This chapter discusses the technology developments outlined above.
Video compression is examined first, followed by HDTV, interactive television,

and encryption.

VIDEO COMPRESSION TECHNOLOGIES

Digital video compression is a signal processing technique that permits
transmission of a television signal using significantly less pandwidth than is
currently needed (6 MHz for terrestrial broacast signals and cable and 24 MHZ
for satellite signals). Digital video compression technology is applicable to
all of the video delivery systems -- satellite, cable, broadcast, and
wireless cable. For a given compression ratio, twice as many NTSC signals can
be transmitted via a 24 MHz satellite transponder as via a 6 MHz terrestrial
chanrel. Compression methods now under development promise to permit as many
as eight standard NTSC television signals to be carried on a single satellite

transponder .46

The technical details of compression technology are beyond the scope of
this paper. However, the key effects of video compression will be a
substantial increase in channel capacity and a concomitant reduction in the

cost of achannel. As a consequence, delivery systems that utilize

———_.

46 This satellite transmission compression ratio translates into a four-to-
one ratio for terrestrial transmissions. Leland L. Johnson and Deborah R.
Castleman, j i 3 i i

ision?, R-4047-MF/RL, (Santa Monica, CA: RAND Corp., 1991) ("RAND DBS
Report"), Pp- 51-59. See also Cable World, March 18, 1991, p. 9-

- 49 -


as GNP through 1995. Thus the rapid historical growth of television

advertising is believed to have come to an end.

TABLE 23
VIDEO ADVERTISING AND GNP

Ad Volume Video Ad Volume Ad Volume/GNP Video Ad Volume/ Video Ad Volume/

($_Biltion) ($_Biillon)* (%) Ad Volume (%) GNP _(%)
1975 27.9 5.3 1.75 18.9 0.33
1980 53.6 11.5 1.96 21.4 0.42
1985 94.8 21.0 2.36 22.2 0.52
1990** 130.5 28.9 2.38 22.1 0.52
1995** 182.7 40.2 2.38 22.0 0.53

SOURCE: 1975-1985, McCann-Erickson, inc., “Estimated Annua! U.S. Advertising Expenditures,” prepared
for Advertising Age, April 1991; 1990-1995, Television Bureau of Advertising, “Trends in GNP, Ad Volume,
and TV Ad Volume 1960-1995," August 1990.

“Includes national syndication and cable. **Projected.

The growth of total advertising expenditures, according to Veronis,
Suhler and Associates, has been slowed by corporate restructuring--changes
in corporate ownership, leveraged buyouts, and the like--which has retarded
the growth of advertising expenditures, in particular shifting advertisers’
focus from long-term advertising designed to build product images to short-
term promotions. Veronis, Suhler predict a rebound after 1992.136 Others

predict a continuation of a twenty-year trend away from media advertising to

136 Communications Industry Forecast, p. 24.

- 113 -


IV. ROADCAST TELEVISION

The advent of alternative video media has radically altered the market
in which television stations and networks operate. This chapter reviews the
effects on the availability and viewing of broadcast stations and on their

financial health.

AVAILABILITY OF OVER-THE-AIR TELEVISION SIGNALS

Despite apparent competition from new cable systems, the total number
of television stations, particularly UHF stations, has increased over the
past decade (table 3). After a period of slow growth in the 1970's, the

TABLE 3
COMMERCIAL TELEVISION STATIONS, 1975-1990

1975 1980 1985 1990
Number of Stations

Total’ 706 734 883 1,093
VHF* 514 516 520 547
UHF* 192 218 363 . 546
Independent** 86 129 262 380

% Change Over 5 Years
Total* 40 20.3 23.8
VHF* 0.4 "1.0 5.2
UHF* 13.5 66.5 50.4
Independent** 103.1 45.0

SOURCES: Total, VHF, and UHF, Television Bureau of Advertising, Inc., "Trends in Television,"
April 1990, p. 9; independents, 1975, Tentative Decision and Request for Further Comments,
BC Docket No. 82-345, 94 F.C.C.2d 1019 (1983), paragraph 111 and table 3; 1980-1990, Arbitron,
cited by CBS.

*January 1st each year. **November each year except 1990, which is based on May.

-15-


not now subscribe to cable will be made worse off because they will be unable
to receive or will have to pay for service that was previously available

without direct payment.

The expansion in the number of cable networks appears to be slowing
down for the time being, however, in part because of cable systems’ limited
channel capacity. In the near future, however, video compression techniques
will bring large increases in channel capacity, which will allow further

innovations in programming, as well as more flexible scheduling.182

Cable programming has produced several general-interest networks that
attract large audiences.183 In addition, many other cable net works have
attempted to defined themselves by creating programming that appeals to
narrowly-defined audiences, and to rely on the specialized character of the
programming to attract audiences.184 All but three basic cable channels have
ratings of less than 1 percent of televison households, but in the aggregate

they account for a substantial share of viewing.185 So cable presents a

182 See chapter V above. Also see "Cable Industry Undergoes Shakeout as
Networks Fight for Viewers," Washington Post, Dec. 19, 1990, p. D-1; Brian
Donlon, “Enthusiasm for cable at ‘all-time high,’/" USA Today, March 22, 1991,
p. A-l.

183 Among the most popular basic cable channels are WTBS, USA, ESPN, and
TNT. See chapter VI for a discussion of cable program offerings.

184 Geraldine Fabrikant, "Channels Seek Identity in Made-for-Cable Films,"
New York Times, April 1, 1991, p. D-8.

185 See table 17 in chapter VI.

- 144 -


more efficient use of resources, but they will also undoubtedly have some
effect on program quality. These changes may to some extent be a response
to a cyclical decline in revenues, but the long-term pattern in audience
shares and program prices makes it likely that a long-term shift in strategy

is at work as well.

The networks face the risk that large cutbacks in program expenditures
may reduce the perceived quality and distinctiveness of network programming
and further reduce the networks’ ability to attract audiences, and that a
downward spiral of program expenditures and audiences will result.176 The
outcome will depend on audience tastes in programming, and remains to be seen. —
At present, total audiences of individual networks in prime time remain
several times as large as those of their nearest rivals, and, as shown below,
for the foreseeable future the networks’ revenues appear large enough to
permit them to outspend cable networks on programming overall, though possibly
not on particular programs such as made-for-TV movies, sports, and
non-continuing series. While cable networks have the advantage of both
advertising and subscription revenues, both are still based on relatively

small audiences.

——_——_-

176 Indeed the Association of Independent Television Stations, Inc. (INTV)
states that such a downward spiral has already begun. INTV Reply Comments,
p. 37.

- 139 -




and almost twice the amount of theater box office revenues.129 This works
out to $2.92 per VCR household per week, or roughly the cost of the rental of
one videocassette per week. Videocassette expenditures are projected to
increase to $16.5 billion by 1995,130 The expenditures on videocassettes
make clear that viewers are willing to spend large amounts for small

quantities of highly-valued programming.

WIRELESS CABLE

An alternative multichannel distribution medium is provided by the
Multichannel Multipoint Distribution Service (MMDS), commonly called
wireless cable. These systems use microwave frequencies to transmit up to
32 chanrels of programming that can be received by conventional television
sets with the aid of a converter. Wireless cable has developed as a
pay service that is a closer substitute for cable than for over-the-
air broadcasting. In fact, wireless cable systems are considered to provide
more promising competition for existing cable systems than do competing
second cable systems ("overbuilds") because they can serve small numbers of

customers with a relatively small capital investment .131

129 See table 2.

130 NBC, citing Paul Kagan Associates, Motion Picture Investor, Dec. 28,
1989.

131 Cable systems must pass large numbers of homes with cable whether they

subscribe or not, while wireless cable systems need only provide a headend
and receiving equipment for actual subscribers.

- 109 -


equipment is high enough to make an advertiser-supported service profitable.
Broadcasters may perceive HDTV as a large additional expense that is
necessary to meet competition but that probably will not increase audiences

or advertising revenues.

Incremental improvements in television picture quality may become
available before full-fledged HDTV. For instance, Faroudja Labs has
developed a technique for improving the picture and sound quality of NTSC
signals. Faroudja claims that its system, unlike so-called
enhanced-cefinition (EDTV) systems, is consistent with the NTSC standard and
so may be introduced with little or no Commission action.61 Faroudja has
announced that television sets to receive its SuperNTSC system could be
available within two years. 62 Encoders required for broadcasting are ready
now. Since SuperNTSC capability is expected to add only $300 to the cost
of a conventional NTSC receiver, and equipment required by broadcasters
might cost $10,000, the system might be attractive to consumers and
broadcasters. As in the case of HDTV, however, consumer demand for such an
innovation is difficult to predict. In the long run such an incremental

improvement in quality would probably have little effect on competition

61 The Commission has determined that it will select an EDTV system, if
at all, only after it selects a simulcast HDTV system. Statement of
Chairman Alfred C. Sikes to the Advisory Committee for Advanced Television,
March 21, 1990.

62 "Faroudja to Bypass HDTV Test Process, Begin Immediate
Commercialization, " Communications Daily, September 12, 1990, p. 2.

- 58 -


considerable audience erosion without substantially reducing costs. In the
largest markets, too, cable penet ration appears to be lower than in smaller
markets because of the large number of over-the-air alternatives, so that
audiences probably will erode less there than elsewhere.

In smaller markets, however, the need to cut costs may in fact reduce
expenditures on local Programming, which may reduce the Quantity or quality of
news and public affairs Programming. Local Programming by independent
Stations, except those in the largest markets, Probably will be affected
little because, as indicated above, most independents spend relatively little
on local programming in any case. (See chapter IV.) The number of broadcast
Stations may fall, but the stations most likely to leave the market are the

marginal ones that probably spend little on local programming. 180

In all markets, a reduction in the number of Stations may increase the

audiences and revenues of the remaining stations. These stations may find it

180 A large percentage of small markets have independent stations. In 1989-
90, of the 109 markets ranked below 100, 52 had one or more independent
stations. Twenty had four or more affiliates. (At least some of these,
however, were overlapping markets, so all stations Probably do not reach the
whole area.) Arbitron, i i Jo Further, the
financial performance of affiliates in small markets was better than that of
independents. In 1989 at least 75 Percent of independents in markets ranked
below 100 reported losses, while between 50 and 75 percent of affiliates in
markets 101-150 reported losses and between 25 and 50 percent of affiliates in
Markets 151-209 reported losses. NAB, i i i , 1990, pp.
44-49, 71. These figures suggest that independent stations are far more at
risk than affiliates, and that the number of viewers that might lose the
Programming of network affiliates is small.

- 142 -


Basic cable service is a package of channels that generally includes
some retransmitted broadcast signals (local and distant), some satellite-
delivered cable networks, and some locally-originated cable channels (e.g.,
public access, educational, and government) .72, The broadcast signals and
cable networks generally include advertising. The subscriber pays a flat
fee for the entire package of channels. During the past year or so, many
cable multiple system operators (MSOs) have “retiered" their cable systems,
i.e., divided basic service into two or more separately priced packages. 73
Subscribers are not required to purchase all basic tiers. Press reports
suggest that this adjustment is motivated by apprehension that rising cable
rates might spark reregulation and by concern over sharply rising carriage
fees charged by a small number of particularly popular cable channels.
Placing such channels on a separate tier makes it possible to pass on price

increases only to those who value the channels.

Pay cable services are offered to subscribers on a per channel basis
for an additional fee. They generally do not carry advertising. Examples
include Showtime, HBO, the Disney Channel, and some of the regional sports

chanrels.74

72 In the Communications Act, basic cable service is defined as “any
service tier which includes the retransmission of local television broadcast
signals." 47 U.S.C. 522(2) See also 47 C.F.R. 76.5 (ii).

73 For a discussion of retiering and the motivation for undertaking it, see
Broadcasting, May 21, 1990, pp. 35-41.

74 Chapter II discusses the importance of direct payment for programming
(or any product) as a mechanism for transmitting to producers information

- 69 -


OT. THE BOONOMICS @ TELEVISION FINANCING METHODS

Broadcast television in the United States has been financed, with few
exceptions, by the sale of advertising time, in contrast with other video
media where direct viewer payment is the norm. While broadcasters clearly
produce programming that informs, educates, and entertains, their purpose
in doing so is to attract audiences to sell to advertisers. Since the
effects of the differing financing methods crucially affect both the
financial viability of the media and their ability to meet consumers’
preferences, it is useful to begin by discussing these financing methods

and their implications for the television marketplace.

Advertiser support historically has provided a means of paying for
broadcast services in the absence of a conventional market for broadcast
programming. A market in which viewers could buy the programs they want,
as they do other commodities, did not develop in broadcasting in part
because collecting payment from viewers historically has been prohibitively

difficult or expensive.l Further, a broadcast system financed by direct

1 Commission rules permit broadcast stations to transmit in the
subscription television (STV) mode, but the Commission has classified those
services as non-broaccast. Report and Order in General Docket No. 85-305, 2
FOC Red 1001 (1987) ("Subscription Video Report and Order"). At the moment,
no full-power television broadcast stations operate in the STV mode, at
least. in part because of the expense of controlling access to the signal via

encryption.


NETWORK ADVERTISING

Historically, broadcast Network advertising was considered far superior
to any alternative for advertising many products. The advantage of
network advertising is greatest for types of advertising, particularly
those introducing new consumer products, where near-universal coverage is
considered essential. Net working reduces transactions costs by permitting the
Purchase of advertising that will reach large audiences in a single
transaction. While it is possible to reach an equivalent national audience
through a combination of national spot and cable network advertising, buying
broadcast network time is much easier for advertising agency time buyers.
Whereas broadcast network advertising can in principle reach essentially the
entire population, cable advertising at best misses about 40 percent of the
households in the country because they do not subscribe to cable. While basic ;
cable channels as a group recently achieved an audience share equivalent to
that of a single network, individual cable channels have only small shares
of viewing, 142

In addition, audience measurement techniques for cable are not well
developed, so that advertisers cannot be sure how large an audience they are
reaching. Network advertising has a lower ost per viewer than national spot

142 “Growth of basic-cable’s Steady," Variety, September 17, 1990, p. 34,

- 118 -


AzZmoumev

Closer substitutes for the networks are clearly appearing. (See
figure 10.) The Fox network now reaches 91 percent of households in the
country, and through deals with cable operators where it is unavailable over
the air hopes to reach another 5 percent ,151 Fox programs only five
evenings a week, but is attempting to expand its schedule. Independent

station revenues jumped in 1989, apparently as a result of Fox's success.152

FIGURE 10
SHARE OF TELEVISION ADVERTISING REVENUE

VIIA

100,

:

1

c
Lon
=

t + { + + : + .
1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990
YEAR
ED Network Station J Nat'l Syndication [3 Cable TV

151 "Tele-Communications Deal Extends Fox’s Cable Reach," New_York Times,
September 7, 1990, p. D-6; “With Cable as Partner, Fox Dances in the Ratings,"
New York Times, September 10, 1990, p. D-9.

152 It is not clear whether enough independent stations remain to make yet
another broadcast network viable. Fox now has 134 affiliates; 94 markets have
a second independent, and 58 have a third. Arbitron, Television Market Guide,
1289-1990

~- 124 -


increased for blacks during the period. College graduation rates have
actually decreased since 1977. Hispanics’ high school completion rates and
both blacks’ and Hispanics’ college completion rates lag far below those of
whites.

How will these changes affect television viewing? The largest and
probably most important change has been the increasing percentage of women
in the labor force. Women aged 18-49 are a demographic group highly valued
by advertisers, and this age group has experienced the greatest increase in
labor force participation. A probable reduction in daytime viewing is an
obvious result, but a decrease in leisure time for these women, and other

family members as well, will probably also redwe viewing at other times.

Slower population growth will also mean that the potential audience
will grow more slowly than in the past. An aging population will have
implications for program tastes, which will be particularly important for
advertiser-supported broadcasters since older age groups will have higher
incomes than in the past and should be more attractive to advertisers. More
importantly, possibly, an older population will mean a larger percentage of
the population working and smaller daytime audiences. A larger percentage
of foreigners in the population may mean less interest in mainstream
programming and more time spent watching foreign-language videocassettes,

for instance.

- 179 -


If, contrary to expectation, the networks networks were to decouple
from their local affiliates, television broadcasting would be substantially
less popular. Decoupling might at some point be profitable to the networks
if other media could pay as much for programming as the networks derive from
broadcast advertising. This probably would leave the former affiliates with
less attractive program choices, though as the gap in quality between net work
and other programming narrows, the potential loss to the affiliates also will
fall. The affiliates would lose network compensation but would regain
advertising spots to sell. The success of the Fox network, and of some cable
networks, however, suggests that, at least on some scale, broadcast networking

can still be highly profitable.

Further, the cable industry may evolve in ways that make it a closer
substitute for broadcast television. Nothing prevents cable systems, or
groups of them, from producing and transmitting local programming. Local
cable news channels are increasing in number and are beginning to duplicate
the last remaining unique service of broadcast stations. And while no one

. appears to be contemplating such a service, free, (i.e., having no subscriber
fee whatever) advertiser-supported cable channels could conceivably garner
some of the remaining audience of nonsubscribers. If so, cable and DBS
between them could offer all the services now provided by over-the-air

broadcasters.

On the other side of the ledger, new technologies could allow

broadcasters to compete more effectively with multichannel media. Video

- 168 -


services will likely cost more than if only a single system is in use.62 When
an encryption system is compromised, it can either be scrapped or repaired.
In either case, subscribers face additional costs -- purchasing a new decoder
or paying for an upgrade of the old one. Thus, system security affects

equipment costs too.

SUMMARY

Digital compression is the technological factor that almost certainly
will have the biggest impact on the video delivery marketplace over the next
ten years. It will allow for greatly expanded capacity on all media and will
reduce the cost of channel capacity, thus spurring the development of new,
competitive program channels, many of them narrowly focused. Compression

will be implemented first for satellites (within the next year), then for

69 Most satellite cable programming services are now encrypted using the
Videocipher II technology. ECC Encryption Standards Report. Because
programmers have powerful incentives to make their wares available to as many
households as possible, they will be likely to address any problems of
incompatible encryption standards that may arise. The options for dealing with
such issues include adoption of a voluntary standard, simulcasting programming
in different formats (the practicality of this option will be enhanced by
the reduction in transponder costs that video compression is likely to bring),
and pursuit of technologies to reduce the cost of a "multi-standard" decoder.
One such technique would be adoption of a standard decoder interface. This
would allow interchangeability and manufacturers could offer receivers with
multiple standard encryption ports for maximum flexibility. The "smart
card," a cartridge that can be inserted in the back of a decoder to change
the manner in which the decoder is authorized to receive scrambled services,
could be used with the standard decoder interface in a multiple encryption
standards environment, or to restore security to a compromised encryption
system. The smart card offers the possibility to make theft of service
unprofitable by permitting relatively inexpensive security upgrades, either
at regular intervals or in response to specific breaches in the encryption
system.

- 64-


FIGURE 3
WEEKLY TELEVISION VIEWING

rey irae srs

NON-CABLE HOUSEHOLDS CABLE HOUSEHOLDS

AMME~ODCOXT O2-SmM-<

EdNetwork Attiliates independents Public E¥Cable

Trends in cable and non-cable household viewing are shown in table 6,
which provides data on all-day viewing shares for the ratings years of
1984/85 and 1989/90.19 The share of viewing accounted for by cable services
increased steadily during this period. For all households, the share of
cable-originated services (i.e., basic plus pay) rose from 14 to 26 percent
during the period. If distant independent stations and superstations, which
in general are available only via cable, are included, in 1989/90 32 percent
of viewing in all television households was accounted for by services

available only via cable. In cable households, the viewing share of cable-

19 Except as noted, the data presented here are percentages of
total viewing, not the commonly-reported shares of households, which do not
account for viewing of more than one chanrel at a time by a household.

-22-


directly in the future, but the success of home satellite in cabled areas is

by no means assured.

