122 in 
1999 to $180 in 2002, a 48% increase over three years. On a monthly 
basis, that equals $10.16 in 1999 and $15.00 in 2002, a $4.84 increase 
over three years, or an average increase of $1.61 per year. An 
increase in programming costs of $1.61 (per month per subscriber) 
would explain 60% of the $2.66 by which basic and expanded basic cable 
service rates increased in 2002. We note that 60% falls within the 
confidence interval around the 65.8% estimate provided in our report. 
Several caveats are necessary for comparison of these two percentages. 
First, the GAO survey covers a particular segment of the industry --
nine of the larger MSOs --while our survey covers a random sample of 
the entire industry. Typically, smaller cable operators pay somewhat 
more than larger operators for their programming, and thus may face 
larger cost increases. Therefore, the GAO sample may understate the 
importance of programming cost increases from the perspective of the 
entire industry. Second, the 60% figure derived from GAO's survey is 
based on an average over the three years covered by GAO's data - 1999 
to 2002, while our data covers a two year period, 2001 and 2002, and 
reports each year separately. If programming cost increases were 
accelerating during those three years, the increase in 2002 would be 
greater than average. Similarly, if decelerating, the increase in 2002 
would be less than average. The GAO report provides some information, 
particularly in the charts on pages 23 and 24, that suggests that 
programming cost increases accelerated in 2002 in comparison with the 
trend of the prior three years.

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

GAO Comments:

1. In a letter dated September 24, 2003, FCC contended that under the 
statutory framework to which the commission is legally obligated to 
adhere in making effective competition determinations, it would be 
ultra vires for the commission to update designations of effective 
competition on a periodic basis. In other words, FCC stated that it did 
not have the legal authority to update periodically its view of the 
competitive situation in individual franchise areas. We disagree that 
the commission's authority is so limited. In order to better understand 
the view that the commission stated in its letter (i.e., it was 
prohibited from modifying its rules to ensure that effective 
competition designations are reflective of current conditions and 
continue to meet the statutory definition to the maximum extent 
possible), we contacted FCC. On the basis of a conversation between 
commission staff and GAO staff, FCC provided us with a second letter 
dated October 9, 2003, that modified its views as expressed in the 
September 24 letter. In the second letter, FCC acknowledged that it was 
not statutorily prohibited from revising its process (see GAO's comment 
8).

2. Although local franchising authorities do see the information that a 
cable franchise provides to FCC in an application for effective 
competition, from filings that we reviewed, we found that these 
authorities at times question the validity of the data and/or 
estimation methodologies. For example, some have noted that reliance on 
2000 census data on housing units can lead to an overstatement of DBS 
penetration because in areas with growing populations, housing 
estimates from 2000 will understate the current number of housing units 
in an area. Such an understatement will result in an overstatement of 
the DBS penetration rate. Moreover, under FCC's rules, local 
franchising authorities have limited time to review such information 
after it is submitted.

3. Resources could clearly be an issue for taking steps to update the 
status of effective competition, and FCC should consider this issue 
when revising its process to keep the status of effective competition 
up to date. FCC could consider requiring cable operators to certify on 
a periodic basis that they still meet the statutory definition and if 
no certification is provided, the finding would be removed. 
Alternatively, as part of the cable rate survey, FCC could ask any 
franchise having a designation of effective competition to provide 
information if that status has changed and, under modified rules, use 
this as a basis for changing the effective competition finding.

4. To develop our measure of competition, we reviewed many sources of 
information, including information from FCC, information from and about 
particular providers, as well as information gathered through 
discussions we had with local franchising authorities. We were not 
attempting to determine which franchises would have effective 
competition under the legal definition. Instead, we focused on 
establishing when meaningful competition, from an economic perspective, 
was likely to exist.

5. We cite FCC's finding on the difference in prices in places with and 
without effective competition, but the more direct comparison for our 
model is FCC's output from its econometric model contained in its 2002 
Cable Pricing report. In that model, FCC tests for the price reduction 
that occurs where there is wireline competition. Although FCC did not 
explicitly define this term in their report, our review of that 
analysis led us to believe that this measure is equivalent or very 
close in concept to our definition of wire-based competition. That is, 
FCC is attempting to measure how prices differ when a cable franchise 
faces a direct wireline overbuilder in the area, which does not include 
all places that have effective competition. Thus, we believe that the 
two measures of wireline competition--that is FCC's and GAO's--did not 
differ in concept.

6. We performed standard statistical tests for the evidence of 
multicollinearity in our model and did not find a significant problem. 
Moreover, we tested FCC's variable for wireline competition in our 
model, and we tested our measure of wireline competition on FCC's 
model. Since we know the findings from each agencies' variable on its 
own model, we were able to discern whether the differences in the 
findings from the two models were caused by differences in the two 
models or by the measure of wireline competition. We found that using 
FCC's measure of wireline competition in our model produced a finding 
similar to that reported by FCC, and using our measure of competition 
in FCC's model produced a finding similar to that found in our model. 
From these findings, we have concluded that any differences between the 
findings of FCC and those of GAO are not caused by differences in the 
two models, but are due to differences in how the wireline variable was 
measured. Further, the GAO and FCC models have much overlap in the 
independent variables specified in the model, and, as such, the degree 
to which there are concerns about multicollinearity, this would be true 
of both models.

7. We agree that FCC's estimate of the percentage of the yearly rate 
increase that can be attributed to programming costs is relatively 
accurate because, as we note in our report, most of the 100 cable 
franchises we interviewed noted that they used actual data when 
calculating these costs. However, we did find that other cost items, 
such as infrastructure investment, were reported with less accuracy 
and, in some instances, were simply "plugs" to ensure that the cost and 
rate increases were equal. In fact, while FCC found that in 2002 about 
6.2 percent of the rate increase was attributable to infrastructure 
costs, the findings from our survey of 9 large cable operators shows 
that overall infrastructure costs increased by $2.23 per month per 
subscriber--or about 84 percent of the average rate increase reported 
in 2002. While these estimates of infrastructure costs vary 
considerably, we recognize that our reported infrastructure cost are 
not directly comparable to the average rate increase since the average 
cost of $2.23 per month per subscriber includes some infrastructure 
costs not attributable to the basic and expanded-basic tiers of video 
service. We believe that these findings are consistent with a major 
point in our report: that is, the data reported on cost increases for 
programming were largely accurate, but the requirement that the sum of 
cost increases equal the average rate increase may have caused reduced 
estimates for other cost factors.

8. In its October 9 letter, FCC recognizes that while the statute 
authorizes it to make findings of effective competition, the commission 
implements this authority through the rules it has established. The 
commission notes that its current rules do not contemplate a 
reassessment of effective competition adjudication, except through the 
Local Franchise Authority recertification process. However, FCC states 
that the statute neither explicitly prohibits nor authorizes the 
commission from revising its rules. Accordingly, FCC now acknowledges 
that it could possibly modify the procedural rules associated with 
findings of effective competition, although the commission notes that 
it is unclear, in its view, whether this would work in communities 
lacking an effective competition designation.

9. We believe that when effective competition designations more 
accurately reflect current conditions, the resulting analysis provides 
a better measure of the impact of competition on cable rates. As we 
note in our report, we found that wire-based competition was associated 
with 15 percent lower cable rates, while FCC's report found that cable 
rates were approximately 7 percent lower with this competition. We 
believe the difference in these results is primarily the result of 
steps we took to update FCC's wire-based competition variable (see 
GAO's comment 6).

10. In our subsequent conversation with FCC staff, they asked us to 
identify possible ways that effective competition determinations could 
be kept more up to date. We identified a number of possible options 
that the commission could consider, recognizing that the commission 
would be the appropriate party to determine how this could best be 
done. We made a number of suggestions including (1) having effective 
competition determinations be time limited, (2) having the cable 
operator periodically certify that the circumstances under which the 
effective competition determination had been made had not changed, and 
(3) utilizing the information gathered as part of its Annual Price 
Survey to update the effective competition determinations. In its 
October 9 letter, the commission questions from a cost/benefit 
perspective the utility of such approaches.