In 1990, between 2.7 and 3 million home satellite dish systems were
in use in the United States.107 This represents roughly three percent of
television households. A recent survey shows that 42.2 percent of dish
owners are also passed by cable, and 11.3 percent of dish owners actually
subscribe to cable.108 ‘his implies that approximately 20 percent of homes

not passed by cable have home satellite dish systems.

The proliferation of home satellite dish systems depends on the
following factors: (1) the cost of the reception equipment; (2) the
availability of cable service; (3) the size of the dish antenna needed; (4)
the availability and price of programming; and (5) the timing of the
adoption of certain innovations, in particular digital signal compression.
This chapter begins by surveying current and proposed satellite services.
After that is an analysis of the prospects of those services in light of the

above factors and a brief conclusion.

107 The lower estimate is from Satellite Business News, November 14, 1990,
p. 1; the higher is from Paul Kagan Associates, Marketing New Media,
September 17, 1990, p. 7.

108 Satellite TV Week survey, reported in SatVision (the magazine of the
Satellite Broadcasting and Communications Association) October 1990, p. 7.

- 93 -


increased viewing of independents and Fox stations accounts for almost as
much of the decline in the prime-time network share as does increased

viewing of cable-only programming.

FIGURE 5
PRIME-TIME VIEWING SHARES
1982-83 1989-90
Wl 3 Networks
E) independents
Fox

£) Basic Cable
Pay Cable

Table 9 shows the shares of viewing accounted for by network affiliates
during "network dayparts" and “non-network dayparts." Overall, viewing
shares of affiliates have declined from 63 percent to 52 percent in all
households and from 53 to 43 percent in cable households during the period
from 1984/85 to 1989/90. However, the decline has apparently been more
precipitous in the non-network dayparts, i.e., those that are programmed

locally by the affiliated stations, either with locally produced or

- 29 -


The ability of cable to attract viewers with relatively inexpensive
programming--even when viewers have to pay for it--suggests the great value
viewers place on breadth of choice and on Programming narrowly tailored to
specialized tastes. At the same time, the large programming expenditures of
the broadcast networks may suggest that broadcast networks! programming funds
are being spent inefficiently. The networks’ high program expenditures also
suggest the possibility that some of the profits of broadcasting are being
Passed on to the program production industry in high payments for top actors
and other talent, and that reduced expenditures on programming might not

result in commensurate reductions in quality.

In some cases, the combination of viewer payment and large audiences has
allowed cable networks to pay higher prices than the broadcast networks could
profitably pay. Sports programming on ESPN, TNT, and other networks appears
to be an example. Another example is loss of programming to cable from public
television, whose source of revenue is voluntary viewer payment rather than

advertising.

In assuming that cable program expenditures will remain a constant
percentage of revenues, these projections may understate future cable program
expenditures. Cable networks, particularly basic networks, now spend a far
lower percentage of their gross revenues on programming than do broadcast
networks. Because of economies of scale, broadcast networks’ non-programming
costs are probably lower than cable networks’. But also cable networks’

subscription and advertising revenues have grown rapidly, and program

~ 154 -


channels for viewers with the appropriate reception equipment. In this
environment, the Commission might well wish to re-examine its dual net working
rule. This rule, in essence, prohibits any firm from operating more than
one television broadcast network. The ability to obtain packaged programming
from multiple suppliers is particularly important in the compression context,
since it is likely that only a small share of the new capacity will be filled
by locally produced programming. On the other hand, to the extent that
compressed video channels were offered on a subscription basis, they might not
constitute broadcasting at all, and thus might not be subject to the dual

networking rule.54

Currently over 40 percent of television households rely on free over-
the-air television for their video programming. For those households,
investment in the additional equipment needed to receive compressed video may
not be immediately attractive. Because households that did not make such an
investment would lose service if local broadcast stations adopted video
compression, it is likely that compression will not be initially adopted for

. broadcast transmissions.55 It is more likely to be introduced along with

HDTV, since a new receiver will be required in any case for HDTV and most of

54 See Subscription Video Report and Order.

55 On the other hand, cable and satellite distribution systems could
introduce compressed video by replacing their subscribers’ converters and
raising the customer premises equipment rental fee component of the monthly
subscription bill.

-~54-


For some kinds of mass-appeal programming, Probably including many
network series and much other programming made for television, reasonably good
substitutes, in terms of audience size, can be created, and the possibility of
expanding supply limits potential price increases. Other kinds of
Programming, including unique sports events such as the Super Bowl and the
World Series, have high value to a large percentage of viewers and cannot be
duplicated. These programs would generate high subscription revenues and are

likely candidates to be bid away to pay or pay-per-view services 174

As a consequence of both declining audience shares and increased program
prices, additional expenditures on Progamming are likely to be less effective
than in the past in increasing audiences. Thus the profit-maximizing strategy
for networks may be to reduce program expenditures and thus offer programs of
lower perceived quality than in the past, particularly if the decline in
audience shares is believed to be permanent and irreversible. If revenues
are expected to be lower than in the past for the long-term future, the
networks may have no choice but to reduce program expenditures over the long

- term. The three conventional networks in fact are reported to be introducing
Programs in less expensive genres in order to cut costs, and appear to be

cutting back on news operations.175 The cutbacks may in part simply involve

174 Considerable political pressure has arisen to keep highly valued sports
events on free television.

175 Tam Shales, "CBS Network Eliminates 400 Jobs," Washington Post, April 6,
Les Angeles Times,

1991, p. D-1; Jane Hall, "Networks’ New News Strategy,"
March 28, 1991, p. F-+1.

- 138 -


Cable subscribership will almost certainly continue to grow, though
the rate of growth may have peaked. Over 90 percent of television
households are now passed by cable, and over 60 percent of those passed
subscribe. Many of the households not passed by cable are located in areas
where cable service would be prohibitively costly, and many nonsubscribers
probably place a low value on cable service. By one estimate, basic cable
subscribership, which grew 41 percent between 1985 and 1990, will grow 18
percent between 1990 and 1995 and 30 percent between 1990 and 1999. By
this estimate, in 1999 about two-thirds of all households will receive
cable.20 But changes in the relative attractiveness of the media could

drastically change this proportion.

Viewing of broadcast network programming has declined more sharply
than viewing of other over-the-air programming. Over the whole period from
1975 to 1990 the three-net work share of households (not percentage of

viewing) in prime time fell from 93 to 64; the absolute number of households

20 Paul Kagan Associates, Inc., Cable TV Programming, August 31,
1990, p. 2.

-25-


according to these projections, HDTV will not have an appreciable effect on
the television marketplace during the period covered by this study, though

it may be widely adopted shortly thereafter.

Since HDTV is a service that, at least at first, is likely to have
small audiences but to be highly valued by its viewers, it is most likely
tobe introduced by a medium that allows direct viewer payment. HDTV is
likely to be offered first on prerecorded videocassettes. DBS also appears
to be a particularly promising early delivery medium for HDTV because it
can aggregate small audiences on a nationwide basis, and because the cost
of HDTV transmission equipment would only have to be incurred once for the
whole nation. Cable will probably also offer HDTV before over-the-air
broadcasting.60 In principle HDTV could be introduced by these media
without waiting for the FCC to set standards, though in practice
compatibility with terrestrial broadcasting appears important enough to

cause other media to wait and adopt the broadcast standard.

Since early audiences will be small, and even in the long run HDTV
may not increase broadcast audiences, broadcasters’ primary incentive to
adopt HDTV will be the necessity to meet competition from other media.

Broadcasters probably will adopt HDTV after penetration of receiving

60S. Merrill Weiss, “Rolling Out Advanced Television in the United States:
A Broadcaster’s Perspective," Broaccast. Cable Financial Journal, March-April
1991, p. 28.

-57-


Changes in family structure may result in a population that will be
increasingly divided between well-off single-person and two-earner
households and struggling single-parent families. Two-earner families will
have the income to buy advanced electronic equipment and program services,
but not necessarily the leisure to use them. Single-parent families, on
the other hand, are likely to lack the resources to purchase expensive
services, which will work to the advantage of broadcast television. A
mismatch between the increasingly sophisticated skills needed and those
available in the work force may similarly divide the population into

economic strata and affect purchase of program services.

- 180 -


CURRENT AND PROPOSED SATELLITE SERVICES

Satellite services can be divided into three categories: C-band,
medium power Ku-band, and high power Ku-band.109 The categories differ
significantly with respect to satellite spacing and permissible transponder
Power, which together influence receiving antenna size, and with respect
to program supply. The high power Ku-band has been allocated by
international agreement to the "broadcast satellite service." It is known
in the United States as DBS, "true DBS," or high power DBS. Of the three
categories, this is the only one originally intended for transmissions
directly to the general public. The other two categories are in the "fixed
satellite service," and were intended primarily for point-to-point or point-
to-multipoint transmissions directed at cable system headends, terrestrial
broadcast stations, or other local distributors, which would then retransmit
the material to individual households. However, there are operating and
Ppianned services in both of these categories that provide programming

directly to home satellite dish (HSD) owners.
The C-Band

Today virtually all home satellite dish systems are C-band systems,
although a significant minority have Ku-band capability as well. Current C-

band antennas are usually ten feet or so in diameter, making them

109 This section draws on Reinhart for background information on these
three categories of system.

- 94 -


consent would allow broadcasters to negotiate for payment for the use of their
programming by cable systems that reflected the value of the programming. to
the cable system, and might give broadcasters more revenue with which to

purchase more expensive programming.209
SUMMARY

Broadcast. networks and stations will have declining audiences, revenues,
and program expenditures in the future. Much of the decline in expenditures
will occur through a reduction in prices, so that the decline in broadcast
revenues will be shared with the program production and syndication
industries. Nevertheless, for both networks and stations, the quality and
distinctiveness of programming will probably also be adversely affected. The
quality of local programming, comprised mostly of news and public affairs, may

also decline.

Because of the large number of channels available, basic cable can
present both general-interest programming resembling that of the networks and
highly focused special-interest programming. While pay and pay-per-view cable
present some expensive, highly popular programming, overall expenditures on

cable programming, particularly basic cable programming, are lower than those

209 A CSS representative estimates, based on fees paid by cable systems to
cable networks, that retransmission consent would result in fees of $72-$160
million per year for CBS and its affiliates. "CBS Believes Retransmission
Consent Plan is ‘Ahead of Schedule,’" Communications Daily, June 3, 1991, p.
3.

- 157 -


TABLE 24
COMPONENTS OF VIDEO ADVERTISING

1975 1980 1985 t990*
Video Ad Volume ($ Million)
Total 5,263 11,469 21,022 28,405

National 3,929 8,494 15,178 20,153
Broadcast Network 2,306 5,130 8,060 9,383
National Spot 1,623 3,269 6,004 7,788
National Syndication - 50 520 1,589
Cable Network - 45 594 1,393

Local 1,334 2,975 5,844 8,252
Local Spot 1,334 2,967 5,714 7,856
Cable (Non-network) - 8 130 396

Percent of Tota!

National 74.7 74.1 72.2 70.9
Broadcast Network 43.8 44.7 38.3 33.0
National Spot 30.8 28.5 28.6 27.4
National Syndication - 0.4 25 5.6
Cable Network a 0.4 2.8 49

Local 25.3 25.9 27.8 29.1
Local Spot 25.3 25.9 27.2 27.7
Cable (Non-network) - 0.1 0.6 1.4

SOURCE: MeCann-Erickson, Inc., "Estimated Annual U.S. Advertising Expenditures,”
Prepared for Advertising Age, April 1991.

“Preliminary.

- 116 -


costs and profits is consistent with artificial supply limitations in large
markets, and with stations in those markets driving costs above the
competitive minimum in an attempt to increase their audiences through
expenditures on improved service, principally more expensive programming,
when they cannot increase the quantity of programming and advertising time
or compete for viewers by price. Noll, Peck, and McGowan saw a similar
pattern of profits in 1973, and noted that the high profits of television
broadcasting are an indicator that too few resources are being devoted to
the indust ry.33

Not all stations in large markets shared the high profits, however.
At least 25 percent of stations in the top ten markets experienced losses. 34
In the current market, many stations experiencing losses may be new entrants
or UHF independents that may have been profitable when there were fewer
competing channels.35 In any case, great differences clearly exist in the

competitive success of large market stations.

33 Roger G. Noll, Merton J. Peck, and John J. McGowan,
of Television Remlation (Washington, D.C.: Brookings, 1973), pp. 17-18.

34 IAB, Television Financial Report, 1990, p. 1.

35 In the past, differences in profits among stations within a market
have been explained by higher costs and smaller coverage areas of UHF
relative to VHF stations, lack of attractive non-network programming due to
the higher costs of syndication relative to networking, and smaller
audiences and revenues of non-network stations. See Noll, Peck, and
McGowan, Economic Aspects of Television Regulation, pp. 58-96. Satellite
delivery has since largely eliminated cost differences between net working
and syndication, and cable has removed some, but not all, of the UHF

handicap.

-35-


chanreis.84 Cable operators clearly have a large number of services and a
wide variety of program types from which to choose. Indeed, due to the
number of local and distant broadcast stations cable carries, and the local
public, educational, and government access channels it provides, few cable

systems can carry all of the national and regional services.
Table 17 displays prime-time and all-day ratings for the first quarter
of 1991 for the most popular cable television channels. The programming

TABLE 17
CABLE NETWORK RATINGS, FIRST QUARTER 1991

Prime Time Total Day
CNN 3.7 2.9
WTBS 2.4 1.6
USA 24 1.3
TNT 15 0.9
ESPN . . 1.4 0.7
Lifetime 1.2 0.7
Nashville Network 14 0.5
Discovery 1.0 05
Nickelodeon 1.0 0.9
Family Channel 0.8 0.5
Headline News 0.7 0.6
MTV 0.6 0.5
VH-1 0.2 ~ 0.2

SOURCE: Multichannel News, May 6, 1991, p. 19 and May 20, 1991, p. 56,
citing Nielsen Media Research.

84 Network Fin/Syn Comments, Volume I, pp. 76-78. See also Report in
MM Docket No. 89-600 ("ECC Cable Report") 5 FCC Red 4962 (1990), para. 43 for
an estimate that there were 181 existing and proposed pay television and
satellite cable services.

-77-


(VCRs); in 1990, 3 percent of television households had home dishes and 69
percent owned VCRs.

Expansion in the availability of outlets and programming has
dramatically changed viewing patterns. The broadcast networks and their
affiliates have been the big losers. The prime-time viewing share of the
three major commercial networks plummeted from 93 in 1975 to 64 in 1990. The
all-day three-net work viewing share fell from 41 to 35 between 1984/85 and
1989/90. These declines have been accompanied by increased viewing of
independent stations and cable networks. In recent years, pay cable and
independent station viewing has leveled off, but basic cable viewing continues
to grow. Overall, viewing of cable-originated programming rose from 14
percent to 26 percent of total viewing and from 24 percent to 39 percent of
viewing in cable households. Thus, the decline in the broadcast share results
from both increased cable penetration and increased cable viewing shares in
cable households. While the tape rental business earns large revenues, the
impact of tape rental on broadcast viewing has been small.

Competition has reduced television station profits, although the
relative profitability of different categories of stations has remained
unchanged. Network affiliates, on average, have much higher profits than
independents. Indeed, independents apparently suffered losses on average in
1986-88. Also, VHF stations normally are more profitable than UHF stations
and, if other factors are equal, large market stations are more profitable
than small market stations. Large-market stations on average still earn very
high profits. Even in large markets, however, independent stations may be
unprofitable, particularly if there are several independent stations in a
single market . .

THE NEXT DECADE

During the next decade, television broadcasters will face increased
competition from more and higher-quality alternatives and, consequently,
broadcast television audience shares are likely to continue their gradual
decline. Audiences and advertisers will find cable programming an
increasingly good substitute for broadcast programming, and each major
broadcast network will increasingly become one of a larger group of
distributors, along with cable networks, Fox, and others.

Cable now passes over 90 percent of television households. While that
fraction will rise slightly, increases in cable subscribership will come
mostly from increased penetration of homes already passed. In 1990, 20
percent of homes not passed by cable owned home satellite dish systems. This
fraction is likely to rise during the next decade. If the reception equipment
costs are sufficiently low, and if programming is available, direct broadcast

- viii -


LIST OF TABLES ....

LIST OF ILLUSTRATIONS .

I.
II.

III.

VII.

INTRODUCTION. . .

THE ECONOMICS OF TELEVISION FINANCING METHODS

THE MARKET FOR VIDEO MEDIA.

BROADCAST TELEVISION. .

TABLE

OF CONTENTS

Availability of Over-the-Air Television Signals.
Television Viewing .....

Television Stations. .
Summary... -

TECHNOLOGICAL ISSUES. ...-

Video Compression Technologies

High-Definition Television .
Interactive Television...

Encryption Systems woe

Summary.
CABLE TELEVISION.

Historical Data and Projections.
The Competitive Impact of Cable on

Costs, Revenues, and Profits of Broadcast

Broadcasting.

DIRECT-TO-HOME SATELLITE TRANSMISSIONS. . . -

Current and Proposed Satellite Services.

Analysis... e+ ee ee eee
Summary. . .

VIII. OTHER VIDEO MEDIA... +++ ++ >

Videocassette Recorders... .

Wireless Cable . .

-ii-

Page

~ vi
» vii
el.

5

- 15

32
45

+ 49

‘I 55

- 62
: 64

- 74
- 90

92

+ 1103

105

-105
+109


SYNDICATED PROGRAMMING

Non-net work Programming is distributed through the Syndication market,
and independent Stations acquire most of their Programming through that
Market. Historically the distribution techniques used for syndication were
inherently more expensive than those used by the networks, and independent
Stations had relatively small audiences, Consequently syndicated Programming
was comprised primarily of low-cost Programming, including game shows and
off-network reruns. Much syndicated Programming in recent years has been
acquired, at least in part, by barter for advertising time rather than for
cash alone.

The expansion in the number of independent Stations over the past decade
considerably increased the demand for syndicated Programming, and satellites
have reduced the cost of distribution. The syndication market in recent years
has procuoed large numbers of new first-run Programs. In fact, 18 of the 25
most popular syndicated programs, and eight of the top ten, are first run,177
The others are off-net work series, The syndication market has been highly
Profitable.

Recently, however, demand for Syndicated Programs, not counting Fox
Programming, has declined for two reasons. First, 35 percent of independents
have now affiliated with the Fox net work, which has reduced the demand for

_

177 Nielsen Station Index, Report on Syndicated Programs, November 1990,

~ 140 -


COSTS, REVENUES, AND PRCFITS CF BROADCAST TELEVISION STATIONS

Broadcast station profitability provides an indicator of the health of
the broadcast televison industry and the sustainability of its current
configuration. Additional competitors can be expected to affect stations’
profits in at least two ways. First, the observed decline in broadcast
viewing has reduced audiences for advertising and may have contributed to
reduced advertising revenues for networks and stations. Second, increased
numbers of video channels may have increased the demand for and bid up the
prices of inputs into broadcast service, especially programming and the

talent that produces it, and thus increased costs.

To see how changes in the video marketplace have affected the
financial position of broadcast stations, we look first at a snapshot of the
revenues, expenses, and profits of commercial television stations. Then we
examine trends over time in the components of these measures.28 The data
are drawn from FCC Television Broadcast Financial Data for 1975 and 1980

and from the National Association of Broadcasters (NAB) Television Financial

28 The statistics shown here are at best suggestive of the relationship
between characteristics of the market and broadcasters’ financial condition.
More rigorous statistical techniques, such as multiple regression analysis,
would be required to provide a definitive explanation of the mechanisms at
work,

-32-


Data are available from Paul Kagan Associates on revenues and
programming expenditures of basic and pay cable networks.198 Projections of
program expenditures are made on the assumption that they will remain the same
percentage of gross revenues as in 1990. The result is revenues of $4.6
billion in 1990 and $7.3 billion in 1995, and program expenditures of $2.4
billion in 1990 and $3.8 billion in 1995, for all cable networks. Revenues of
cable networks were thus 49 percent of those of broadcast networks in 1990,
and are projected to increase to 60 percent in 1995. Cable network program
expenditures were 39 percent of the broadcast network total in 1990 and are

projected to be 48 percent in 1995.