FCC's underlying concerns about these approaches is that the market has 
changed. The commission notes that the level of competition is 
increasing year to year so that the number of communities reverting to 
a noncompetitive status is likely to be limited, while the number of 
communities facing effective competition for the first time is likely 
to be significant. For example, the commission provides that DBS 
penetration has reached an average of 15 percent or more (the threshold 
for a finding of effective competition) in at least 40 states. In our 
view, these changes in the market emphasize the need for FCC to review 
its process for making effective competition determinations. Moreover, 
as FCC emphasizes, the commission has a statutory mandate to report on 
average prices comparing cable systems that it has found are subject to 
effective competition with cable systems that it has found are not 
subject to effective competition. We believe that this report should, 
to the maximum extent possible, reflect the current conditions in order 
to ensure its utility.

[End of section]

Appendix VII: Comments from Industry Participants:

Below we summarize the written and oral comments that we received from 
industry participants that reviewed a draft of our report. Because many 
of these comments are opinion-based, we are not offering our views on 
them. In one case, however, we provide some clarifying information 
about the GAO model on cable rates.

American Cable Association:

The American Cable Association (ACA) noted that because we focused much 
of our analysis on larger cable operators, the report does not address 
issues of great importance to ACA and its membership, which are mostly 
small cable operators. ACA noted that for smaller cable operators, DBS 
providers are highly competitive, and programming costs are an even 
higher percentage of overall costs than is the case for larger cable 
operators. As a result, ACA disagreed with our suggestion that greater 
competition is a potential solution to increasing cable rates.

ACA provided, in its comments, a number of policy solutions that would 
address, in their view, the level of programming costs. Such options 
include mandating public disclosure of programming rates, requiring an 
 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  la carte system would impose additional technical 
costs and not cause cable rates to generally decline. Further, ACA did 
not believe that we adequately addressed the link between increased 
carriage of cable networks affiliated with broadcasters and higher 
cable rates.

Consumer Federation of America:

A representative of the Consumer Federation of America suggested that 
the costs associated with infrastructure upgrades were recouped from 
revenues generated by advanced services, such as the digital tier and 
cable modem service, and should not influence cable rates for the basic 
and expanded-basic tiers. Therefore, this representative believes that 
we overstate the contribution of infrastructure costs to increasing 
cable rates. Moreover, this representative noted that we do not fully 
account for the revenue obtained from advertising, which in this 
representative's view, should mitigate the need for increasing cable 
rates.

This representative also provided several comments on GAO's cable 
network carriage econometric model. First, this representative 
suggested that advertising revenues per subscriber could be treated as 
an endogenous variable--that is, it is a variable that is codetermined 
with other dependent variables in the model. Second, this 
representative suggested that we include a table reporting the results 
for the alternative specification, in which we consider cable networks 
owned by a cable operator.

Consumers Union:

A representative of Consumers Union believes that our finding that 
cable rates are 15 percent lower where a second wire-based competitor 
is present is evidence of cable operators' market power. He believes 
that we should measure the savings to American consumers that would 
accrue if cable rates were 15 percent lower in all franchises 
throughout the country. Additionally, this representative believes that 
our draft overstated the negative aspects of regulation. He stated that 
regulation may be the only viable option for addressing cable 
operators' market power because wire-based competition may not be 
feasible on a widespread basis.

Regarding our analysis of ownership affiliations, this representative 
believes that we should test for the impact of lower ownership 
thresholds, in addition to the analysis of majority-owned networks.

This representative made numerous comments regarding an  la carte 
system. First, he suggested that we overstated the costs of equipment 
associated with an  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  
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  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  la carte regime.

National Association of Broadcasters:

National Association of Broadcasters officials identified several 
issues associated with the cable industry. First, they stated that 
while our report implies that a greater number of channels are a 
benefit to subscribers, it is not clear whether this is the case. 
Second, they also noted a concern about how we measured the popularity 
of cable networks for the cable network carriage model.

These officials noted that in discussing pricing under an  la carte 
system, we should include the possibility of cable operators 
implementing a pricing scheme wherein subscribers are charged a flat 
monthly fee for access to the cable network and additional fees for 
each network selected. They believe that this would be the pricing 
structure implemented because cable operators must be able to recoup 
costs associated with their networks and overhead that are currently 
imbedded in the price for the basic and expanded-basic tiers.

Regarding retransmission consent, these officials do not believe there 
was sufficient discussion in our report of the history of 
retransmission consent. In particular, the option for cable network 
carriage in lieu of cash payment for retransmission of the broadcast 
station was largely supported by the cable industry. Additionally, they 
noted that our discussion regarding how retransmission consent is used 
was too broad because it implied that all broadcast stations use 
retransmission consent to gain carriage, while there are only a limited 
number of stations that do so.

National Association of Telecommunications Officers and Advisors:

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

NATOA also raised concerns about the lack of government data on cable 
rates and related issues. NATOA expressed concerns that we relied on 
FCC data--which we have noted may not be of high reliability--as well 
as on data from Kagan World Media, a cable industry data vendor. For 
example, NATOA expressed concern that we had no hard data on 
expenditures on customer service. NATOA noted that we should recommend 
to the Congress that some responsible agency (such as the Department of 
Justice) conduct an audit of the cable industry, including an 
examination of the contracts between cable networks and cable operators 
for the purchase of programming.

NATOA also raised concerns about how we analyzed the effect of 
ownership relationships on the cost of programming. NATOA's comments 
noted that our analysis of the effect of "majority-owned" programming 
was too limited, and that we should have included a broader definition 
of ownership affiliations, including, for example, agreements between 
companies that are separately owned, for this analysis.

According to NATOA, infrastructure investments are largely a benefit to 
subscribers of advanced services and, to the extent that basic and 
expanded-basic rates rise due to these investments, it represents a 
cross-subsidy.

NATOA also pointed out that, as we have noted, DBS penetration data 
used for effective competition filings have not been fully validated 
and are generally not available to stakeholders other than the cable 
operators. Moreover, NATOA noted that the Congress should reevaluate 
the 15 percent penetration level required under law for a finding of 
effective competition when the basis is competition from DBS providers. 
NATOA also noted that our finding of a 15 percent price reduction in 
areas with a wire-based competitor may be the result of temporary price 
discounts by new companies. Finally, NATOA noted that we do not fully 
discuss in this report the ramifications of a finding of effective 
competition. In particular, NATOA noted that we did not discuss that 
cable franchises with such a finding no longer have to price uniformly 
across the franchise area and are no longer subject to the tier buy-
through provisions of the Cable Television Consumer Protection and 
Competition Act of 1992.

Lastly, NATOA noted that it is critical for us to make it clear that, 
on the basis of the model results, there is only a slight reduction in 
cable rates due to the level of DBS penetration.

National Broadcasting Company:

National Broadcasting Company (NBC) officials suggested that we explain 
why broadcaster-owned cable networks are more frequently carried than 
other cable networks. In their view, cable operators, as a rule, do not 
pay any license fees for the right to carry a local broadcast station, 
notwithstanding the value of that programming to the cable operator. 
They also noted that, according to our data, cable operators also do 
not pay higher license fees for the right to carry these broadcaster-
affiliated networks. Instead, NBC officials said that the sole 
compensation that broadcasters receive in exchange for retransmission 
of the local broadcast stations' programming is an arguably higher 
penetration of cable carriage for their affiliated programming 
networks.

National Cable and Telecommunications Association:

The National Cable and Telecommunications Association (NCTA) had 
serious concerns about the finding from our econometric model, which 
indicates that cable rates are 15 percent lower in markets with a 
second wire-based competitor. NCTA officials noted that only about 45 
franchise communities have such an overbuilder compared with about 
10,000 cable systems nationwide. They also noted that the number of 
such overbuilders has declined in recent years, and the type of 
companies operating these businesses has been changing. As such, they 
believe that it is not appropriate to extrapolate these findings for 
the vast majority of markets that currently have no wireline 
competition. In its written comments, NCTA noted that "given the 
limited nature of wireline overbuild competition, it is important not 
to overstate its importance to determining a 'competitive' 
rate."[Footnote 66]

NCTA officials stated that there is no link between the possible 
exercise of market power and the increase in cable rates. They noted 
that, according to FCC's survey, rates for areas with effective 
competition have actually risen in the last 2 years at a slightly 
faster pace, on a percentage basis, than rates in areas without 
effective competition.