The cable revenue data reported here should be interpreted with caution,
and should probably be considered a lower bound for cable program
expenditures. Information about individual cable networks suggests that the
cable program expenditures reported here may be lower than actual
expenditures. Cable networks are reported to have spent almost $700 million
on original non-sports programming in 1990 and almost $2 billion on sports

rights in 1989-90, as compared with the $2.3 billion total reported here.199

198 Paul Kagan Associates, "Cable TV Programming," August 31, 1990, p. 2,
and Paul Kagan Associates, “The Pay TV Newsletter," April 24, 1990, p. 3.
Pay-per-view networks are not included, but their total gross revenues were
only $136 million in 1990. "PPV and DBS: Partners in Uncertain Future,"

Broadcasting, February 18, 1991, pp. 49-50.

199 Separate Statement of Commissioner James H. Quello, Mass Media
Docket No. 90-162, pp. 6-7; Goldman, "Cable-TV Networks Strive to Stand Out
From the Crowd with Original Programs," Wal) Street Journal, December 17,
1990, p. Bl.

- 151 -


have been offered in the past, it appears that subscription services are only
viable as part of a package over which the costs of encryption, decryption,

and conditional access can be spread.

The choice of an encryption system or systems affects the number of
households willing to purchase subscription services. Hence, this choice also
affects the degree of competition that broadcast television will face from
subscription services. First, programmers will not continue to supply their
Product to distribution systems without reasonably secure encryption and
conditional access systems; unfortunately, there are no foolproof systems, 68
Second, the choice of encryption system or systems affects the cost of
reception equipment, whether it be a cable converter box or a satellite
integrated receiver decoder. Equipment cost is a determinant of the price
subscribers must pay for subscription services. In particular, if multiple,

incompatible encryption systems are in use, equipment that can decode all

68 Theft of services is a significant problem both in the cable and the HSD
context. In addition to reducing the revenues of cable operators and
programmers, it also results in higher prices to legitimate customers. The
impact of theft of services, colloquially referred to as "piracy," is greater
in the satellite context. The conservative estimates are that 50 to 60
percent of those receiving scrambled satellite services are stealing them.
See Report in Gen. Docket No. 89-78, 5 FCC Red 2710 (1990) ("ECC Encryption
Standards Report") para. 39. In the cable case, the corresponding figure is
roughly 13 percent. This calculation is based on 8 million households
receiving basic cable service without authorization and 51.6 million basic
cable subscribers. See Cable World, Jan. 21, 1991, p. 10 and table 15 below.
By contrast, there are 710,000 legally authorized home satellite dish
subscribers. See note 113 below.

- 63 -


Data are also available on peretration of homes passed in each of the
211 ADI markets, for December 31, 1989.81 There are two markets in which
penetration was above 90 percent, and an additional nine in which
penetration was between 80 and 85 percent. The national average at this
time was 59.6 percent. Penetration is presumably highest in those markets
where the conditions favor cable television and where cable has been
available for a relatively long period of time. These figures support the
plausibility (although not the precise magnitude) of the projection in table
15 that 70.5 percent of homes passed in 1999 will subscribe to cable.

Table 16 provides information on the revenues of cable system
operators. Roughly half of cable operators’ revenues derive from basic
subscription fees, which have grown rapidly since 1975. Pay cable fees
have grown little in the past few years after growing rapidly between 1975
and 1985. Some in the industry attribute the flat revenues of pay cable to
competition from VCRs. Pay-per-view for individual events is a new but
growing source of revenue for cable operators. Cable advertising has

grown rapidly, but remains only 3.6 percent of cable operators’ revenues.

81 Paul Kagan Associates, Inc. ADI Cable Report; December 3], 1989, June
1990.

-72-


Federal Communications Commission

ss % 6 Office of Plans and Policy
2HxC:? 445 12th Street, SW

Washington, DC 20554

OPP Working Paper Series

26 Broadcast Television
ina
Multichannel Marketplace

June 1991

Florence Setzer
Jonathan Levy



area for expansion in the near term appears to be homes not passed by cable.
As table 15 indicates, there are now eight million such homes; in 1999 there

will probably be seven million.

R Equi 6 Availability of Cable Servi

In a recent study on cable-DBS competition, Johnson and Castleman
conclude that DBS could be competitive with cable in many parts of the country
with equipment costs in the $300 to $500 range and that it could be viable in
uncabled areas with even higher equipment costs.118 Equipment cost estimates
for the various medium and high power DBS services range from $500-$700, with
one prediction that the price will drop to $300. Thus, if Johnson and
Castleman are correct, DBS is unlikely to be a major factor in cabled areas,
at least initially. The presence today of an estimated 1.2 million C-band
hame satellite systems in cabled areas suggests that the Johnson-Castleman
criteria cannot be mechanically applied. It is clear, however, that the
competitive conditions facing DBS are different in cabled and uncabled areas.
Satellite service is likely to grow first in uncabled areas and then,

possibly, expand to compete directly with cable.

One key component of satellite reception equipment is the decoder.
Should DBS services develop with incompatible encryption systems, subscribers

could be faced with the need to purchase more than one decoder, or a

118 See RAND DBS Report, pp. 15-38.

- 98 -


redress the competitive balance between broadcasting and cable. Full
copyright liability for cable systems and retransmission consent for local

broadcast stations might give broadcasters an additional source of revenue.

Economic and technological developments over the past 15 years have
vastly expanded the array of video choices available to the American
public. Increased time diversity, choices, and new technologies have given,
and increasingly will give viewers the ability to control their television
viewing. The new video marketplace is making it possible, therefore, for
viewers to signal their preferences far more precisely than before, and
programmers are responding by producing more targeted programming to serve
the increasingly segmented market. Advertisers are adjusting their purchases
of commercial time to target the geographic and demographic groups most
valuable to them. These trends will continue producing a diverse viewer-
centered video marketplace. Broadcast television will have its place in this

Tew world but as one player among many.

- 172 -


TABLE 25

INFLATION-ADJUSTED VIDEO ADVERTISING REVENUES, 1975-1990
(1982-84 Dollars)

Nationai Television % Change in
Total Network Syndication* Station** Cable*** Rea! GNP
($_Million) ($ Million) {$ Million) ($_ Million)

1975 9,783 4,286 ~ 5,496 -

1976 11,812 §,021 - 6,791 - 49
1977 12,561 5,710 - 6,852 ~ 47
1978 13,735 6,097 - 7,638 - 5.3
1979 13,986 6,335 ” 7,652 - 25
1980 13,919 6,226 61 7,568 64 0.2
1981 14,132 6,095 83 7,826 129 1.9
1982 15,167 6,367 155 8,424 221 2.5
1983 16,826 6,983 301 9,209 333 3.6
1984 19,103 8,006 404 10,175 518 6.8
1985 19,537 7,491 483 10,890 673 3.4
1966 20,877 7,611 547 11,938 781 27
1987 21,042 7,482 671 12,041 848 34
1988 21,713 7,753 762 12,187 1,011 45
1989 21,686 7,347 1,039 12,069 1,231 25
1990°*** 21,677 7,179 1,216 11,969 1,369 0.9

SOURCE: McCann-Erickson, Inc., "Estimated Annual U.S. Advertising Expenditures,” prepared for
Advertising Age, April 1991; consumer price index, Economic Repor_ of the President, transmitted
to the Congress February 1991, U.S. Government Printing Office, (Washington: 1991), p. 351.

‘Includes Fox network advertising, 1988-90.

**Includes national and local spot advertising.

***Includes network and non-network cable advertising.

****Preliminary.

- 121 -


of program prices, which could lead to broadcasters being outbid for specific
popular programs. If popular programming moves to cable, the movement of
audiences from broadcast to cable viewing will accelerate. Although pay and
pay-per-view channels do not compete directly with broadcasters for

advertising dollars, all cable channels compete with broadcasters for viewers.

Financial data from broadcast and cable networks can shed light on
trends in the revenues of both advertiser-supported broadcasters and cable —
networks and on their ability to compete in program purchase.194 It should be
noted that the ability of various media to purchase programming of a given
quality is a different issue from market power in program purchase. Here the
question is whether given purchasers have the ability to make roughly
comparable program expenditures, not the ability of firms to behave

anticompetitively .195

194 Declining revenues,at least in the short run, do not
automatically result in declining program expenditures. Commercial broadcast
and cable networks strive to maximize profits, and the profit-maximizing level
of expenditure on programming will depend on the response of audiences, and
advertising revenues, to program expenditures.

195 The relevant market for the purpose of the financial interest and
syndication rules, for example, includes not only broadcast and cable, but
theatrical movies and home video as well. In this market, individual
broadcast networks have small market shares. A large number of cable networks
are independent purchasers in this market, and some pay high prices for
programming. For a discussion of net work market shares in this market, see
Robert W. Crandall, "The Economic Case Against the FCC’s Television Net work
Financial Interest and Syndication Rules," Network Fin/Syn Comments, Appendix
Cc.

- 149 -




Recent Working Papers Series
Office of Plans and Policy
Federal Communications Commission

Broadcast Television in a Multichannel Marketplace, by Florence Setzer and
Jonathan Levy; Working Paper #26, June 1991

What Makes the Dominant Firm Dominant?, by John Haring and Kathy Levitz,
Working Paper #25, April 1989.

Through the Looking Glass: Integrated Broadband Networks, Regulatory
Policy, and Institutional Change, by Robert Pepper; Working Paper #24,
November 1988.

Loosening the Ties that Bind: Regulating the Interstate Telecommunications
Market for the 1990's, by Kathleen B. Levitz; Working Paper #23, February 1987.

Competition Policy in the Post-Equal Access Market, by John R. Haring and
Evan R. Kwerel; Working Paper #22, February 1987.

The Economic Efficiency Benefits of the Current Subscriber Line Charge, OPP
Staff Study, January 1987.

Private Frequency Coordination in the Common Carrier Point-To-Point Microwave
Service, by John R. Williams; Working Paper #21, September 1986.

Alternatives for Improved Personal Communications, by James E. McNally, Jr.;
Working Paper #20, August 1986.

“The Impact of Regulatory Policy, Competition, and Divestiture on U.S.
Telecommunications Services:” A Critical Assessment, by Jonathan Levy, April 1986.

Promoting Competition Between International Telecommunication Cables and Satellites,
by Evan R. Kwerel and James E. McNally, Jr.; Working Paper #19, January 1986

Telephone Pricing to Promote Universal Service and Economic Freedom,
by Gerald W. Brock; Working Paper #18, January 1986.

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multistandard decoder. This would add to their equipment cost and could limit

the number of households choosing to access satellite services.119
; .

Many segments of the satellite industry have placed a high priority on
reducing the size of the home dish, believing that the size of the potential
market is inversely related to the size of the dish. Currently, the relatively
large size of the dish antenna--10 feet in diameter for C-band--presents
problems with respect to esthetics, zoning, and even safety (particularly in

cases where the antenna needs to be mounted on the roof of a dwelling).

Medium power Ku-band and DBS services will employ dishes one to three
feet in diameter, while advances in receiver technology might support the use

of four-foot antennas in C-band, if the spacing of satellites is not reduced

119 Cable subscribers would not be affected significantly by such a
situation. The cable operator would presumably provide them with a standard
converter box. Since cable operators need to be able to provide all
channels on their systems simultaneously, they need a separate receiver and
decoder for each channel anyway. If those decoders do not all embody the
same encryption system, their costs are hardly affected. See chapter V above
for a more detailed description of this issue.

- 99 -


The causes of the decline in measured viewing are not entirely clear.
The change may have been caused by a change in audience measurement
techniques by A.C. Nielsen in 1987.16 on the other hand, as detailed in
the appendix, changes in the demographic characteristics and behavior of the
population make it likely that a real decline in viewing time per household
has occurred. Most importantly, labor force participation of women has
increased steadily and is predicted to continue to increase, meaning less
daytime viewing by women and less leisure for viewing in other time periods
by all family members. The growth of single-parent families has reinforced
the trend. In addition, the population is aging, producing a larger
proportion of working-age persons. Slower population growth will also mean
slower growth in the number of television households.

Cable viewing appears to have displaced viewing of over-the-air
signals to a considerable extent in recent years. In 1990, cable households
viewed 18.8 percent less broadcast television than non-cable households,

on average, even though they viewed 32.5 percent more hours of television

16 But measured viewing was slightly lower in 1986 than in 1985, using
the old measurement technique.

-20-


Cablé networks can earn more revenue than broadcasters from audience
of equal sizes. For basic cable networks, this is because they collect fees
from both advertisers and subscribers. For pay networks, it is because
viewers value programming more highly than advertisers value viewers 86
This makes it possible for cable to outbid broadcasters for national or
regional rights to programming, such as sports, where cable audiences are
large. Some sports programming on cable did not and would not appear on
broadcast television, but some of it has "migrated" or has been "siphoned"
from broadcast television. The National Football League (NFL) packages on

ESPN and TNT are the best but not the only examples of this phenomenon.

The NFL contracts with cable networks have increased the number of
games available nationally to those with cable service. Moreover, because
those contracts require the cable services to make their NFL games available
to broadcast stations in the home markets of the teams that are playing,
home town fans without cable service are not deprived of access to their
teams’ games. On the other hand, ESPN’s multi-year contract with Major
League Baseball increases the number of games available nationally to cable
subscribers, but it has exclusivity provisions that have caused some over-

the-air viewers to lose access to some baseball telecasts.

If a substantial additional amount of sports programming leaves

broadcast television for cable, broadcast audiences could be reduced

86 See chapter II.

- 79 -


Cable subscription revenue is a measure of the value viewers place on
cable service. The magnitude of viewer payment for cable is strikingly
large. Cable operator revenues, not including advertising, in 1989 were
63.5 percent of total broadcast advertising revenues. Including cable
network and local cable operator advertising, cable industry revenues were
71.8 percent as great as those of the broadcast industry, or 41.8 percent
of the broadcast-cable total.82 yet cable, including distant signals and
superstations, accounted for only 32 percent of viewing in 1989/9083, and
cable advertising remains far below its potential level. Clearly cable
has succeeded in earning much more revenue per viewer-hour than

broadcast ing.

THE COMETITIVE IMPACT CF CABLE ON BROADCASTING

In order to predict the future competitive impact of cable on
broadcasting, it is necessary to examine the number of television households
that will not be reached by cable and the expected viewing of broadcast
Programming in cable homes. The projections for 1999, reported in table 15,
include an estimate that 35.2 million television households, 34.3 percent of
the total, will not subscribe to cable. According to the Kagan projections,
6.8 percent of television households will not have the option of subscribing

82 See table 2 above.

83 See table 6 above. The cable viewing fraction for 1988/89 was 29
percent. See Cabletelevision Advertising Bureau, Cable TV Facts, 1990 ed.,
Pp. 12-13.

-74-


marketplace in which all firms can compete on an even basis, unhindered by
artificial regulatory handicaps, and all have an opportunity to provide the
most highly valued and most efficient service possible. The Commission should
be concerned about the availability of service to viewers rather than the
profitability, or even the continued existence, of particular firms or

industries.

Many of the Commission’s existing rules conflict with these goals,
hindering broadcasters’ efforts to provide service and preventing them from
competing on an even footing in the new, more rigorous competitive
environment. Many broadcast regulations, for instance, place restrictions on
stations and networks that may make it difficult for them to show the
programming that would be most valued by viewers or to make business
arrangements that would increase their efficiency. Many rules place
restrictions on broadcasters or broadcast networks that do not apply to

their competitors.

While eliminating sources of inefficiency is always desirable, that
objective takes on particular urgency at a time when broadcast stations and
networks face intense competition and, in extreme cages, the prospect of
insolvency. While broaccasters’ programming for the most part is carried by
cable systems, and could in principle be transmitted by other media,
broadcasters furnish an important service to viewers not passed by cable or
who cannot or are unwilling to pay for cable or other video media. They also

provide the major source of competition to cable systems.


TABLE 14
PROGRAMMING EXPENSES OF COMMERCIAL
BROADCAST STATIONS, 1975-1989
(Percent of Total Expenses)

1975 1980 1985 1989
AFFILIATES

Programming 42.8 42.5 43.8 44.3
Broadcast Rights 12.4 11.5 11.8 18.0
News - - 20.6 19.1
Other - - 11.4 7.2

INDEPENDENTS
Programming 48.8 49.4 52.5 57.1
Broadcast Rights 26.8 32.6 39.2 43.4
News - ~ 43 4.3
Other - - 9.0 9.4

SOURCES: 1975 and 1980, FCC, Public Notice, “TV Broadcast Financial Data," August 2, 1976
and August 10, 1981; other years, NAB, Television Financial Report, 1986 through 1990.

NOTE: For consistency, expense categories from the FCC reports were used. The NAB
Categories of “programming and production” and "news" were combined into “programming.”
“Broadcast rights” includes features, amortization of all syndicated programs, specials,

Sports events, and barter programming.

For both network affiliates and independents, programming is by far
the largest expense item, averaging over 50 percent of total expenses for
independents at least since 1985.45 Programming expenses are a lower
percentage of the total for affiliates because they do not pay for net work
programming with cash. On the other hand, affiliates spend far more for
news, about 19 percent of the total as compared with about 4 percent for

independent s.

45 Comparing this finding with table 13 makes clear that large-market
Stations swamp small-market stations in the data.

- 44 -


voluntary viewer payments and government and charitable contributions, public
television was created as a response to the failure of the
advertiser-supported program market to produce programming to suit the tastes
of small audiences. With the advent of commercial viewer-supported
programming on cable, many of the needs public television was intended to
fill have begun to be met by cable. In the future, government funding of

public television may have to be justified on different grounds.

Despite a decline in viewing, a substantial audience for broadcast
television will remain in 1999. About one-third of households in the United
States probably still will not receive cable. Even if cable households shift
their viewing increasingly toward cable channels, these non-cable households
will still provide large audiences for television advertisers. The households
that do not subscribe to cable will be less valuable to broadcasters, on
average, than cable households would have been because they will
disproportionately be low-income households that advertisers find relatively
less valuable, or they will not subscrire to cable because they watch little
television or receive satellite service. But as long as most broadcast
stations are carried by cable, they will still be able to draw audiences from

among cable subscribers as well as non-subscribers.

For the foreseeable future, a considerable broadcast audience will
remain and will continue to provide broadcasters with advertising exposures
to sell. In addition, broadcasters have an opportunity to diversify by using

their expertise in programming to offer programming to cable channels and

- 161 -


FIGURE 8
CABLE SYSTEM CHANNEL CAPACITY

1975 1990
wer, Ha 21+

OM 54+

30-53
20-29

El 13-19

@ 6-12
B@i-s

DO Not Available

Capacity expansion is high on the agenda of most cable operators, 6
For example, Time-Warner has announced plans for a 150-channel system in
New York that would offer interactive services and data information
services.97 Discussions of major capacity expansion stress new applications
such as HDTV or video-on-demand rather than new forms of programming,
though lack of channel capacity on cable systems appears to be an important

impediment to the introduction of new program services. Expanded channel

96 For the next several years, it is likely that digital signal
compression, plus fiberoptic backbone, will be the preferred ingredients for
enhancing cable system capacity. See chapter V above for a more extensive
discussion of the technological options for capacity expansion.

97 "Time-Warner Constructing 2-Way Cable TV System," New York Times, March
8, 1991, p. D5.