These officials also noted that our study did not take into account the 
rise in the quality of cable programming. In particular, they noted 
that a recent study by Professor Wildman, of Michigan State University, 
found that when analyzed on a price per-viewing-hour basis, cable rates 
have declined significantly in recent years. Additionally, they noted 
that there have been enormous benefits from the upgraded infrastructure 
of cable systems. They also noted that important benefits to those 
upgrades accrue to video subscribes (even if they do not take advanced 
services) in the form of better picture quality and more reliable cable 
service.

NCTA officials had two comments related to cable operators ownership of 
cable networks. First, they stated that our discussion of program 
access rules implied that there could be a significant problem for 
entrants' gaining access to programming. Conversely, they noted that 
program access concerns have always been minimal and that, if anything, 
these problems have declined in recent years, in part because few cable 
networks are owned by cable operators. Second, in terms of the carriage 
benefits that accrue to cable networks owned by cable operators, these 
officials noted that few cable networks are owned by cable operators. 
As such, they believe that while these cable networks may have an 
advantage in carriage, this is not a serious concern.

News Corporation:

Regarding programming costs, News Corporation (Fox) officials stated 
that the 59 percent increase in the cost of sports programming that we 
reported seemed high, and they suggested that we mention that the 
analysis did not include regional sports networks. Further, these 
officials also noted that the 72 networks that we compared with the 
sports programming networks include some networks that are not widely 
distributed. They said that our inclusion of such networks could 
exacerbate the difference in programming costs between the sports and 
nonsports networks because some of the less distributed networks would 
have low license fees.

News Corporation officials noted that one reason the sports leagues 
might have told us that the cost of sports rights has not increased 
much in the past year is because the leagues are in the middle of 
multiyear contracts. These officials noted, however, that when compared 
with previous multiyear contracts, there has been a large increase in 
the cost of sports rights.

Regarding retransmission consent, News Corporation officials noted that 
broadcast networks are highly valuable to consumers. Further, they 
noted that there are important objectives served by the retransmission 
provisions that should be more fully discussed in the body of our 
report.

These officials cited two concerns regarding our cable network carriage 
model. First, they indicated that we should include an explanatory 
variable for the price, or license fee, for each cable network. Second, 
they believe our model should include a variable that incorporates 
launch fees.

News Corporation officials believe that it is important to note that 
even if people only watch 17 channels, consumers value having access to 
more than 17 channels. Moreover, they indicated that consumers may not 
choose to watch the same 17 channels in any given year.

Satellite Broadcasting and Communications Association:

The Satellite Broadcasting and Communications Association chose to 
provide no comments.

Viacom:

Viacom (CBS) chose to provide no comments.

Walt Disney Company:

Walt Disney Company (ABC) officials said that our draft provided 
extensive information on how programming costs have increased over 
time, but did not provide enough coverage of how infrastructure costs 
have changed over time. Additionally, they believe the figures for 
programming costs that we reported are too high, and similarly that 
advertising revenues offset a greater portion of programming costs than 
we reported.

Disney officials noted that the value of cable service today is much 
greater than it was in the past in terms of the number of networks and 
quality of programming that subscribers receive. As evidence, they said 
that subscribers are watching cable networks more and broadcast 
networks less. They referred to a study prepared by Professor Wildman, 
of Michigan State University, which estimated the "real" cost of cable 
by considering viewing hours; the study finds that the value of cable 
service to subscribers has risen dramatically in recent years.

Regarding a sports tier, these officials noted that a sports tier only 
exists in New York, and that it has been bitterly fought-over, involved 
mediation, and is only a 1-year agreement. Moreover, they believe we 
should emphasize that the Yankees Entertainment and Sports (YES) 
network agreement only applies to regional sports networks, not ESPN. 
They said that the YES arrangement does not represent a trend and 
noted, for example, that cable operators continue to place cable-
affiliated sports networks on the expanded-basic tier.

Regarding retransmission consent, Disney officials said that we should 
provide more discussion about why the Congress passed this provision. 
They believe that without retransmission consent, free over-the-air 
television would be undermined. Moreover, they said that, prior to:

retransmission consent, broadcasters were required to provide content 
free of charge to cable operators that they subsequently sold to 
subscribers. Additionally, they said that it is important to note that 
the option of carriage of broadcaster-affiliated cable networks instead 
of payment for retransmission was discussed by Congress and has been 
endorsed by FCC. More importantly, according to these officials, Disney 
always offers a cash option to cable operators--their most recent offer 
was 70 cents per subscriber per month.