~ 86 -


TABLE 27
SELECTED FAMILY CHARACTERISTICS, 1975-1987

1975 1980 1985 1987
Median Age at 1st Marriage
Men 22.7 23.6 24.8
Women 20.8 21.8 23.0
Marital Status
(% of Population 18 or Over)
Single 17.5 20.3 21.5 21.8
Married 69.6 65.5 63.0 62.9
Widowed 8.3 8.0 7.9 75
Divorced 46 6.2 7.6 78
Average Family Size 3.4 3.3 3.2 3.2
Births to Unmarried Women 14.2 18.4 22.0
(% of All Births)

SOURCE: Statistical Abstract, 1989, pp. 42, 66, 86.

by historic standards.217 Between 1975 and 1990, as shown in Table 28,
married-couple households declined from 66.0 percent to a projected 56.3
percent of households, while families headed by a single person increased
from 12.1 to a projected 14.5 percent of the total. Only 70.8 percent of
the population were projected to live in married-couple families in
1990.218 Between 1975 and 1986, births to unmarried mothers increased from
14.2 to 23.4 pexcent of the total.219

——_—_—

217 ‘Thid., p. 61.
218  Thid., p. 48.
219 «Ibid, p. 66.

- 175 -


of the effect of reduced expenditures will be felt in reduced program quality.
Some broadcasters may scale back Program production, and to the extent that
they do, the quality of local Programming may suffer. Since we have little
ability to measure how viewers value local programming, it is not clear how
much the welfare of viewers would be affected. Some marginal stations in
large markets will probably leave the market, but many healthy stations can be

expected to remain.

In smaller markets the effects on television broadcasting probably will
be more severe. In markets below the top ten, more than half of all
independent stations are already experiencing losses, at least on paper.210
Here, a reduction in the number of stations May occur, which would reduce
over-the-air choice. One can speculate, however, that local programming will
be affected little by stations leaving the market, since marginal stations
apparently spend very little on local programming. In the short run, the
revenues of remaining stations would increase; the long-run effect on revenues
and programming of remaining stations is unclear. The number of markets in
which broadcast stations provide a competitive check on cable systems probably
will decline.

Public television stations, though not supported by advertising, may

also face declining revenues because of declining audiences, Supported by

210 +=-NAB, Television Financial Report, 1990, pp. 1-16.

~ 160 -


cable (in a few years), and last in broadcast television (probably not until

broadcast HDTV is deployed).

It is impossible to forecast the rate of diffusion of HDTV with
precision. However, because , in the early years, home receivers will be
expensive, adoption is likely to be slow. Moreover, at the beginning, the
lack of HDTV receivers will make HDTV broadcasting unprofitable, while the
lack of programming will retard the purchase of HDTV receivers. This, plus |
the cost of HDTV broadcast transmission equipment, makes it likely that HDTV
will be introduced first by prerecorded tapes and then by satellites, which
can aggregate audiences efficiently over large geographic areas. The
practical impact of HDTV on broadcast television by the end of the decade will

be small.

With respect to interactive television, in the absence of switched
video, little appears to be gained by having a dedicated return channel. The
common telephone line appears to be sufficient, and there is no evidence that
a dedicated return channel, given the amount of time it would be used, would
be cheaper than the public switched network. The remaining question is the
demand for services that can be delivered by a cable or satellite system and
requested by a telephone call. The utility of interactive broadcast services
will be limited by the relatively limited channel capacity available.

Encryption technology facilitates or permits the operation of

subscription services, which compete with broadcast television. The

- 65 -


reached fell by 11.4 percent (table 7).21 The largest decline in the
network share occurred between 1980 and 1985, while the largest decline in
households reached occurred after 1985. This result is consistent with a
pattern in which viewers, particularly new cable subscribers, first increase
their total viewing by adding cable and new independents to their existing
viewing, then reduce viewing to a level closer to the original level but

maintain the new net work-independent-cable proportions.

TABLE 7
PRIME-TIME VIEWING OF THE THREE MAJOR COMMERCIAL NETWORKS

1975 1980 1985 1990° 1994*
Share 93 89 74 64 61
Households Reached (Millions) 39 40.0 38.0 32.7 33.5

SOURCE: Communications Industry Forecast, 1990, pp. 45-46.
NOTE: Share of households, not percentage of total viewing.

*Projected.

In the top ten markets the three networks began with a smaller share,
and the decline has been less steep, than in other markets. The three-

network share of total viewing in these markets fell from 75 in 1980 to 63

21 In the earlier years there was very little difference
between percentages of households and percentages of total viewing. In
recent years multiple set viewing has increased; total share points for all
households were 105 in 1989/90. As a result, shares of viewing are slightly
higher than percentages in recent years, So that the decline in viewing
is slightly understated in table 7.

-26-


the Commission should eliminate its own prohibition, perhaps subject to
certain conditions. Rules that prevent vertical integration of the major
broadcast networks into program production and syndication, despite the fact
that their competitors appear to find such integration valuable, also cause
broadcasters to operate under a competitive handicap and should be
reconsidered. In particular, the Commission should eliminate its broadcast

net work-cable crossownership ban.

The efficient adoption of the new technologies described above also
will require some regulatory action. The dual networking rules, for instance,
may hinder the offering of multiple channels by a single broadcaster, and
network dominance, which the rules were intended to curb, will scarcely be

an issue in the future multiple-provider environment.

The evolution of the broadcast industry may entail considerable change
in the use of spectrum. In the short run, the number of broadcast stations is
likely to decline. In the longer run, video compression techniques will allow
the transmission of multiple channels in the spectrum now used for a -single
channel, or to broadcast HDTV in an NTSC channel. Such changes will reduce
the value of spectrum for broadcasting. The Commission will have an
opportunity to allow broadcasters to acquire an additional source of revenue
by using their spectrum for other, higher-valued purposes in addition to

broadcast. ing.

In the shorter run, allowing broadcasters and program producers to

receive market value for the use of their programming by cable systems would

-1721-


possibly as a result of the success of the Fox stations and falling prices

of syndicated programming.39

The decline in profits of commercial television stations over the late
1980s is consistent with increased competition from increasing numbers of
independent stations and cable systems. As noted above, network affiliates’
audience shares, and total audiences, have declined. Viewing of
independents, on the other hand, appears to have increased in the aggregate.
Yet profits of independents have fallen far more than those of affiliates.
An explanation may be found in the increasing number of independent
Stations, which kept viewership per independent station low. Between 1982
and 1989, while independents’ prime-time share of all viewing increased from
14 to 19, the number of independent stations more than doubled. Looking
at all-day viewing rather than prime-time viewing, the share of local
independents only increased from 12 to 13 percent between 1984/85 and
1989/90.40 Thus it is not surprising that independents’ average profits
plummeted during this period.

39 Disaggregating further shows the same downward trend, in general,
for all groups of stations, but VHF independents had high average profits
(17.2 percent of net revenue in 1989), while UHF independents had large
average losses from 1986 on. Losses of UHF independents averaged over 20
percent of net revenues from 1986 to 1988, falling to 13.7 percent in 1989.
NAB, Television Financial Report, appropriate years. The high profits of
VHF independents may have occurred because they are primarily located in
the largest markets and benefit from technical and coverage advantages over
UHF stations.

40 See tables 6 and 8.

- 38 -


suggest that what little effect VCRs have on time spent watching nonrecorded
television programming is positive. Since VCR households probably value
television programming more highly than others, however, it is possible that
they would have viewed much more broadcast programming than non-VCR households
in the absence of a VCR and the option of viewing prerecorded programming.
If so, VCRs have a negative effect on viewing that does not appear in the

data.

TABLE 21
TELEVISION USAGE OF NON-VCR AND VCR HOUSEHOLDS
(Average Hours Per Day)

Non-VCR VCR Households*
Year Households Total Regular Record with
Usage Set Off
1987 6.9 7.4 6.9 0.2
1988 7.0 7.0 6.8 0.2
1989 7.0 7A 6.9 0.2

SOURCE: Television Bureau of Advertising, Inc., “Trends in VCR Usage,” April 1990, p. 6.
NOTE: Data prior to September 1987 based on NTI Audimater Sample; from September

1987 on, based on NTI People Meter Sampie.
Includes VCR recording with set off but does not include any playback activity.

Time spent using a VCR is shown in table 22. The average time spent
both recording and playing has declined since 1986, but the difference
between the two, the time apparently spent watching prerecorded material,

has increased.128 Compared with the total time spent with television,

128 This interval, 1.8 hours, is consistent with the viewing of one
prerecorded movie per week. This estimate may understate the time spent
watching prerecorded material because households may record over-the-air

material but never play it back.

- 107 -


FIGURE 7
COMMERCIAL TV STATION EXPENSES (%)

MARKETS 1-10 MARKETS 176+

ct

@ Engineering

3) Programming & Production
B News

B sales

a Advertising & Promotion

B General & Administrative

Industry observers have reported that the increasing number of over-
the-air and cable channels has bid up the price of programming, increasing
station costs at the same time that their audiences are falling. To explore
this assertion, we examine trends over time in the composition of broadcast

station costs.

Table 14 shows programming expenses of commercial broadcast stations
as a percentage of total costs. Where data are available, programming
expenses are further broken down into broadcast rights, news, and other
programming expenses. Affiliates and independents were examined separately
because affiliates’ program acquisition arrangements with the networks make

their cost structure different from independents’.

- 43-


much faster than GNP from 1981 through 1986 but more slowly after 1986, and
declined in real terms in 1989 and 1990,161

Veronis, Suhler predict that television stations’ share of total
television advertising will fall through 1992 and then increase slightly as
the rate of growth of cable slows. They predict that television station
advertising will grow faster than network advertising, but still more slowly

than GNP.162 As noted above, the predictions are likely to be optimistic.

Because the number of stations has increased, the growth rate of
advertising revenues per station has been lower than that of aggregate
station advertising revenues. Dividing television station advertising
revenues in table 25 by the number of commercial stations shows that
advertising revenues per station in fact have fallen in the neighborhood of 4
percent per year in real terms from 1987 on.163 The downward trend clearly
began well before the current recession, so it is not a cyclical

phenomenon 164

161 Communications Industry Forecast, p. 49; "$3-Billion Syndication
Business Feels a Pinch," Los Ameles Times, January 21, 1991, p. F-12.

162 = Communications Industry Forecast, pp. 22, 51.

163 Data on numbers of stations are taken from Television Bureau of
Advertising, Inc., "Trends in Television," April 1990, p. 9.

164 Like the data reported here, the NAB data on average station
revenues reported in chapter IV, which are disaggregated into several station
categories, show rapid growth in the early eighties, ending in 1985 or 1986.
The NAB data, however, show less pronounced declines in recent years than are
shown here, and show a slight recovery for independents in 1989. See table
12.

~- 128 -


The difference in profits between large and small markets appears to
have persisted over time. Profits were lower in markets below the top 100
than in all markets in 1975 and 1980 as well, but in those years profits
occurred, in the aggregate, even in markets below the top 100. In 1980
profits were 26.9 percent of net revenve in all markets and 14.1 percent in
markets below the top 100.42

The large losses reported here must be interpreted with caution.
Accounting losses may not reflect economic losses. For instance, broadcast
station selling prices, which reflect the value of the license in addition
to the value of plant and equipment, have varied greatly over time.
Interest on debt incurred to purchase stations enters into costs and may

affect the pattern of profits in ways that are not obvious.

The losses reported in the NAB data may overstate the stations’
difficulties, as the pattern of losses over time suggests. The FCC data
show, for instance, that the percentage of independent stations reporting
losses was 40.2 in 1975 and 45.5 in 1980. The NAB data show that in 1989
between 50 and 75 percent of independents reported losses. For the category
with the worst financial performance, UHF independents, the percentage
reporting losses was 75.0 in 1975, 88.9 in 1980, and something greater than
75 percent in 1989. With long-term losses of this magnitude, one would

expect to see wholesale exit from the market. Yet the number of

—_—_———

41 FCC, Public Notice, «Ty Broadcast Financial Data," August 2, 1976;
FOC, Pubhic Notice, " TV Broadcast Financial Data," August 10, 1981.

=-39-


availability and basic cable subscribership for 1995 and 1999, made by Paul
Kagan Associates, are also included. Penetration refers to subscribership
as a fraction of some universe of households. Thus, "basic cable

penetration of homes passed" is basic subscribers as a fraction of homes

passed.
TABLE 15
CABLE SUBSCRIBERS AND HOMES PASSED
1976 1980 1985 1990* 1995** 1999°*
Basic Cable
Television Households (TVHH) (Millions) 69.6 76.3 84.9 92.1 98.3 102.7
Homes Passed (HP) (Millions) 23.1 34.9 64.7 84.0 91.4 95.7
Basic Subscribers (Millions) 11.8 19.2 36.7 51.6 61.0 67.5
Homes Not Passed (Millions) 46.5 4t4 20.2 8.1 6.9 7.0
Homes Not Subscribing (Millions) 57.8 57.1 48.2 40.5 37.3 35.2
Homes Passed/TVHH (%) 33.2 45.7 76.2 91.2 93.0 93.2
Basic Subscribers/Homes Pi id (%) St. 55.0 56.7 61.4 66.7 70.5
Basic Subscribers/TVHH (%) 17.0 28.2 43.2 56.0 62.1 65.7
Homes Not Subscribing/TVHH (%) 83.0 748 56.8 44.0 37.9 34.3
Pay Cable

Pay Units (Milllons) 1.0 91 30.6 418 49.4 54.7
Pay Units as % of Basic 85 474 83.4 81.0 81.0 81.0
Pay Households (Millions) - 21.8 24.0 - -

Pay Households/HP (%) - 33.0°°" 33.7 28.6 - -
Pay Households/TVHH (%) - 17.3°°" 25.7 26.1 - ~
SOURCES: For 1995, 1909, Paul Kagan Associates, The Kagan Cable TV Financial Databook (June 1990), p. 10; TVHH,

homes passed, basic subscribers for earlier years, Gable Television Investor (Nov. 21, 1890), p. 9, except 1976 TVHH
from Television Bureau of Advertising, Inc., “Trends in Television," (April 1990), p. 3: pay units and households

from Gable TY Investor, Nov. 21, 1990, p. 9.
“Estimated. “Projected. "1981.

- 68 -


of three of the five most popular cable networks in prime time--WTBS, USA
Network, and TNT-~can fairly be described as similar to that of independent
broadcast stations. They offer movies (some old and some new), sports, and
entertainment series (some first run and some off network). Clearly,
cable’s popularity is not based solely on narrowcasting or niche
programming. The other two most popular networks--ESPN and CNN--are, of
course, more specialized. Moreover, Nickelodeon, another specialized
network (presenting childrens programming) is tied for fourth in the total
day cable network ratings.

The strong demand for sports programming, and the important role of
cable television in meeting it, are demonstrated not only by the performance
of ESPN but also by the proliferation of regional sports channels. ESPN,
the major national sports network, is available in virtually all cable
households. This, and its high ratings (by cable standards), suggest that
a substantial proportion of cable subscribers value it highly. The
emergence of regional sports channels has been one of the most striking
cable programming developments of the past several years. There are now 31
such channels, with 39.1 million subscribers.85

85 Twenty-six of these are affiliated with either the Prime Network or
Sportschannel America (SCA), both of which have a national feed with some
regional selections. Programming from SCA is available to dish owners.
Cablevision, January 28, 1991, p. 41; March 11, 1991, p. 30.

- 78 -


Report for more recent years.29 The data are averages over all reporting

stations in each category.

Table 10 shows averages of net revenues, expenses, and profits in

1989 for commercial stations grouped by ADI market rank.30 In general,
TABLE 10

AVERAGE REVENUES, EXPENSES, AND PROFIT OF COMMERCIAL
TELEVISION STATIONS, 1989

ADI Market Average Net Revenue Average Expenses Average Pre-Tax Profit as % of

Rank {$ Million) ($ Million) Profit ($ Million) Net Revenue
1-10 56.4 40.7 15.7 27.8
11-20 26.8 23.1 3.7 13.7
21-30 20.1 17.3 2.8 14.0
31-40 13.8 13.7 0.2 1.3
41-50 11.4 10.4 1.0 8.7
51-60 8.9 9.0 (0.1) (1.4)
61-70 85 77 0.9 10.1
71-80 7 68 0.2 3.5
81-90 6.1 5.8 0.3 5.6
91-100 : 65 57 07 11.3
101-110 5.3 641 (0.8) (15.3)
111-120 5.0 5.4 (0.4) (8.2)
121-130 42 47 (0.5) (10.8)
131-150 3.8 4.2 (0.4) (11.3)
151-175, 36 3.6 0.1 1.6
176+ 25 28 (0.2) (8.1)
SOURCE: NAB, Television Financial Report, 1990, pp. 1-16.

NOTE: Parentheses denote loss.

29 FCC, Public Notice, "TV Broadcast Financial Data," August 2, 1976;
FCC, Public Notice, "TV Broadcast Financial Data," August 10, 1981; National
Association of Broadcasters, Television Financial Report, (Washington, D.C.:
National Association of Broadcasters, 1986, 1987, 1988, 1989, 1990).

30 Net revenue is gross revenue minus agency and rep commissions, not
gross revenues minus costs. NAB, Television Financial Report, 1990, p. 118.

- 33 -


advertising.143 Advertising agents claim that it has a higher perceived
quality and status than the alternatives. Thus, despite the audience erosion
of recent years, many advertising agents continue to believe that network
advertising has no good substitutes.144 This perception, however, appears to

be changing.

If all viewer exposures are considered equivalent, other media can
substitute for network television. Then declining network audiences will .
result in at least proportionate declines in network revenue. To the extent,
however, that advertisers do not view other media as equivalent to the
broadcast networks, whether because of higher transactions costs to reach an
equivalent audience, poor audience measurement, or for some other reason, the
decline in network audiences will reduce the supply of network-quality
advertising exposures and may allow the networks to raise their prices per
viewer. The decline in network audience size, however, will reduce the
transactions cost advantage of buying network advertising, as will increased
audience size for the popular cable networks. This effect may counterbalance
the networks’ ability to raise prices in response to the decreased supply of
exposures. The collapse in 1991 of the so-called upfront network advertising

market, in which advertisers buy time in advance for the coming season, may

143 Television Bureau of Advertising, “Trends in Media," August 1990, pp. 3-
7.

144 Based on conversations with executives of advertising agencies.

- 119 -


SUMMARY

Direct-to-home satellite distribution systems, including DBS, are likely
to expand, particularly in the non-cabled areas, and particularly if the
Satellite services gain access to programming at reasonable rates. The
effect on the broadcast audience of expanded DBS use in uncabled areas is
unclear. Many of the areas not now cabled have very sparse broadast service,
so there may be very little audience to erode. On the other hand, while DBS
cannot bring local broadcast service to these areas, it can provide
superstations and network stations pursuant to the satellite carrier

compulsory license (17 U.S.C. 119).

In cabled areas, DBS equipment cost projections and uncertainty
regarding access to cable programming suggest that, at least initially, DBS
will not be a strong head-to-head competitor delivering conventional cable
programming. However, if DBS were to offer popular new services at moderate
prices, it could make inroads into both broadcast and cable audiences.125 The
leading possible categories appear to be near-video-on-demand and niche
programming. The key unresolved question is what new services will have a

significant impact on viewing.

125 These services could also increase total viewing, but, given the
current level, it seems unlikely that the increase would be great. Thus,
the primary effect of these new services would be to divert audiences from
existing services.

- 103 -


IX. THE ADVERTISING MARKET

Sale of advertising time and Payments from advertiser-supported
networks comprise, for practical purposes, the sole sources of revenue for
broadcast stations, Consequently the state of the overall advertising market,
and competition from other advertising media, crucially affect the health of
broadcast television. Here we examine the overall market for advertising and
the sub-markets in which broadcast networks, television Stations, and cable

systems operate, and briefly consider non-video advertising options.
TOTAL ADVERTISING AND VIDEO ADVERTISING

Television advertising is one component of a larger advertising market.
Total advertising grew rapidly as a percentage of GNP until the mid-1980's
(table 23) ,135 Recently the pie has ceased to expand: advertising volume
has grown at roughly the same rate as GNP since 1985, and is expected to
continue to do so. Video advertising (including broadcast and cable
television) grew as a proportion of total advertising through 1984, then
declined slightly. Industry Projections indicate that advertising, and the

video component of advertising, are expected to grow at about the same rate

135 Forecasts of advertising expenditures are most commonly based on
projections of GNP growth with some ad hoc corrections for events such as
Olympic and election years and subjective adjustments for structural changes
in the economy. “Advertising Revenue’s Great Expectations," ing,
April 15, 1991, p. 82. Consequently such predictions are subject to
considerable error and should not be given excessive weight. More important
for our analysis than precise predictions are the direction of trends and
the relative positions of competing media.

- 112 -


demographic criteria, sometimes collapsing the decision to the size of the
audience in a single target demographic group.141 The decline over time in
broadcast networks’ advertising share and the increase in the shares of cable
and national syndication, shown in table 24, are roughly consistent with the
movement of audiences away from network television and toward cable and

independent stations.

As viewing shifts from broadcast television to other media, audiences
for television advertising will decline. If viewers move to non-advertiser-
supported media, such as prerecorded tapes or pay cable, total video
advertising audiences will decline, and broadcast stations and networks may be
able to raise prices per viewer in consequence of the reduced supply
(assuming the remaining audiences are qualitatively similar to those in the
past). On the other hand, if viewers move to basic cable, advertising
audiences will remain undiminished (to the extent that cable advertising is
a substitute for broadcast advertising), but broadcasters’ share will fall.
Thus the consequences for broadcasters of basic cable viewing are potentially
more serious than those of pay cable viewing. It should be noted that basic
cable has a much larger share of viewing than pay cable, and its share has

been growing rapidly.

141 As discussed below, fragmentation of both video and print media
have recently been accompanied by more targeted advertising, which places
advertisements in media that attract groups of viewers or readers likely to
have an interest in the product.

-117-


other syndicated programming. Second, many independent stations are in a
weak financial position because of overexpansion and because of the current
recession. Recently prices paid for syndicated programming are reported to
have fallen,178

LOCAL PROGRAMMING

Local programming, particularly news and public affairs, is the single
program service that, at least for the present, remains primarily the |
domain of local broadcasters; a desire to foster programming responsive to
the needs of the local community provides the primary rationale for the FCC’s
public policy interest in local broadcast stations. Local news appears to be
highly valued by viewers and profitable to stations. Network affiliates are

reported to derive as much as a third of their revenues from local news.179

Smaller audiences for broadcast stations will mean declining revenues,
which may lead to reduced expenditures on local programming (depending on
expectations concerning the effects of program expenditures on audiences) .
The effects will vary greatly among stations, however. Major stations in

large markets have sufficiently high profits that they may sustain

178 "$3-Billion Syndication Business Feels a Pinch," Los Angeles Times,
Jamary 21, 1991, p. F-12.

179 Paul Farhi, "The Great Big Broadcast of 1991," Washington Post, March
11, 1991, p. Fl.

- 141 -


spectrum of programming, ranging from general interest to niche programming

for small audiences.

Basic cable channels are increasing program expenditures, and are moving
toward made-for~cable programming, including movies and first-run series. As
cable advertising grows, moreover, cable operators will increasingly have
an incentive to increase viewing as well as simply numbers of subscribers,
and so to offer general-interest programming and otherwise behave more like
the broadcast networks.186 Programming on most basic cable channels, however,

remains less expensive than that of the broadcast networks.

The most highly valued programming, such as first-run movies and certain :
sporting events, has been offered on pay channels or on a pay-per-view basis.
Pay cable networks are reported to have shown as many original movies as the
three major broadcast networks combined in 1990, in many cases paying as much

and even more than broadcast networks do.187

186 INTV points out that cable networks are increasingly developing and
buying mass appeal programming like that on broadcast networks. JINTV_ Reply
Caments, pp. 32-38.

187 For instance, HBO recently spent a record $9 million for "The Josephine
Baker Story." Electronic Media, November 12, 1990; Wall Street Journal, p. B-
1, December 17, 1990. See also INTV Reply Comments, p. 34, and Network
Ein/Syn Comments, Vol. I, pp. 82-83.

- 145 -


BROADCAST TELEVISION IN A MULTICHANNEL MARKETPLACE

Florence Setzer*
Jonathan Levy*

Office of Plans and Policy
Federal Commmications Camnission
Washington, D.C. 20554
dune 1991

OPP Working Paper No. 26

* The opinions and conclusions expressed in this paper are those of the
authors and do not necessarily reflect the views of the Federal
Commmications Commission or any of its Commissioners or other staff. The


X. THE PROGRAM MARKET

Growth in the number of video outlets has increased demand for
programming. Because direct-payment media can charge on the basis of viewers!
rather than advertisers’ valuation of programming, and in some cases these
media receive both advertising and subscription revenues, direct-payment media
receive more revenues than advertiser-supported broadcasters from audiences
of the same size. Thus they are able to present programming that would not be
financially viable for broadcasters, and they may be able to purchase more

expensive, and presumably more attractive, programming.

The ability to provide programming at the mix of quality and price that
viewers want is crucial to success in the mass media. Entrepreneurs starting
new ventures with DBS or MMDS often consider access to programming a key
element in determining their success or failure, and more likely to be an
impediment than the technical ability to deliver additional channels.172 The
Fox network’s role in reversing the fortunes of many independent stations
makes clear the importance of programming that appeals to viewers’ tastes, as

well as the efficiency of net working.

172 1990: Pivotal Year for DBS Hopefuls," Multichannel News, January 7,
1991 p. 4; “Pies in the Sky?" Channels, Dec. 3, 1990, p. 51; “Of Lobbies and
Lawsuits," Channels, Dec. 3, 1990, p. 59. See also ECC Cable Report, para.
114.

- 135 -


use C-band transmissions for program distribution, so the home dish market

be able to "piggyback" on this programming source during that period.
Medium Power Ku-Band Systems

One medium power Ku-band system is operating and a second one is
scheduled to launch soon. PrimeStar is currently offering a package of
superstations and pay-per-view services in this band. SkyPix plans to begin
its service in the summer of 1991, offering 80 channels of Programming by
utilizing an eight-to-one signal compression ratio.114 Most of this capacity
will be used to offer popular current movies, each one transmitted several
times per evening with staggered starting times, perhaps every half hour.
This scheduling provides a service close to video on demand that may be seen
as a substitute for cassette rental. Some industry observers believe that,
in order to prosper, SkyPix will have to gain access to additional

programming, such as popular basic cable channels.

SkyPix plans to sell its reception equipment for $699, while PrimeStar
- equipment costs $595 installed. Both services claim that an antenna rougly

three feet in diameter is needed for reception, both expect to break even

114 The information in these paragraphs on Primestar is drawn from
Satellite Business News, April 3, 1991, p. 4; Nov. 28, 1990, pp. 7, 14; Nov.
14, 1990, pp. 1, 22; Electronic Media, Nov. 5, 1990, p. 12; and Satellite
Communications, April 1990, p. 6.

The description of SkyPix is drawn from Satellite Business News, May 1,
1991, pp. 1, 22-23; March 20, 1991, pp. 1, 22; and Oct. 3, 1990, pp. 1, 21.

- 9 -


possibly as much as $3000 initially--and viewers will need very large
screens to be able to appreciate the improvement in picture quality. So

the extent of consumer acceptance of HDTV in the short run is urclear.

For broadcasters, the cost of HDTV transmission equipment will be
substantial. Recent studies estimate that for a large-market station,
$1,5-$2.0 million would be required to transmit a network signal, and $10-
$12 million would be required for local production capability .58

An Advisory Committee to the FCC is preparing to test HDTV systems to
make recommendations to the Commission concerning adoption of technical
Standards for terrestrial broadcasting. The Commission expects to choose a
Standard by mid-1993. Service will begin in mid-1995 at the earliest. By
the most optimistic current projections, penetration-of receiving equipment

will not reach 1 percent of television households by the year 2000.59 So,

58 "Estimates of TV Stations’ HDTV Conversion Costs Cut by 2/3,"
Communications Daily, October 5, 1990, p. 2.

59 Videocassette recorders required between seven and eight years and
color television receivers required eight years to reach 1 percent
penetration. "Economic Potential of Advanced Television Products," report
by Larry F. Darby Associates for the National Telecommunications and
Information Administration, April 7, 1988. Research for Working Party 5 of
the Planning Subcommittee of the Advisory Committee on Advanced Television
Service indicates that only under the most optimistic assumptions does the
rate of adoption of HDTV approach those of color TV or VCRs. Memorandum
from Scott Frederick to Michael Tyler, "Revised Projections of ATV Receiver
Cost and Penetration Rates for Discussion by the FCC Working Party," August
16, 1990. Demand for HDTV receivers, however, will almost certainly be
highly sensitive to price, and developments in all-digital technology that
have occurred since the forecasts were made may reduce receiver costs enough
to increase the rate of adoption.

- 56 -


examines changes over time in the composition of costs.43 The most striking
difference across markets is the higher percentage of total expenses devoted
to news and to programming and production in large markets (e.g., a total of
59.3 percent in the top ten markets) than in small markets (e.g., 23.8
percent in markets below 175) (table 13). This finding is consistent with

stations in large markets competing through increased program expenditures

TABLE 13
EXPENSE ITEMS OF COMMERCIAL BROADCAST
STATIONS BY MARKET SIZE, 1989
{Percent of Total Expenses)

ADI Programming Advertising General &
Market Rank Engineering & Production News Sales _& Promotion Administrative

1-10 6.7 42.7 16.6 64 59 216
41-50 64 29.1 12.4 9.2 42 38.6
91-100 79 26.5 WS 11.6 3.7 38.9

131-150 77 17.5 10.8 10.6 24 51.4
176+ 85 14.8 9.0 12.5 20 53.2

SOURCE: NAB, Television Financial Report, 1990,
NOTE: Percentages do not add to 100 due to rounding.

where the price and quantity of output are fixed. Also, prices of
syndicated programs are to a large extent based on audience size, resulting
in higher prices in larger markets for comparable programming.44 At the
same time, engineering, sales, and general and administrative expenses make
up a decreasing share of expenses as market size increases.

43 Cost categories are taken from the NAB Television Financial Report.

44 Noll, Peck, and McGowan, Economic Aspects of Television Requlation,
pp. 71-80.

- 42 -


reputation for superior production quality that historically distinguished
the broadcast networks. Viewers will increasingly see cable and broadcast
programming as interchangeable. The Fox network will provide a close
substitute for the traditional networks in terms of both audience perception
and nationwide advertising reach. Other nationwide distribution media may
develop through some combination of cable and DBS. The networks will continue
to lose their uniqueness to both audiences and advertisers, leaving them

increasingly three program packagers among a large number.

As program packagers, networks have the flexibility to serve various
distribution channels. As the broadcast advertising market shrinks, the
networks will have an incentive to diversify into other markets. Indeed, to
the extent that regulations restrict their ability to expand their broadcast
activities, the networks will have significant incentives to diversify into
non-broadcast media. Two of the three broadcast networks already have
interests in cable programming ventures, and their programming is delivered
to home satellite dishes in areas where it is not available over the air.
In the future the networks may provide programming for DBS or MMDS systems
as well. Thus the networks’ long-term prospects are not wholly tied to the
fortunes of over-the-air broadcasting, and at some point the networks may
find it more profitable to supply programming directly to cable or other
media, or directly to the home, than to broadcast affiliates.

For the short term the continued viability of networking is suggested

by the success of the Fox network and its affiliates. Fox’s success,

- 163 -


Wholesale migration of sports programming to nonbroadcast media, or a
significant expansion in the provision of local programming such as news by
cable, could also cut into the broadcast audience. On the other hand,
cable’s growth could be slowed by loss of the compulsory license to
retransmit broadcast programming. This possibility, discussed in more
detail in chapter X, could not only raise cable operators’ program
acquisition costs, but, by providing broadcasters with a second revenue
stream (from subscriptions or "retransmission fees") could enable them to
acquire more expensive programming. While this would have a positive effect
on the competitive position of broadcasting, it alone is unlikely to
counterbalance the inroads on broadcast audiences being made by cable

networks and increased expenditures on cable programming.

-91-


number of commercial UHF stations grew by 150 percent between 1980 and 1990.
About 70 percent of the new stations since 1980 have been independents,
that is, stations unaffiliated with the three major broadcast television
networks, ABC, CBS, and NBC; the number of independents nearly tripled
between 1980 and 1990. The number of independents grew from about 18

percent to about 35 percent of the total.

FIGURE 1
COMMERCIAL TELEVISION STATIONS

1100,
990]
sol

770[. Y
s6olyy
550]

440]
330

220]
110]

ONOZO-AFPHAHH *

12

Vee

; +
1975 1980 1985 1990
YEAR
© VHF UHF

-16-


TABLE 1
HOUSEHOLDS WITH TELEVISION EQUIPMENT AND SERVICES, 1975-1990

1976 1980 1985 1990
Television Sets (% of All Households) 97.4 97.9 98.1 98.2
Multiple Sets (% of TV Households) 43.1 50.1 56.8 65.3
Average Number of Sets 1.56 1.68 1.83 2.0
Homes Passed by Cable (% of TV Households) 33.2 45.7 76.2 91.2°
Cable Subscribers (% of TV Households) 17.0 25.2 43.2 56.0°
Videocassette Recorders (% of TV Households) 0.0 14 20.8 68.6
Home Satellite Dish Systems (% of TV Househoids) 0.0 0.4 1.6 29

SOURCES: Television sets and videocassette recorders, Television Bureau of Advertising, inc.,
“Trends in Television,” April 1990, pp. 3-6; homes passed by cable and cable subscribers, Paul Kagan
Associates, Cable Television | , Nov. 21, 1990, p. 9; home satellite dish systems, 1980 and
1985, Report and Order in General Docket 86-336, 2 FCC Red 1669 (1987), paragraph 25 and tabie 2;

1990, Satellite Business News, Dec. 12, 1990.
“Estimated.

from satellite master antenna television (SMATV) systems in large buildings.11
Videocassette recorders, whose use was negligible in 1975, are now used by
more than two-thirds of all households. Other innovations introduced during
‘the period, video games and home computers, compete for viewers’ time (and

their television screens).

11 Satellite program delivery has been essential to expanding the
alternatives in the market, providing inexpensive program delivery to cable
systems, home receiving dishes, wireless cable systems, SMATV systems, and
independent stations, as well as to network affiliates.

-12-


impractical in many congested urban areas. In addition to the issue of sheer
availability of space, considerations of safety, esthetics, and municipal
regulations (i.e., zoning rules) also affect the decision to install a home
satellite system. One source estimates that a complete C-band HSD system

costs between $2000 and $4000.110

Cable programmers use the C-band for delivering programming to cable
system headends, and employ the Videocipher II (vC IT) technology to encrypt |
it.111 prices, particularly for annual subscriptions, are comparable to or
below cable subscriber rates.112 There are roughly 710,000 legally
authorized subscribers to C-band services and at least that many additional
signal "pirates" (i.e., households with decoders altered to permit theft of
scrambled satellite services).113 Recently the major cable programmers signed
long term leases for transponders on the new generation of C band satellites.

Thus, for at least the next ten years, cable networks will almost certainly

110 ~=- Reinhart, p. 417.
111 See FCC Encryption Standards Report.

112 See Satellite Orbit (May 1991), pp/ B3, B7-B9; FOC Cable Report, para.
20 and appendix F, tables 1B and 9; Satellite Broadcasting and
Communications Association, SBCA Home Satellite Subscription Information,
(May 1990); Second Report in Gen. Docket No. 86-336, 3 FCC Rcd 1202 (1988),
paras. 38-50.

113. The General Instrument Corporation (GIC) is the patent holder and
primary manufacturer of Videocipher II equipment. GIC figures for April 30,
1991 show 459,000 legally authorized Videocipher II and 251,000 legally
authorized Videocipher II Plus decoders. Chapter V contains a brief
discussion of signal theft issues.

- 95 -


Cable networks are reported to have spent about the same amount in total on

made-for-TV movies as broadcast ret works.200

Cable program expenses in 1990, according to the Kagan data, made up
about 16 percent of the total including the conventional broadcast net works,
the Fox network, stations, and syndicators. This is a modest amount,
considering that in 1990 cable programming attracted 32 percent of total
viewing, and that viewers have to pay for cable service. Excluding distant
signals and superstations, for which cable operators apparently pay below-
market prices through the Copyright Royalty Tribunal, cable viewing still
makes up 26 percent of the total.201

Revenues of basic cable networks are derived from advertising and from
license fees, which are the per-subscriber fees paid by cable operators to
networks. License fees, the "second revenue stream" available to basic cable
in addition to advertising, accounted for 33.2 percent of gross revenues of
basic cable networks in 1990. The share of license fees is projected to fall
over time as advertising revenues rise, but to remain at 30.7 percent in

1999,202 These percentages are smaller than expected, since industry reports

200 Tbid.; Cable World, May 20, 1991, p. 1.
201 See the discussion of the compulsory copyright license below.

202 Calculated from Paul Kagan Associates, "Cable TV Programming," August
31, 1990, p. 2.

- 152 -


expenditures may have lagged; basic cable network program expenditures have
in fact fallen as a percentage of gross revenues. Furthermore, because profit
margins for cable networks such as ESPN, TBS, and CNN appear to exceed
substantially the broadcast networks’ margins, it appears that at least the
most successful cable networks could increase their program expenditures
considerably.205 Press accounts report that cable networks are in fact
increasing program expenditures, while broadcast networks are experiencing

losses and are attempting to slash program costs.
COMPULSORY COPYRIGHT LICENSE

A factor affecting both broadcast and cable revenues and program
expenses is the compulsory copyright license, under which many television
broadcast signals are retransmitted by cable television systems. Royalties
paid by cable operators under the compulsory license are distributed to
copyright holders by the Copyright Royalty Tribunal.206 While the bulk of
these royalties go to the producers of entertainment series and to the various

sports interests, a small fraction, roughly 5 percent of the total, goes to

205 See, e.g., “Down Year in Profits for the Big Three," Broadcasting, May
6, 1991, p. 19, and Turner Broadcasting System Annual Report for 1990.

206 The compulsory copyright license raises the issues, discussed in chapter
II, of conflict between efficient production and efficient distribution of
programming. Requiring cable systems to pay market prices for programming
would improve the incentives for program production, but would probably raise
prices to viewers and cause service to be denied to some viewers who would
place some value on it. See chapter II above.

- 155 -


XI, THE FUTURE CF BROADCAST TELEVISION

The broadcast. television industry has suffered an irreversible long-term
decline in audience and revenue shares, which will continue through the
current decade. The effects will differ greatly, however, for various groups

of firms in the market and for different groups of viewers.
TELEVISION STATIONS

Broadcast television stations will experience declining revenues and ©
increasing program costs. Network compensation will fall with network
advertising revenues, and national spot advertising will erode partially to
cable. The potential for greatly increased competition from cable in local

advertising is clear as well.

The effects of these trends will vary greatly across stations and
markets. The current revenues and profits of broadcast stations vary
enormously with market size. In large markets, audiences probably will remain
large enough to support many television stations, particularly since over-
the-air alternatives are so plentiful in these markets that cable penetration
remains relatively low. Broadcasters in large markets will see their profits
fall and probably will have to cut costs. But in the largest markets, profits
and costs are so far above the minimum required to operate a station that
for many of the largest stations, great declines in revenue could probably
occur without appreciably affecting service. In addition, program prices

likely will fall as the revenue potential of the programs falls, so only part

- 159 -


originated services rose from 24 percent in 1984/85 to 39 percent in
1989/90. So the declining share of broadcast viewing results both from
increased cable penetration and from an increased share of cable programming
in the viewing of cable households. In 1989/90, services available only via
cable accounted for a substantial 45 percent of viewing in cable households
and 51 percent--over half--in pay cable households. The increase in cable
viewing occurs entirely in basic service; pay viewing shares have remained
flat, while the combined share of superstations and distant independents has
fallen.