[End of section]

Appendix VIII: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Amy Abramowitz, (202) 512-2834 Michael Clements, (202) 512-2834:

Staff Acknowledgments:

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

FOOTNOTES

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

[2] Each year, FCC samples between 700 and 800 of the universe of 
roughly 10,000 cable systems using a stratified sampling approach that 
is based on the status of effective competition and the size of the 
cable system.

[3] These 9 cable operators that provided data to us serve 
approximately 62 percent of all cable subscribers in the United States 
as of 2002.

[4] While programming expenses are directly related to the cable rates, 
it is less clear how much of the infrastructure investment underlies 
cable rate increases since some of these costs are more directly 
related to the provision of digital cable tiers and cable modem 
service.

[5] In some cases, state public service commissions are also involved 
in cable regulation.

[6] The 1984 Act restricted regulation to only basic services for cable 
systems that were not subject to effective competition. In its 
rulemaking, FCC initially said that effective competition existed if 
three or more over-the-air broadcast signals existed in a given market. 
Under this definition, over 90 percent of all cable systems would be 
subject to effective competition and therefore not subject to rate 
regulation.

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

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

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

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

[11] This cable operator also noted that current rates in the market 
are not sustainable given the increasing cost of programming.

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

[13] See Ninth Annual Report, FCC 02-338.

[14] In our October 2002 report (GAO-03-130), we did not find that DBS 
competition was associated with lower cable rates. Although the 
parameter estimate was negative--indicating that DBS competition was 
associated with lower cable rates--the estimate was not statistically 
significant. As part of our analysis for this report, we further 
examined and refined our competition measures to more accurately 
reflect the true nature of competition in the franchise areas that were 
included in our analysis. Although the parameter estimate remains 
negative and the estimate is now statistically significant, the 
magnitude of estimate is very small.

[15] See U.S. General Accounting Office, Telecommunications: Data 
Gathering Weaknesses In FCC's Survey of Information on Factors 
Underlying Cable Rate Changes, GAO-03-742T (Washington, D.C.: May 6, 
2003), page 7, for a summary of the approaches used by cable operators 
to complete the form.

[16] In unregulated markets, for example, costs are an important factor 
in price setting by companies, but several other key factors, such as 
consumer demand and the competitiveness of the market, also influence 
the market price. Thus, costs and prices need not move in tandem.

[17] Many cable franchises we surveyed said that their profit margins 
for basic and expanded-basic cable services decreased in 2002, but many 
also said that those decreases were offset by increased profits from 
other services, such as cable Internet and digital cable. 

[18] For example, 15 cable franchises said that they entered dollar 
values in the factors until the entire rate increase was justified and 
did not consider the remaining cost factors; many others cited specific 
cost factors that were adjusted to reach a balance. 

[19] See Federal Communications Commission, Report on Cable Industry 
Prices (Washington, D.C.: Apr. 1, 2002). This is the most recent FCC 
report that is consistent with the data used in our analysis.

[20] The 1992 Act established three conditions for a finding of 
effective competition, and a fourth was added in the 1996 Act. 
Specifically, a finding of effective competition in a franchise area 
requires that FCC has found one of the following conditions to exist: 
fewer than 30 percent of the households in the franchise area subscribe 
to cable service (low-penetration test); at least two companies 
unaffiliated with each other offer comparable video programming service 
(through a wire or wireless (e.g., DBS service)) to 50 percent or more 
of the households in the franchise area, and at least 15 percent of the 
households take service other than from the largest company 
(competitive provider test); the franchising authority offers video 
programming service to at least 50 percent of the households in the 
franchise area (municipal test); or a local telephone company or its 
affiliate (or any other company using the facilities of such a carrier 
or its affiliate) offers video programming, by means other than DBS, 
that is comparable to that offered by the cable provider in the 
franchise area (local exchange carrier (LEC) test). For the LEC test to 
be applicable, the telephone company and the cable provider must be 
unaffiliated.

[21] Without a finding of effective competition, the cable operator 
must also charge a uniform rate for cable services throughout the cable 
franchise.

[22] The low-penetration test of effective competition applies if fewer 
than 30 percent of the households in the franchise area subscribe to 
cable service.