FIGURE 4
ALL-DAY VIEWING SHARE

1984-85 1989-90

AA

Network Affiliates
Local independents
Distant Independents
Superstations
Public

Basic Cable

4 Pay Cable

is} slay [f=]

-24-


presumably will be the one with the least popular programming, the loss is
probably small. We have noted that marginal stations probably produce little
local news or public affairs programming, so the loss of local content
probably will be negligible. If broadcast programming moves to a pay (or
particularly a pay-per-view) service, viewers will be worse off because they
will have to pay for what was previously free. But that effect must be
balanced against the supply of previously unavailable programming that would

be supplied on a subscription basis.

Viewers who are passed by cable but do not subscribe will experience a
loss of welfare if the number of broadcast stations or the quality of
programming declines.211 Those who value television highly but cannot afford
to subscribe will suffer the greatest loss. Those who currently choose not
to subscribe because they do not value television programming highly or
because over-the-air programming suits their tastes will experience a smaller
loss. Some will continue not subscribing to cable and experience a reduction
in service. The associated welfare loss will depend on their taste for
television as well as the magnitude of the reduction in service. Some will
subscribe to cable, choosing to pay for service that, while more valuable
than what is available off-air, may be inferior to what they previously

received without charge.

211 About 35 percent of television households are passed by cable but do
not subscribe. See table 15.

- 165 -


VII. OTHER VIDEO MEDIA

Videocassette recorders and wireless cable systems provide additional
sources of video programming. While unlikely to have the massive effect of
cable and, conceivably, satellite service, these media clearly expand viewers’
options and affect the broadcast television market. The cumulative effect of
several additional alternatives may be considerable. We describe these media

briefly below.
VIDEQCASSETTE RECORDERS

VCRs expand the choices available to television households by
providing pre-recorded material as well as recording and playing material
received over the air. VCRs allow viewers to see material in the home
that commercial broadcast TV stations could not offer because it would
mot be attractive to advertisers or is inappropriate for broadcast, and
even of material too specialized to be offered by cable. They also allow
viewers to control the time at which they view over-the-air programs.
Because VCRs both provide additional options and increase the convenience of
over-the-air viewing, in theory they might either increase or decrease the
amount. of time spent viewing over-the-air material. Some broadcasters also
fear that the ability to fast-forward through commercials may reduce the

effectiveness of commercial messages.

Videocassette recorders were introduced in the early 1970's and by 1990

were used by over two-thirds of television households, as shown in table 20.

- 105 -


Industry predictions show the network share of television advertising
revenues, which fell from 44.7 percent in 1980 to 33.8 percent in 1990,
continuing to fall. The Television Bureau of Advertising predicts a network
share of video advertising of 31.9 in 1995; Veronis, Suhler and Associates
predicts a share of 32.4 percent in 1994,156 The Television Bureau of
Advertising prediction implies network advertising growth slightly slower than
the growth of GNP, 26.4 percent as compared with 33.2 percent, in nominal

terms, over five years.

These predictions of advertising revenues are likely to overestimate
future network revenues for several reasons. The Veronis and Suhler
predictions are based on optimistic assumptions for the networks: no
recession, slower ratings declines, and a stronger national advertising
market. The network rating predictions may be optimistic because even if
the growth of cable subscribership slows, cable viewing by cable households
will almost certainly continue to increase. In addition, until recently
networks have been able to raise the price per thousand viewers for

- advertising time.157 prices for network advertising time plunged in late 1990
and spring 1991, however, indicating that the networks may no longer have that
ability .158

156 Television Bureau of Advertising, "Trends in GNP, Ad Volume, TV Ad
Volume, 1960-1995," April 1991; icati » Pp. 22, 50,
52-53.

157 Television Bureau of Advertising, “Trends in Television," p. 11.

158 "CBS Strikes Out With Sports, Posts $156-Million Loss," Los Angeles

- 126 -


housenholds.212 Moreover, it is important to remember that by historic
standards, the existing level of service is high: the number of commercial
television stations in operation is 50 percent greater than in 1980, and
recipients of multichannel services have enormously greater choice available
to them. For those to whom cable or other multichannel service is
unavailable, or who cannot afford such service, however, the loss of broadcast

service would be a significant loss.

QUALIFICATIONS

These predictions assume a continuation of current trends. Some
dramatic departure from these trends may drastically alter the outcome. One
such occurrence could be early development of a highly successful DBS service.
A DBS system could provide nationwide coverage, even in areas not reached by
cable or broadcasting; could aggregate audiences with unusual tastes even
more efficiently than cable; and could have enough channels to offer near
video on demand. The single obvious drawback of DBS is that it probably could
not offer local programming, though regional programming would be technically
possible. A popular DBS service would accelerate the migration of audiences

away from terrestrial broadcasters.

212 Only 15.2 percent of television households live in small television
markets, i.e., those below the top 100. Moreover, those markets are now

served by 35.1 percent of the total number of television broadcast stations in

the United States. See Arbitron Ratings Company, Television ADI Market Guide

1989-1990.

~ 167 -


V. TECHNOLOGICAL ISSUES

Several new technologies may radically change the economics of video
distribution and the range of services delivered. Video compression is the
development likely to have the biggest impact in the coming decade. Video
compression technologies offer the potential to expand greatly the capacity of
video distribution systems. While video compression is likely to be utilized
first for satellite program distribution, it is applicable to cable and
terrestrial transmissions as well. Another potentially important technology
now under development is high definition television (HDTV), which would

provide substantially better picture and sound quality.

Interactive services (i.e., those utilizing two-way communications) is
a third area of technological development that will permit enhanced offerings
of services available today such as pay-per-view and home shopping. Should
significant demand for additional interactive services develop, interactive
capacity will be an important determinant of the popularity of the various

delivery systems.

A fourth important area of technological change is signal encryption.
Any distribution system that relies even in part on subscriber fees must have
an adequate method of controlling access to the product. Ina wide range
of applications, this means encrypting the signal. Video service providers
are confronting, and will continue to confront, issues relating to the

security and cost of encryption systems.

- 48 -


television stations’ broadcasts. Currently, distant broadcast stations, both
independents and, in some areas, network affiliates, are available via
satellite, as are regional services. If the major broadcast networks offered
programming directly to viewers (e.g., directly to the home via satellite, or
directly to the home via cable) without broadcast stations as intermediaries,

DBS’s lack of local broadcast signals would become less of a disability.

Services that DBS might be able to offer that are not available on
cable, or that might become available on satellite before cable can offer
them, include near video on demand and very narrowly targeted programming.
With respect to near video on demand, satellite services may have a head start
on cable by virtue of their possible earlier implementation of video
compression technology. Should these services prove highly valued by
consumers, DBS might overcome any comparative disadvantages due to high

equipment costs or restricted access to conventional cable programming. 124

124 While compressed video services probably will be available in 1991 via
satellite, industry sources estimate that compression will not be introduced
on cable until 1994. See Cable World, April 1, 1991, p. 44; i i
Daily, March 28, 1991, pp. 2-3. Satellites may have an advantage in the
aggregation of narrow preferences because a single orbital slot can serve
the entire contiguous United States, while cable faces a significant
cost for each additional home passed. By one estimate, the per-
channel cost of reaching all television households is $3.7 million via
satellite and $378 million via cable. (Calculations based on data in RAND
DBS Report, p. 17 and RAND Broadband Services Report, p. 86.) At least one
DBS entrepreneur asserts that cable operators will not find it economical to
devote channel capacity to services with very narrow appeal. See

Broadcasting, April 8, 1991, p. 66.

- 102 -


technology, particularly in the satellite area, is evolving toward flexible
systems that can be upgraded at relatively low cost in the event of a security
breach. In the event that satellite programmers adopt incompatible encryption

technologies, incentives will exist to develop multistandard decoders.

Overall, technological developments are likely to increase competition
to broadcasters. Expansion of channel capacity will benefit nonbroadcast
media disproportionately, allowing them to offer more time diversity, as well
as additional targeted programming. Technological considerations per se do
not change the most likely scenario for broadcast television over the next
ten years--a continuing gradual decline in viewing shares. However, if some
of the new services technology will make available turn out to have a
fundamental effect on the way people watch television (e.g., if pay-per-view
is wildly successful) the potential exists for a more rapid erosion of
broadcasting’s share. On the other hand, these technologies may permit
television broadcasters to become multichannel, multi-revenue stream

competitors.

- 66 -


TABLE 4

HOUSEHOLDS IN ADI'S WITH VARIOUS
NUMBERS OF OVER-THE-AIR SIGNALS

1975 1980-81 1984-85 1989-90
% Cum. % % Cum. % % Cum. % % Cum. %
20+ 0.0 0.0 0.0 0.0 0.0 0.0 10.1 10.1
15-19 14.3 14.3 13.8 13.8 20.5 20.5 17.2 27.3
10-14 6.8 214 12.8 26.6 15.2 35.7 26.5 53.8
5-9 57.7 78.8 56.8 83.4 51.9 87.6 40.1 93.9
1-4 214 99.9 16.5 99.9 12.4 100.0 6.1 100.0

SOURCE: Arbitron Ratings Company, Television Market and Rankings Guide, 1975,

1980-81; 1984-1985 ADI Market Guide; Television ADI Market Guide 1989-1990.
NOTE: Percentages do not add to 100 due to rounding.

percent of television households had available 15 or more over-the-air

stations; in 1990 27 percent had 15 or more stations and 10 percent had

20 stations.

Not only has the number of television signals available

increased dramatically over the past 15 years, but over-the-air service is

such that most households have considerable choice in programming even

without cable. Ironically, however, this expansion of over-the-air signals

was made possible by cable.

-18-


identification, have been developed to handle the last-minute bulges in
orders. As these become more widely applied, the pay-per-view ordering
process will become easier, which should spur demand. 94

The projections of growth in pay-per-view subscribership reported
in table 18 appear to be based on the assumption that the nature of the
pay-per-view business will not change significantly. They suggest that
Pay-per-view will probably be used infrequently by large numbers of
customers, and so will probably have little effect on broadcast viewing.
However, the developments described below under the headings of increased
channel capacity and timeshifting could change the nature of the pay-per-
view business radically. The assumptions underlying the predictions in
table 18 would then be irrelevant, and pay-per-view use would likely be well
above the predicted levels.

Increased Channel Capacity

Channel capacity also affects the demand for cable service. Table
. 19 shows that cable system channel capacity has increased steadily over
time. In 1983, the earliest year for which disaggregated data are

available, 48.7 percent of cable subscribers were served by systems with

94 One proposed satellite service, SkyPix, plans to adapt its near video on
demand satellite pay-per-view service for cable use. This would make it
possible for subscribers without addressable converters, but with compressed
video converters, to access impulse pay-per-view services. See Cable World,
April 1, 1991, p. 27 and chapter VII below.

- 84 -


satellite (DBS) service also could have a substantial impact. DBS is likely
to spread more rapidly in areas not passed by cable, which may have limited
broadcast service. To the extent that satellite services proliferate in
cabled areas, the impact on broadcast shares will almost certainly be
negative. Not only will satellite services offer additional viewing options,
but they will exert competitive pressure on cable, resulting in lower cable
rates and improved service.

The technological development with the greatest impact on the video
marketplace in this decade will almost certainly be digital video signal
compression, which will allow substantially expanded channel capacity. This
capacity will be used in part for additional conventional services, but more
importantly to provide time diversity, either through multiple feeds of
conventional cable (or broadcast) networks or through "near video on demand"
pay-per-view services. Compression will be introduced first in the satellite ©
media, then in cable, and then, perhaps, in broadcasting.

Video advertising, the source of broadcasters’ revenues, is likely to
grow very slowly over the next decade, after an earlier period of rapid
growth. The composition of video advertising will shift toward cable and
national syndication and away from network and national spot. Consequently,
television stations’ overall share of advertising will fall further. The
likelihood of continued rapid growth of cable advertising (national and local)
is suggested by the fact that cable accounts for 6 percent of video
advertising revenues but 22 percent of viewing on channels accepting
advertising. . .

The effects of increased competition on broadcast television will be
significant but vary among viewers and firms. Broadcast television stations,
as a group, will suffer declining revenues. In large markets, most television
broadcasters will remain profitable, though some may scale back local
programming--mostly news and public affairs--and same marginal stations may go
dark. In smaller markets the effects will be more severe with some stations
going off the air, reducing viewer choice. Overall, by the end of the decade,
fewer broadcast television stations will serve a shrunken, but nevertheless
substantial, audience.

The three conventional television net works’ audiences’ will continue to
decline, albeit more slowly than over the recent past. As cable advertising
becomes a better substitute for network advertising, network revenues will
fall along with audiences. The effect on network programming likely will be
lower-cost and lower-quality programming, with the result that the networks
will continue to lose their uniqueness to both audiences and advertisers. It
is possible, however, that in the long run program quality will decline less
than program costs because payments to the most popular talent will fall with

-ix-


VI. CABLE TELEVISION

Cable television constitutes by far the most significant rival to
broadcast television today, and is likely to remain so over the next ten
years. Cable systems began in areas with poor off-air television reception,
and at first primarily offered improved reception of existing broadcast
signals or imported a few distant signals. The advent of satellite program
delivery to cable headends made possible the nationwide distribution of both
broadcast signals and cable networks. The additional programming created a
demand for cable even in areas with good over-the-air reception. The major
urban areas of the country were generally cabled following the development of .
these national program services, in part because abundant off-air television
service limited demand and in part, perhaps, because construction costs are
higher in urban areas. Cable subscribership remains lower in most large urban
areas as well.70

HISTORICAL DATA AND PROJECTIONS

Table 15 provides historical data on cable availability,
subscribership, and penetration for the two main categories of cable

television service—basic and pay.71 Projections of basic cable

70 In 1990, cable penetration was below the national average in seven of
the top ten markets. Television and Cable Factbook, 1990, Services Volume,
pp. C-340, C-337-38.

7 The third category, pay-per-view, which is not currently significant, is
discussed later in the chapter.

-67-


TABLE 16

CABLE OPERATOR REVENUES

1975 1980 1985 1990° 1995** 1999°*

Revenues ($ Million)
Totai 804 2603 9305 17874 28045 38401
Basic 764 1649 4353 9828 14953 20151
Pay 29 785 3787 5108 6501 7650
Pay Per View 7 ” - 417 1677 3913
Advertising - 8 167 635 1500 2402
Other 1 161 998 1886 3414 4285

Percent of Total

Basic 95.0 63.3 46.7 55.0 53.3 52.5
Pay 3.6 30.2 407 28.6 23.2 19.9
Pay Per View - - ~ 23 6.0 10.2
Advertising 7 0.3 1.8 3.6 5.3 6.3
Other 1.4 6.2 10.7 10.6 12.2 14.2

SOURCE: Paul Kagan Associates, The Kagan Cable TV Financial Databook (June 1990), p. 10, 12, 70.

NOTES: Advertising is “national and local spot.”

Temotes, etc. Estimated expanded basic revenues were $440 million in 1990.
**Projected.

“Estimated.

Other includes: expanded basic, second set hookup

The projections in table 16 suggest that the relative importance of

basic cable revenues will not change much in the next ten years.

In 1990,

basic fees were 54.9 percent of total revenues, while they are projected to

drop only to 52.5 percent in 1999.

While pay-per-view revenues are

projected to increase significantly in relative terms, from 2.3 to 10.2

percent of total revenues, this development appears to reflect a switch

from pay-per-channel to pay-per-view programming.

The sum of pay and pay-

per-view revenue shares hardly changes, according to the projections, with

a 30.9 percent composite share in 1990 and a 30.1 composite share in 1999.

-73-


Figure
1. Commercial Television Stations. .. -
2. Number of Broadcast TV Signals Available to
Share of Households .. +--+ ++ eees
3. Weekly TV Viewing... - eee ees
4,  All-Day Viewing Share. .- +--+: > we
5, Prime-Time Viewing Shares... +--+ +++
6. Profits as a Percentage of Revenue. . .
7. Commercial TV Station Expenses (B). 2 ee
8. Cable System Channel Capacity ...-.--
9. Total Video and Network Advertising Revenue .
10. Shere of Television Advertising Revenue .
11. Cable Advertising Revenue (1982-84 Dollars

LIST OF ILLUSTRATIONS

-vi-

Page

- 24

- 43
. 86
122
+124

+ 130


that discriminate against HSD antennas.122 The Commission has before it two
petitions that, in essence, request more vigorous enforcement of the
Commission’s preemption order.123 such enforcement might have a significant
impact on HSD system sales, and thus might indirectly influence the

competitiveness of HSDs with cable, broadcasting, and other video delivery

Because of the demonstrated popularity of cable services, it appears
that, in order to be competitive, satellite services need to offer cable
networks (or close substitutes for them) or new services that are highly
valued. Access to cable programming seems assured only for the C-band
service. The programming is already being encrypted and delivered to cable
headends via C-band so the marginal cost of delivering it to dish owners is
quite low (the conditional access and billing system are the primary added

expenses) .

While DBS cannot deliver local broadcast signals, satellites can deliver

the nationally-distributed programming that comprises a large share of local

122 Report and Order in CC Docket No. 85-87, 57 Fed Reg 5519 (Feb. 14,
1986), esp. paras. 1, 40.

_ -Betition of Joseph Carine for Datla ulin Cla DA 91-145, filed
21, 1991, and Panation for besleratony Aaa ae Ausinst fone
i , Satellite

Broadcasting and Communications Association, filed April 16, 1991.

- 101 -


Table 15 shows that between 1985 and 1990 the pay cable penetration of homes

passed actually dropped. The number of pay households increased only
modestly.77

The projections in Table 15 suggest that over the next decade basic
cable subscribership will grow at a slower rate than in the past. The
projections reflect a growth rate of basic subscribers of 5.5 percent in
1990 and 2.5 percent in 1999. The slower growth occurs largely, but not
entirely, because very Little of the country remains uncabled, and in much
of the uncabled area, constructing cable systems would be prohibitively
expensive. The projections assume that new homes passed subscribe at the
same rate as in the past, but subscriber growth in homes already passed
slows from 3.9 percent a year in 1990 to 2.0 percent a year in 1999.78 Press
reports speak of market saturation after 1991, so that declining growth
rates appear plausible.79 Although projections of the number of
households subscribing to pay cable are not available, current trends seem

likely to continue. 80

777 Table 16 below indicates a similar pattern for pay cable revenues. From
1985 to 1990, their share in total cable operator revenues fell, while the
increase in absolute magnitude was moderate. Competition from videocassette
recorders and tape rental may explain this pattern. See chapter VIII below.

78 Paul Kagan Associates, Inc., "Cable TV Programming," August 31, 1990, p.

79 "Cable Growth Pegged at 15 Percent," Multichannel News," January 7,
1991, p. 38.

80 Table 16 projects a modest increase in cable operator pay cable revenues
and a declining share of those revenues in total operator revenues.

-71-


The rate of poverty remains far above the 1973 low.222 Poverty among
the elderly has declined, but poverty among children has increased.223 In
1986 about 15 percent of all families with children were poor, but 46
Percent of female-headed families with children were poor.224 ‘the rate of
Poverty among blacks and Hispanics is much higher than among whites. In
1987, 10.5 percent of whites, 28.2 percent of Hispanics, and 33.1 percent
of blacks were poor.

Ethnic minorities will make up an increasing proportion of the working
population, and particularly of the younger population, because of
immigration and higher birth rates among minority groups. Between 1988 and
2000, two-thirds of new entrants into the labor market will be Hispanic,
Asian, black, or female.225

Education requirements for jobs will continue to rise, but educational
attainments of the population are not growing commensurately.226 High school

completion rates have remained about constant since 1973, though they have

222 transmitted to the Congress
February 1990, U.S. Government Printing Office, (Washington: 1990), p. 167.

223 Statistical Abstract, 1989, p. 454.
224° ~— Thid., p. 456.

225 Economic Report of the President, 1990, p. 148.

226 Tbid., pp. 149-153.

- 178 -


with 300,000 subscribers, and both plan to move from their leased space on
medium power satellites to high power Ku-band satellites (DBS) when such

satellites become available later in the 1990's
High Power DBS

True DBS (i.e., high-powered Ku-band satellite service) is on the
horizon. Eight DBS permits have been issued and one application is still
being evaluated.15 The permittees have made varying degrees of progress
toward constructing their satellites. None have yet launched, but some
launches are currently scheduled for 1994.116 pBs home reception equipment
will likely include a dish antenna 18 inches in diameter. Eventually,
antennas may be as small as 12 inches in diameter. Estimates of the initial
cost of the systems range from $500 to $700, with one source predicting that

equipment costs will fall "rapidly" to from $700 to $300 or less.127

ANALYSIS
The growth of the home dish market is difficult to predict.
Notwithstanding the relatively high fraction of current dish owners passed

by cable, because of the high cost of receiving equipment, the most promising

115 RAND_DBS Report, p. 8.

116 See Satellite Business News, May 15, 1991, pp. 1, 21; June 12, 1991
pe. 1, 22, 23.

117 For information on proposed DBS services, see Broadcasting, April 8,

1991, p. 66 and Feb, 18, 1991, pp. 29-30; Satellite Business News, July 11,
1990, p. 37; and Communications Daily, April 19, 1991, p. 4.

-97 -


discourage viewing, it is not yet clear to what extent they will affect
the size of broadcast audiences. Pay-per-view events are now mostly movies
or sporting events such as boxing or professional wrestling matches,
along with some concerts; the overwhelming majority of pay-per-view revenues
now come from boxing and wrestling.92 Particular events are offered at
scheduled times and subscribers place orders for them, generally in advance.
With state-of-the-art equipment, orders can be accepted at the last minute

as well.
Table 18 provides current data and projections regarding pay-per-view

subscription activity. In 1990, about 19 percent of homes passed by cable,

TABLE 18
PAY-PER-VIEW (PPV) SUBSCRIBERSHIP

1990* 1995** 1999**

PPV Subscribers (Millions) 15.4 33.0 50.1
PPV Subscribers/Basic Subscribers (%) 27.9 54.1 74.2
PPV Subscribers/Homes Passed (%) 18.6 36.1 52.4
PPV Subscribers/TV Households (%) 16.7 33.6 48.8

SOURCE: Paul Kagan Associates, The Kagan Cable TY Financial Databook (June 1990), p. 10.
*Estimated. **Projected.

92 See note 63 above. One indicator of the potential of pay-per-view is
the success of the recent Holyfield-Foreman boxing match, which earned bet ween
$55 and $60 million in pay-per-view revenues. Broadcasting, April 29, 1991,
p. 39.

- 82-


than 9 percent of total expenses for all size classes of stations.213 allowing
networks and stations to apply their expertise in acquiring and distributing
programming in ways they find advantageous, both within broadeasting and in
other media, will improve broadcasters’ ability to provide service the public

values, This will permit them to compete more effectively.

Commission rules that restrict stations’ and networks! ability to
deliver service should be reconsidered. Among these are the various rules
restricting ownership of broadcast stations and ownership of other media along
with broadcast properties. In today’s market, for instance, common ownership
of larger numbers of broadcast stations nationwide, or of more than one
station in a market, may permit exploitation of economies of scale and reduce
costs or permit improved service. Joint newsgathering operations, for
instance, might permit improvements in the quality of local news coverage.
For these reasons, the Commission should eliminate its broadcast multiple
ownership rules, relax the duopoly rules to permit common ownership of
television stations unless their grade A contours overlap, and consider

eliminating the duopoly rules for unaffiliated UHF stations.

_ Similarly, allowing combinations bet ween broadcasters and other media,
as long as they did not decrease the competitiveness of local broadcast
markets, could allow efficient use of programming and other resources. Hence,

Congress should repeal the broadcast-cable crossownership prohibition and

213 NAB, Television Financial Report, 1990, pp. 1-16.

- 170 -


APPENDIX

DEMOGRAPHIC TRENDS AND BROADCAST AUDIENCES

Changes in the nation’s population, family structure, and work
behavior in the next decade will greatly affect both tastes for video
services and the resources households have to purchase these services.
Because changes in the population will almost certainly have a considerable
effect on broadcast viewing, we examine some of the more important trends
here.

Table 26 shows past and projected population trends in the United

States. In the period since 1975 the population has grown at roughly 1

TABLE 26
POPULATION OF THE UNITED STATES, 1975-2000

YEAR TOTAL % CHANGE MEDIAN
POPULATION IN_5 YEARS AGE
1975 215,973 28.7
1980 227,757 6.5 30.0
1985 239,279 5.1 31.5
1990° 249,891 44 33.0
1995° 259,619 3.9 48
2000* 267,747 34 36.5

SOURCES: 1975-1987, U.S. Bureau of the Census, Statistical
Abstract of the United States, 1989 (109th Edition.) Washington,
D.C., 1989, p. 13; 1980-2000, U.S. Bureau of the Census, Current
Population Reports, Series P-25, No. 1017, Projections of the
Populati Ri
U.S. Government Printing Otfice, Washington, D.C., 1988, pp. 20-21, 29.
*Projected.

- 173 -


compression will be able to offer a substantial degree of time diversity.
This could mean separate feeds of cable and broadcast networks for each time
zone in the United States, and it could also mean staggered starting times for
pay-per-view exhibitions of popular movies. In other words, a pay-per-view
programmer could transmit a box office hit several times each night, with
starting times every fifteen minutes or half hour of prime time. Since
viewers would never have to wait very long for their chosen movie to begin,

this service can be characterized as "near video on demand."47

The reduction in the cost of channel capacity will also lower the

barriers to entry for new channels. As a result, it is likely that more

47 Chapter VI contains a more extensive discussion of near video on demand
and timeshifting in general. An alternative to near video on demand is pure
video on demand, which would allow a subscriber to dial up a movie or other
Program at will. The technology to provide video on demand appears very
expensive and is not yet commercially available. Leland L. Johnson and
David P. Reed. Residential Broadband Services by Telephone Companies? _
Technoloay, Economics, and Public Policy. R-3906-MF/RL, (Santa Monica, CA:
RAND Corporation, 1990) ("RAND Broadband Service Report")

Video on demand requires switching capability, as well as at least a
fiber optic backbone and some fiber distribution plant and a link to the home
that can carry a few switched video lines (to accommodate simultaneous on-
demand viewing of multiple programs) in addition to capacity for the package
of dedicated channels now used to supply cable programming to subscribers.

Whether it were provided by a cable operator, or even a telephone
company, it is not clear if sufficient demand exists beyond near video on
demand to justify the investment. For this reason, several firms are now
conducting market research to determine the demand for switched video and the
exent to which it would substitute for near video on demand and other
subscription services. AT&T, TCI, and US West will offer 450 customers video
on demand and "enhanced pay-per-view" (50 channels, with time diversity),
while GTE’s video on demand test involves four households. See Communications
Daily, May 6, 1991, p. 2 and Jure 18, 1990, p. 6.

-50-


In households with pay cable services, less than half of viewing is
accounted for by broadcast television. Prime-time network audiences have
been falling since 1980; affiliates’ audiences appear to have been falling
faster during non-network time periods than during net work-programmed
periods. While viewing of independent stations as a group has increased,
average per-station viewing has fallen because of the increased number of

independent stations.

Broadcasters’ revenues fell over much of the late 1980’s while
programming costs increased, resulting in declining profits or increasing
losses for all classes of stations, with heavy losses concentrated among UHF
independents and small-market stations. Independents appear to have had a
reprieve in 1989. Unless the longer-term trend reverses, a shakeout could
well occur. Changes in revenues appear to have lagged behind changes in
viewing: while network audiences have been falling at least since 1980,
affiliates’ revenues peaked in 1985-86. The lag in the advertising market
suggests that current declines in audiences will result in further declines

in revenues in years to come.

Great differences emerge in costs, revenues, and profits between
large-market and small-market stations. Stations in large markets on
average appear to have revenues and expenses many times as large as those in
small markets and to enjoy high but falling profits. The level and structure
of the costs of large market stations suggests that they have considerable

leeway to reduce costs if revenues fall. Marginal stations in large

- 46-


number of viewers and programs that are expensive to produce, relative to
what would be supplied if viewers could be induced to pay what programs
were worth to them. The biases are larger, however, with advertiser support

than with viewer payment.

Spence and Owen show that advertiser support is closer to the optimum
when viewers perceive programs as close substitutes than when viewers have
strong preferences among programs. When viewers have only weak preferences
among programs, the value of increased viewing due to the availability of
free programming is high relative to the value of greater resources devoted
to program production. On the other hand, if viewers have strong
preferences, the gain from the availability of highly-valued programming to
those willing to pay for it may outweigh the loss due to inefficient
distribution, i.e., denying access to programming to those who are not
willing to pay the market price but who place some value on the

material.

Spence and Owen speculate that a mixed system with both advertising
and viewer support may best serve consumers’ needs, making available low-
cost programming for those without strong program tastes and allowing those
with strong tastes to purchase programming that would not otherwise be
produced. Such a system would be particularly valuable where incomes and
intensities of preference varied widely. Such a mixed system has indeed

developed in the cable television industry.


Affiliates’ profits peaked at 29.9 percent in 1985. By comparison, average

profits as a percentage of total receipts for all corporations filing income

tax returns averaged 3.9 percent in that year.

Rr GA-nODT

mozm<mD

FIGURE 6
PROFITS AS A PERCENTAGE OF REVENUE

28

24. TT

20 ———

16

1

8,

4.

of 4 1 + N\, , F

A t ' jot
1975 1980 1985 1986 1987 1988 1989

YEAR

e Affiliates alndependents «500 Largest Corporations

For both affiliates and independents, average profits show a

pronounced downward trend over the last half of the 1980's. For network

affiliates, however, average profits remain high at the end of the period,

21.8 percent of net revenues. While independents as a group were marginally

profitable in 1989, they experienced increasing losses from 1986 through

1988.38 The performance of independents improved in 1989 over 1988,

———-

38 Average net losses bottomed out at 3.2 percent of net revenue in 1988.

See table 11.

-37-


Affiliates’ revenues peaked in 1986. Independents recovered to some extent

in 1989 from earlier declining revenues.

TABLE 12
AVERAGE INFLATION-ADJUSTED NET REVENUES
OF COMMERCIAL TELEVISION STATIONS, 1975-1989
(1982-84 Dollars)

1975 1980 1985 1986 1987 1988 1989 85-89
Revenues ($ Million)
Affillates 6.3 8.0 12.1 13.3 12.6 12.7 12.7
Independents 75 9.4 12.2 10.9 11.3 Wa 12.0
% Change in Revenues
Affiliates 26.8" 49.8" 10.6 6.0 0.7 0.6 8.7
independents 25.2" 29.8" 10.7 3.3 1.6 85 3.6

SOURCES: 1975 and 1980, FCC, Public Notica, “TV Broadcast Financial Data," August 2, 1976 and August 10,

1981; other years, NAB, Television Financial Report, 1986 through 1990.
NOTE: Missing data imputed beginning in 1987.

*Over five-year period.

Breaking down costs into their constituent categories can provide an

insight into observed cost changes and differences in costs across groups of

stations. This section looks first at the composition of costs of

commercial broadcast stations in markets of various sizes in 1989, then

-41-


In 1976, roughly one-third of television households had access to
cable (i.e., were "passed" by cable). In 1990, 91.2 percent of television
households were passed by cable.75 The share of homes with access to cable
that choose to subscribe to basic service rose from 51.1 percent in 1976 to
61.4 percent in 1990. The consequence is an increase in the percentage of
all television households that subscribe to cable from 17 percent to 56
percent .76 The enormous growth in cable subscribership over the period was
thus accomplished primarily through rapid construction of cable systems in
uncabled areas, accompanied by moderate growth in the percentage of homes
passed that subscribe to cable. While penetration of pay services grew

rapidly in the earlier years, it appears to have levelled off recently.

about consumer preferences and providing producers with proper incentives to
supply programming closely matched to those preferences. In fact, for cable
programming, with the exception of pay-per-view services, the information and
incentive functions of prices are limited by the fact that viewers must
purchase a bundle of services. This may be a bundle of channels (basic
service) or a bundle of programs (a pay channel). Regardless of why cable
operators undertake it, retiering can have the effect of restoring some
efficiency to the information transmission mechanism. If all programs were
pay-per-view, it would be possible for viewers to signal their valuations of
those programs much more precisely than they can now. However, the
transactions costs of assembling an individual schedule of programming appear
excessive. Offering channels on an a la carte basis is an intermediate step,
perhaps more practical, that would allow viewers to signal their preferences
more accurately than they can now.

75 Other industry sources estimate a lower number of homes passed.

76 Neilsen figures for May 1991 indicate that 60.3 percent of television
households subscribe to basic cable service. Communications Daily, June 17,
1991, p. 5. Arbitron data for November 1990 show 58.5 percent of households
subscribing to basic service. See National Cable Televison Association, Cable
Television Developments (March 1991) p. 1-A.

-~77-


In sum, cable advertising can reach desirable audiences, can target
audiences more narrowly than broadcasting by interests and geographic
location, and has a lower cost per viewer. Its limitations are higher
transactions costs to reach the same audience and smaller total audiences,
The disparity in price between broadcast and cable advertising suggests an
opportunity for developing interconnects among cable systems and other

institutions to facilitate purchase of cable advertising.

Industry observers see great potential for growth in the cable
advertising market, particularly the local market. Cable advertising is the
fastest-growing segment of the video advertising market, with inflation-
adjusted revenues growing at 22 percent in 1989. But considering that basic
cable (i.e., cable-originated channels carrying advertising) comprises 6
percent of the video advertising market, by one estimate, but accounts for
20 percent of total viewing and 22 percent of viewing of channels carrying
advertising, the potential remains for much greater growth, independent of
likely increases in cable subscribership and viewing.168 Moreover, advertisers
are reported to believe that ret work advertising was overpriced in 1990, and
to be considering cable as an alternative because of increased cable

ratings .169

168 See tables 6 and 25.

169 ~—='"’Upfront’ Study Finds Weakness For Networks," Wall Street Journal,
April 2, 1991, p. Bl.

- 132 -


For statistical purposes, advertising revenues of the Fox network and
national syndicators are combined. This revenue category, adjusted for
inflation, is shown in the third column of table 25. While not a clear
measure of Fox revenues, this category does provide a measure of competition
to the major networks from national suppliers of advertising time.153
Revenue from these sources was about 16 percent of three-network advertising
revenues in 1990, or close to half of the major-network average. National

syndication is expected to continue to grow rapidly.154

In other media, interconnects among local cable systems are developing
to reduce transaction costs for advertising purchases, and nationwide
mechanisms may also develop. In the future, DBS or some combination of DBS
and cable probably will provide nationwide service. These developments will
increase the supply of advertising time and reduce the transactions cost of
purchasing national (or at least very broad) coverage, and may further erode

network revenues .155

153 Fox network revenues in fact are expected to be about $500 million in
the most recent fiscal year, which amounts to about a third of the total
"National Syndication" category. Kathryn Harris, “Making money on rotten
ratings," Forbes, May 27, 1991, p. 42.

154 Communications Industry Forecast, p. 4.

155 The increased supply of advertising time is believed to be a cause of
lower network advertising rates. John Lippman, "CBS Strikes Out with Sports,
Posts $156-Million Loss," Los Angeles Times, February 14, 1991, p. D-8.

- 125 -


Many of the FCC's broadcasting rules were adopted when there were far
fewer channels per market and the three networks dominated the supply of
programming. Much of the FCC’s broadcast regulation was motivated by a desire
to limit economic market power and concent ration of control over program
content on the part of broadcast stations and networks. These concerns appear
misplaced, or at best of greatly diminished importance, in a world where
broadcast stations and networks face dozens of cable channels and program

ret works.

This study shows that a reduction in the quantity and quality of
broadcast service is highly likely and provides a factual basis for
reconsideration of a large body of mass media rules, Changes in Commission
rules to allow more efficient provision of service may have an important
effect in allowing broadcasters to continue to offer service the public
values. The study documents the changes that have occurred in the video
marketplace over the past fifteen years and the effects of those changes on
over-the-air broadcasting. The study attempts to project trends in the
marketplace over the next decade and discusses new technologies that may
affect those trends. The study focuses in particular on two related issues:
(1) the impact of multichannel video providers on the competitive position of
television broadcasting; and (2) the implications of changes in viewing
patterns, changes in the advertising market, and the use of direct payment
for programming for the ability of broadcast television stations to pay for

programming.


TELEVISION STATION ADVERTISING

Local television stations received $15.9 billion in advertising revenues
in 1990, divided approximately equally between national spot and local
advertising. 159 National spot advertising is considered a substitute for
network and national cable advertising. Local station advertising is the
closest television substitute for local cable advertising, though local cable

advertising appears to compete more directly with local radio.

Inflation-adjusted television station advertising revenues are shown
in the fourth column of table 25, which shows the sum of national spot and_
local advertising. Advertising is not the sole source of revenue for broadcast
stations because both the three major networks and Fox pay compensation to
their affiliates, though compensation also reflects sale of advertising time

by the net works, 160 Aggregate television station advertising revenues grew

Times, February 14, 1991, p. D-8; Paul Farhi, "’Recession-Resistant TV
Networks Feel Pinch," Washington Post, October 27, 1990, p. C-1; “Nervous
Networks Wheel Early Deals," Variety, May 20, 1991, p. 21.

159 McCann-Brickson, "Insiders Report," December 1990.

160 Network compensation has also been declining recently, and is
expected to continue to decline. "Big 3 affiliates adapting to changes in
economy," Electronic Media, May 20, 1991, p. 39; "No quick end foreseen to
network economic woes," Electronic Media, January 14, 1991, p. 20.
Compensation averaged 4.5 percent of gross revenues for all affiliates in
1989, ranging from an average of 2.2 percent in the top ten markets to an
average of over 9 percent in markets below 120. NAB, Television Financial

Report, 1990.

-127-


Programming expenses as a percentage of the total appear to have
increased slightly for affiliates and considerably, 8.3 percentage points,
for independents over the period. For affiliates, the share of broadcast
rights has increased much more rapidly than all program expenses. Clearly
increasing costs of broadcast rights contributd substantially to the decline

in broadcast station profits over the period.

Stations appear to devote only a small percentage of total expenditures
to local programming. Excluding news, program expenditures other than those
for broadcast rights were less than 10 percent of total expenditures in 1989
for both affiliates and independents. For independents, program
expenditures, even including news, for anything other than broadcast rights
were less than 14 percent of the total. Moreover, the figures in table 13
suggest that even these expenses were disproportionately incurred in large

markets.

SUMMARY

The number of broadcast stations, particularly UHF independents, has
increased greatly in the past decade, largely because cable carriage has
reduced the disadvantage of UHF relative to VHF stations and thus increased
their potential audiences. At the same time, broadcast station audiences
are declining. Viewing hours per household appear to be declining. Cable
households view less over-the-air television than non-cable households,

and the share of cable-originated services in their viewing is increasing.

-45-


TABLE OF CONTENTS (cont)

IX. THE ADVERTISING MARKET. .....-.

Total Advertising and Video Advertising. ......

Network Advertising. .....
Television Station Advertising
Cable Advertising. ......
Other Advertising Markets. . .
Summary... 2... ee see

xX. THE PROGRAM MARKET...» 1. 2. eee

Network Programming. .....
Syndicated Programming ....
Local Programming. ......
Cable Programming. ......-
Program Prices... 2... 50

Revenues for Program Purchase. .