[23] We calculated the penetration rate by dividing the number of 
franchise subscribers by the number of households in the franchise 
area, as reported by the cable operator to FCC. 

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

[25] In addition to the BLS cable television subcategory index, FCC 
also reports the price per channel over time. Contrary to the BLS index 
indicating that cable prices increased just under 30 percent, FCC found 
that the price per channel rose by about 5 percent during this 5-year 
span. 

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

[27] Since the rates that cable networks negotiate with their clients/
affiliates are confidential, we do not know the actual fees cable 
operators pay to carry the networks. We thus relied on license fee data 
compiled by Kagan World Media.

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

[29] Two of the three sports leagues with whom we spoke told us that 
the cost of sports rights, paid by networks to the leagues, has not 
increased faster than the cost of other network programming in the last 
couple of years. However, representatives of the leagues did note that 
the cost to sports networks of producing sports programming is 
increasing because these are live events that require complex and 
costly production.

[30] For this analysis, we only used networks included in the Kagan 
publication that had financial data for the years 1999 to 2002. Later 
in this report, we have other analyses that use more of the networks 
included in the Kagan publication. In those analyses, we did not need 4 
historical years of data.

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

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

[33] We also performed the analysis reported in this section with a 20 
percent ownership affiliation threshold--that is, we considered a 
network as "owned" by a broadcast network or cable operator if the 
network was at least 20 percent owned by either of these types of 
providers. With this ownership threshold, our findings were nearly 
identical to those reported here.

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

[35] License fees received by broadcaster-affiliated networks were 
higher than those received by cable networks that were not majority-
owned by broadcasters or cable operators, but the difference was not 
statistically significant. Moreover, when sports networks were 
eliminated from the analysis, the average level of license fee was 
almost identical across these two groups. 

[36] In the cable license fee model, we regressed the average monthly 
license fee for 90 cable networks on a series of variables that might 
influence the license fee. See appendix I for a list of variables 
included in that model.

[37] Representatives of a broadcast organization told us that the 
digital local broadcast signals are sometimes carried on a digital 
tier.

[38] See The Carmel Group, The Telecom Future of Independent Cable: ACA 
Member Concerns and Issues (Carmel-by-the-Sea, CA: May 2003), a report 
prepared for the American Cable Association.

[39] Sometimes certain cable networks are transmitted unscrambled and 
trapping devices are used outside of the customer's home to keep 
networks that the home has not purchased from transmitting to the 
customer's televisions. This trapping technology would not be 
economically viable in an  la carte regime. 

[40] Recently, the Yankees Entertainment and Sports (YES) network was 
placed on a sports-only tier, with Madison Square Garden and FOX Sports 
Net New York, on selected Cablevision systems in the New York City 
metropolitan area following a lengthy dispute between YES and 
Cablevision. Subsequently, YES was offered on an  la carte basis on 
Time Warner Cable franchises in New York.

[41] One sports league also requires its cable network carriers to 
arrange for all cablecast games to be simulcast (subject to league 
sell-out rules) on free over-the-air television in the home cities of 
the participating clubs.

[42] In one case, the cable operator simultaneously added one or two 
other networks to the expanded-basic tier. 

[43] U.S. Public Interest Research Group, The Failure of Cable 
Deregulation: A Blueprint for Creating a Competitive, Pro-Consumer 
Cable Television Marketplace (Washington, D.C.: August 2003).

[44] Under the Communications Act, the prohibition on exclusive 
contracts enacted as part of the program access provisions in the 1992 
Act were set to sunset in October 2002 unless FCC determined the rules 
were still necessary. In 2002, FCC extended the prohibition until 
October 2007 because the commission determined that the prohibition 
continues to be necessary.

[45] In July 2003, FCC adopted a Notice of Inquiry asking for comment 
on a variety of issues related to competition in the video market. One 
of the issues related to program access issues.

[46] Recently, DIRECTV announced that it would provide local broadcast 
stations in all 210 television markets by 2008.

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

[48] Each local broadcast station has the right to negotiate for 
retransmission or to assert must-carry status. Under must carry, the 
cable operator is required to carry a local broadcast station, but can 
do so without paying any compensation.

[49] We also found that cable networks owned by cable operators are 
also more likely to be carried than networks not owned by broadcasters 
or cable operators.

[50] One possible option would be to replace the retransmission consent 
provisions with a must-carry right.

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

[52] Kagan World Media, Economics of Basic Cable Networks 2003 (Carmel, 
CA: 2003).

[53] Due to the confidential requirement of industry contracts, we 
could not independently verify the data from Kagan World Media. To 
assess the reliability of these data, we asked cable networks that we 
interviewed about the Kagan data. Eight of the 12 national cable 
networks we interviewed said that Kagan data on license fees, revenues, 
and programming expenses were fairly accurate.

[54] In the course of our review, we also identified some cable 
franchises that were apparently sampled because of clerical-type 
mistakes, such as the transposition of a franchise identification 
number or an inconsistency between franchises identified in the 
effective competition report and the franchises ultimately sampled. 

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

[56] See GAO-03-130.

[57] See GAO-03-130 for a discussion of why we use the three-stage 
least squares method, rather than the two-stage least squares method. 

[58] A dummy variable takes a value of 1 if a certain characteristic is 
present and a value of 0 otherwise.

[59] The dummy variables in the model include the following: horizontal 
concentration of cable systems, vertical relationship, regulation, 
presence of a wire-based competitor, presence of a MMDS competitor, DBS 
provision of local channels, and nonmetropolitan area. Also, because 
the natural log of 0 is undefined, we added 1 to the observed value of 
any continuous variable that can take the value of 0.

[60] For dummy variables (those variables that can take a value of 0 or 
1 depending on the presence of a condition (e.g., presence of wire-
based competitor, DBS providers offering local broadcast stations)), we 
report the percentage change arising from a discrete change from 0 to 
1. We calculated this percentage change as: [exp(parameter estimate)-1] 
times 100.

[61] In our October 2002 report (GAO-03-130), we did not find that DBS 
penetration was associated with lower cable rates. As part of our 
analysis for this report, we further refined our measure of competition 
to more accurately reflect the actual status of competition at the time 
our data were gathered. These refinements contributed to our finding 
that DBS penetration was associated with lower cable rates.

[62] In our October 2002 report(GAO-03-130), MMDS competitors were 
included in our variable that measured nonsatellite competition. For 
this report, we removed MMDS competitors from the nonsatellite 
competition variable, thereby creating a wire-based only competition 
variable, and created a separate variable for MMDS competition. We made 
this adjustment because (1) MMDS relies on a different technology than 
either wire-based or DBS competitors and (2) many MMDS operators are 
scaling back or discontinuing video service.

[63] For example, see Waterman, D. and A.W. Weiss, "The Effects of 
Vertical Integration Between Cable Television Systems and Pay Cable 
Networks," Journal of Econometrics, 72 (1996): 357-395 and Chipty, T., 
"Vertical Integration, Market Foreclosure, and Consumer Welfare in the 
Cable Television Industry," American Economic Review, 91(3) (2001): 
428-453. These studies found that cable operators were more likely to 
carry networks that they owned. These studies, however, did not test 
whether cable operators were more likely to carry a network owned by a 
broadcaster.

[64] An alternative method to estimate the reduced-form equation is the 
probit model. In a binary choice model, the differences between the 
logistic and probit models are generally not significant. Differences 
can arise in the multinomial model, where there are three or more 
choices, because the logistic model imposes independence conditions 
that sometimes do not reflect the conditions being modeled. Such was 
not the case in our model, since we estimated a binary choice equation.

[65] We calculated these percentages by taking the mean values of all 
variables included in the model and deriving a predicted value of 
carriage for a broadcast-affiliated network and a nonbroadcast-
affiliated network. We then took the percentage differences in these 
predicted values. The same methodology was used for determining the 
relative likelihood that a cable-affiliated network would be carried. 

[66] In our model, we included approximately 100 franchises that were 
classified as facing wire-based competition--we believe that FCC's 
number of only 45 overbuilders, as cited by NCTA, does not include all 
wire-based competitors. Moreover, the sample of franchises included in 
our model was only about 720, which were randomly selected by FCC to be 
representative of the universe of franchises. As such, approximately 16 
percent of the franchises included in our model were classified as 
having a wire-based competitor. 

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