Compulsory Copyright License .
Summary. 2 6 ee ee eee

XI. THE FUTURE OF BROADCAST TELEVISION.

Television Stations. .....
Networks .......- eee
Viewers. ©. ee ee ee ee
Qualifications ........,
Implications for Regulation. .

Page

we et ee wee -112
. 112

ee ee ee . -118
ee ee 127
ee ee eee . «129
ry -133
rr tee . 134
er ee 135
see . eee 136
rr ry oe . -140
Pe ee ee 141
eee eee se eee . -143
ae ecw wae sae . 146
. er er) 148
oe wee eee . -155
re ee . .157
ea er er .159
i ary 159
wee ee ee ee . -162
ee ee ee ee . .164
Pe a er er . .167
wee ee see . .169
173

APPENDIX: DEMOGRAPHIC TRENDS AND BROADCAST AUDIENCES .....

- iii -


ironically, is to some extent attributable to the growth of cable, since many
Fox affiliates are UHF stations that depend on cable carriage for much of
their coverage. Moreover, in some cases, Fox supplies its programming
directly to cable systems if no local broadcast affiliate is available. It
is not clear whether enough independent stations remain to make yet another
broadcast network viable. For the near future, the three major broadcast
networks will attract larger total audiences than the alternatives, and will
out spend their competitors on programming.

VIEWERS

For viewers, the effects of additional video competitors so far appear
to have been highly beneficial. Not only do viewers have the choice of
purchasing additional program services, but the number of advert iser-supported
channels has increased, Providing more choice even to those who do not pay for

programming.

In future, however, the number of broadcast television stations is
likely to decline, and the quality of broadcast service may deteriorate. The
effects will vary for different groups of viewers who face reduced broadcast
service. For households that subscribe to cable or another multichannel
service, a reduction in the number of broadcast stations they can receive or
movement of some programming from broadcast to basic cable will cause little
or no welfare loss because the cable system almost certainly will replace the
lost station with another channel. The only possible loss may be a less

desired mix of programming. But since the station that left the market

- 164 -


suggest. that about half of cable networks’ revenues come from license fees.203
Pay cable networks, of course, receive 100 percent of their revenues from
subscription fees. Kagan’s data show basic cable revenues--and program

expenditures--rising much faster than comparable pay cable figures.

The cable revenues reported here are spread over a large number of
networks (currently nine pay networks and 111 basic networks, not counting
home shopping networks) with a wide range in programming strategies from from
low-cost niche programming to high-cost first-run mass-appeal programming. ©
Consequently average per-channel revenues of cable systems are very low. But
the variation in revenues among cable networks is high. Consequently the
more popular cable networks have the potential to spend much more on
programming than the comparisons here would suggest .204 Considering the
difference in the numbers of broadcast and cable networks, we can conclude
that some cable channels have the revenues to compete as serious rivals in the
program acquisition market, but for the near-term future broadcast networks

will still be able to outspend them.

203 In a 1986 filing with the FCC, ESPN, for instance, stated that
subscription fees accounted for “almost half" of its revenues. Comments of
ESPN, Inc., in General Docket 86-336, filed October 17, 1986, p. 3.

204 Press reports of quarterly earnings of Turner networks imply that CNN
has annual revenues above $400 million, and that TBS and TNT combined have
annual revenues greater than $500 million. Geraldine Fabrikant, "Turner
Broadcasting Profit Fell 11.6% in First Quarter, New York Times, May 7, 1991,
p. D-19. ABC Video Enterprises, which consists primarily of ESPN, had
revenues of $546 million in 1990. "Down Year in Profits for the Big Three,"

/ May 6, 1991, p. 19. These revenues compare with an average of
$3.1 billion apiece for the three major broadcast net works.

- 153 -


For services that entail placing a single order but do not require a
continuing series of interactions, it is not clear that a return channel
more sophisticated or dedicated than a telephone line is needed. Video on
demand scenarios frequently include the capability to "dial up" a movie from a
library of many titles. While this is a more sophisticated and versatile
service, a telephone return channel still appears adequate. There are some
continuing interactions, such as video games or catalog shopping, for which
a dedicated return channel seems efficient. On balance, though, the need for

interactive capability beyond that provided by telephone lines is not clear.
ENCRYPTION SYSTEMS

Any video service provider wishing to charge viewers for its service
must be able to control access to that service. For satellite or terrestrial
transmissions, in practice this means encrypting the signal and installing a
conditional access system. 67 Encryption is important in the cable context
as well. First, it is possible to tap into cable systems without
authorization. Second, when different signal complements (e.g., tiers of
basic services, premium channels, or pay-per-view events) are delivered to
different subscribers, it is necessary to limit subscribers to services they

are authorized to receive. Although single channel subscription services

67 Encryption and decryption refer to the process of "scrambling" and
"descrambling" the signal, while conditional access refers to the process
of authorizing particular subscribers to decrypt particular packages,
channels, or transmissions.

-62-


Industry observers believe that the growth of cable made possible the
expansion in the number of broadcast television stations by increasing the
potential audiences of UHF stations.13 Cable carriage of over-the-air
signals reduces the disadvantage of UHF relative to VHF stations by
increasing UHF stations’ geographic reach and improving their reception
quality. Channel positioning also appears important to the success of
broadcast stations, and cable systems can give UHF stations desirable low
chanrel positions. Satellite delivery of syndicated programming may also
have encouraged the growth in numbers of television stations by making

program distribution more flexible and efficient and less expensive.

The increase in the number of over-the-air stations is reflected in an
increase in the number of stations available to viewers (table 4).14 In
1975, 79 percent of television households were located in markets with 5 or
more stations, not counting cable channels; by 1990 94 percent of
television households were in markets with 5 or more stations (typically the

three major networks, a PBS station, and an independent). In 1975 14

——_—_—

13 For a discussion of the disadvantages under which UHF television
stations operate, see UHF Comparability Task Force, Comparability for UHF
Television: Final Report, FCC, Office of Plans and Policy, September 1980,
pp. IV-xXXvIl.

4 The data in table 4 are percentages of households in Arbitron Areas of
Dominant Influence (ADIs), not percentages of total U.S. households. Each
county in the United States, except in ‘Alaska and Hawaii, is assigned to one
ADI. In 1990 ADI households comprised 99.1 percent of all U.S. households.
The data on numbers of stations represent all stations in the ADI; not all
of them are receivable by every household.

-17-


national political issues to how to end a television program to voting for

contestants in a talent contest.

The "return channel" that viewers use to transmit messages can be, but
dees not have to be, integrated with the video distribution system. In the
1970's and early 1980's, Warrer Cable experimented with an interactive system
known as "Qube" on its Columbus, Ohio cable system and others. 64 Recently
the FCC has proposed to allocate a small amount of spectrum, just above
television channel 13, for two "viewer response channels." This proposal
would permit two television licensees in each market to offer interactive
broadcast services to viewers equipped with miniature radio. transmitters

attached to their television receivers.65

The telephone provides a non-integrated interactive capability. In
recent years, telephone companies have developed automatic number
identification systems that allow them to process thousands of requests ina
few seconds. This provides “impulse pay-per-view" capability. In other
words, viewers can decide at the last minute to order a pay-per-view movie.

: While cable and terrestrial broadcasting will be able to offer either

64 See Edward Meadows, "Why TV Sets Do More in Columbus, Ohio," Fortune,
Oct. 6, 1980, pp. 67-73 and "Qube services to be dumped if TCI buys Warner
Amex’s Pittsburgh system," Broadcasting, April 16, 1984, pp. 94-95.

65 Notice of Proposed Rulemaking in Gen. Docket No. 91-2, 6 FCC Red 1368
(1991).

- 60 -


This chapter briefly discusses trends in network, syndicated, and local
broadcast programming, and in cable programming. It then considers the
determinants of program prices and how the media are likely to be affected
by price changes. Then it examines the ability of broadcast and cable media
to compete in program acquisition. Finally, the effects of the compulsory

copyright license on that competition are considered.
NETWORK PROGRAMMING

The broadcast networks act as intermediaries bet ween program producers
and broadcast stations and, ultimately, audiences, matching programming with
audience tastes in order to produce advertising exposures. Historically the
networks acquired their pre-eminent positions by using low-cost program
distribution techniques and aggregating large audiences, which gave them the
advertising revenues to purchase expensive programming.

In the days before multimedia competition, the primary way networks
could increase advertising revenues was to increase audiences. The networks
could increase the total audience--either by adding television households or
by increasing hours of viewing of existing viewers—or they could increase
their audience shares by luring viewers away from other networks. In both
cases, increasing program expenditures in an effort to produce more popular
Pprogramming—as long as doing so resulted in equal or greater increases in

advertising revenues--was a rational strategy.

- 136 -


ampLification.51 If compression, using a four-to-one ratio, were combined with

fiber-coax hybrid systems, a cable system could offer as many as 600 channels.

Compression can also be used with cable systems that utilize only
coaxial cable. With the same four-to-one ratio assumed above, a 25-channel
cable system could be upgraded to 100 channels and a 54-channel system to over
200 channels. Moreover, the cost of the compression equipment is relatively
low. Although no digital video compression converter boxes are on the market
yet, they are under development. Cost estimates are in the $100-$200 range.92
In addition to new customer premises equipment, compression will require some
new hardware at the headend, but its cost also appears low, by one estimate
as low as $200 per subscriber to upgrade systems to 100 or more channels
within two years.53 This represents a significant savings, since the same
source estimates that, without compression, the best option for upgrading

would be to 60 or more channels over five years for $300-$600 per subscriber.

Digital compression is also applicable to terrestrial broadcasting, with
the posibility that a compression ratio of four-to-one or more is achievable.

Thus, a market with ten broadcast channels could expand to at least 40

51 Time Warner has announced plans to upgrade its Queens, New York cable
system to 150 channels using this technique. Communications Daily, March 8,
1991, p. 3.

52 See Satellite Business News, April 3, 1991, pp. 1, 22; Broadcasting,
April 8, 1991, p. 66; Cable World, March 18, 1991, p. 9.

53 Communications Daily, April 12, 1991, p. 3.

-53-


supported channels than can be supported. The viability of advertiser-
supported broadcast stations will depend on the size of the audience for
mass-market programming relative to that for specialized programming, and on
the demand for advertising to the remaining viewers of over-the-air
channels. Most viewers probably have some demand for mass-market
programming and some demand for specialized programming. Demand for
broadcast television advertising, in turn, will depend in part on what
advertising substitutes exist to reach the broadcast audience. If few good
substitutes exist for television advertising, advertising revenues will not

necessarily decline proportionately with the decline in audiences.

Cable and other new media offer additional choices to subscribers, and
the fact that subscribers are willing to pay for those choices indicates
that they place significant value on having those additional choices
available. As long as the quality of broadcast service, in terms of meeting
the preferences of those who view it, remains equally good, subscribers to
other media are made better off and no one is made worse off. If the
quality of broadcast service declines, however, viewers who do not subscribe
to cable will be made worse off. The following chapters consider changes
in the markets in which broadcasters operate, and likely consequences of
those changas for viewers, as a result of new media and technologies.

-10-


in 1989.22 As a result, the three-network share now appears to be about
the same in all markets as it is in the top markets. A possible explanation
is that network viewing has historically been lower in markets with more
over-the-air alternatives. With the growth in the numbers of independents
and cable systems, the number of alternatives available in smaller markets
has risen, making viewing in those markets more comparable to that in the ~
largest markets. This is in accord with the projections in table 7 of a
slower decline in the viewing share of the networks through 1994, Veronis,
Suhler, and Associates attribute this pattern to slower growth of
competitors, and also project a modest increase in the number of households
reached caused by an increase in the number of television households. As
we discuss below, this prediction probably understates the decline in

network audiences .23

The networks’ share of prime-time viewing remains larger than their
share of daytime viewing, but the decline in prime-time network viewing has

been more rapid than the decline in daytime viewing.24 The decline in

22 Nielsen Station Index, Nov. 1980 and Nov. 1989.

23 For elaboration of the Veronis, Suhler view, see

i (New York: Veronis,
Suhler & Associates, Inc., 1990) (" i ") Pp.
46-47. In fact, the networks’ prime-time share dropped to 61 in 1991.

, dune 17, 1991, p. 33. Hence, the Veronis, Suhler network
share projection is too high.

24 1991 Cable TV Facts (New York: Cabletelevision Advertising Bureau,
Inc., 1991), p. 14.

-27-


programming may increase readily in response to increased demand. To some
extent the price increases for programming may have resulted from short-run
difficulties in expanding the supply of programming, in which case the the

price increases may prove to be largely transitory .190

Syndicators typically appropriate some of the advertising revenues
generated by their programs by charging stations on the basis of market size
rather than charging a flat fee per program, and often by acquiring
advertising time through barter.191 Thus, the price of a program will vary
greatly between large and small markets, even though the product reaching
viewers is the same. As broadcasters’ audiences fall, prices paid for
programs can be expected to adjust to the revenue potential of the market,
as has in fact occurred through the use of barter, where the value of the
advertising spots traded depends on the audience. So the decline in program
quality may be less than would be expected from the decline in expenditures.

Broadcast stations and networks will remain important programming
outlets for the foreseeable future. Therefore, in order to keep this
distribution system healthy, program suppliers are likely to absorb part of

the effects of smaller audiences by accepting lower license fees. (Cases of

190 A great demand for programming from DBS operators or other new outlets,
on the other hand, could cause prices to continue to rise.

191 See Noll, Peck, and McGowan, Economic Aspects of Television Regulation,
pp. 70-79 for a discussion of non-net work program pricing.

- 147 -


markets, however, may not have the same ability to reduce costs. In
intermediate-size markets, cost-cutting also appears to be possible; some

small-market stations may have little room to cut costs.

-47-


More channels of video service are available to viewers as well. The
number of over-the-air television stations available to the median household
increased from six in 1975 to ten in 1990. Including cable channels increases
the median number of available channels to well over thirty.12

The relative size of the segments of the video industry, and their
recent. growth rates, reflect the revolution in the market in the last 15 years
(table 2). Expenditures on cable television (by both subscribers and
advertisers) are now more than half as large as those for broadcast
television. Total expenditures on broadcast television grew more slowly than
the Gross National Product (GNP) between 1984 and 1989; expenditures on
network television grew slowly during this period. (Indeed, when adjusted
for inflation, network television expenditures actually dropped from 1984 to
1989.) Cable advertising and subscriptions, by contrast, have grown much
faster than the GNP. Consumer expenditures on home video in 1989 were larger
than advertiser expenditures on network television and almost twice as large
as theater box office revenues. Consumer expenditures on home video grew at

47.5 percent per year between 1984 and 1989.

12 ~=‘Television stations calculated from Arbitron Ratings Company, Television
, 1975, 1980-81, 1984-1985 ADI Market Guide,
7 cable channels from NBC, citing

Television ADI Market Guide, 1989-1990,
Nielsen Television Index, Television Audience 1990 (1991).

-13-


SUMMARY

The rapid growth of the video advertising market appears to have ended.
The share of the networks in that market has been falling for a decade, and
the share of cable has been growing. Since the mid-1980’s real advertising
revenues of the networks, and per-station real advertising revenues of
broadcasters, have been falling. Network revenues have fallen less rapidly
than audiences, but as audiences continue to decline, and as cable advertising
becomes a better substitute for network advertising, the decline can be
expected to worsen. Cable now has a much smaller share of advertising
revenues than of viewership of channels carrying advertising, so cable

advertising has great potential for growth.

The lag between audience loss and advertising loss has bought time for
broadcasters and networks, but in the long run advertisers can be expected
to adjust to actual viewing patterns in the market. The current recession
may hasten the adjustment by making advertisers more cost-conscious and
causing them to buy time on the basis of cost per viewer rather than habit or

notions of prestige or status.

- 134 -


significantly .87 Such migration of sports events to cable raises issues of
access and income distribution. To the extent that events previously
available via broadcast television move to cable, households passed by cable
end up paying for something that was previously available free. This
constitutes a redistribution of income from consumers to the sports leagues
and players and, to a lesser extent, to the cable networks. To the extent
that homes not passed by cable had broadcast service available prior to the
migration, a loss of access to the events in question and a loss of welfare
to those households occurs. The structure of the professional sports leagues
suggests that the additional income is unlikely to affect the quantity or
quality of football, baseball, or basketball games. The basic problem
appears to lie in market power in the production of popular sports events,

not in cable networks purchasing the programming.88

A look at planned or announced new basic cable services provides
additional insight into the range of programming that will be available to
cable subscribers in the future. These services include comedy networks,
networks devoted to legal matters, children’s networks, a science fiction

network, a cowboy network, a landscaping network, and several others .89

87 It should be noted, however, that not all broadcast network sports
programming has been profitable. See, 2%, Broadcasting, May 6, 1991, p. 19.

88 Political pressure is likely to keep at least some of the major sports
events on broadcast television.

89 Network Fin/Syn Comments, Vol I, p 79.

~ 80 -


other media. This opportunity will be most valuable to large-market stations
that have extensive programming operations. The overall result of these
changes is likely to be a smaller over-the-air television industry (i.e.,

fewer stations).
NETWORKS

For the three conventional television networks the decline in audience
shares will probably slow over the decade as cable matures and as marginal
independents go dark. On the other hand, cable subscribers’ viewing will
shift increasingly to cable~originated channels. In 1989/90, each of the three
major networks averaged roughly 19 percent of prime time viewing and 12
percent of all-day viewing. (See tables 8 and 9 above.) Sime the trend away
from broadcast viewing will continue, one could speculate that by 1999 average
network prime time viewing shares might fall to 15 percent, while their
average all-day viewing shares could well sink to 8 percent. As cable
advertising becomes a better substitute for network advertising, prices of
network advertising time will fall, and advertising revenues will fall along
with audiences.

Networks have responded to reduced revenues by cutting costs,
particularly program expenditures, and will almost certainly continue to do
so. Another way for networks to cut costs will be to reduce compensation to
affiliates, which may result in affiliates’ carrying less network programming,
further reducing network audiences. Less expensive network programming,

coupled with better programming on competing outlets, will erode the

- 162 -


stations in large markets have many times the revenues and expenses, and
much larger percentage profits, than stations in small markets. Average
1989 revenues range from $56.4 million3l in the top ten markets to $2.5
million in markets ranking below 175. The high revenues of stations in
large markets are usually explained by the high rates advertisers are
willing to pay to advertise to large audiences, coupled with a limited
number of frequency allotments that prevents expansion of the number of

broadcast stations.

Average annual expenses were $40.7 million for stations in the top ten
markets but only $2.8 million for markets below 175. Assuming similar
service areas across markets, the technical cost of delivering signals is
invariant with the number of viewers. While cost differences exist between
UHF and VHF stations, and rent and other input costs are likely to be higher
in large markets, such cost differences are highly unlikely to explain the

pattern of expenses seen here.

Despite the high average expenses in large markets, average profits
were also very high in the top 30 markets. In the top ten markets they

amounted to 27.8 percent of net revenue for all stations.32 This pattern of

31 In the largest markets, some stations have substantially higher
revenues.

32 For network affiliates average profits were 38.0 percent of net
revenues in the top ten markets. Ibid., p. 34.

-34-


to cable and 27.5 percent will be passed by cable but choose not to
subscribe. In 1990, 35.2 percent of television households could subscribe

but chose not to d so.

If it is assumed that approximately one-third of 1999 television
households do not subscribe to cable, then, at least in principle,
broadcasting will retain a considerable advantage over cable in terms of
access to large audiences. But the advantage in penetration enjoyed by
broadcast. television will be more than offset by a decline in viewing if a
large enough proportion of cable households shifts enough of its viewing
fran broadcast to cable. On the other hand, to the extent that it improves
the reception of over-the-air stations, cable may increase the audiences. of

those stations above what they otherwise would have been.

Both cable subscribership and viewing patterns in cable households
depend on the menu of programming offered by cable. The projections in
table 15 are, presumably, based on some assumptions about the content of
cable programming. The relatively modest predicted increases in penetration
of homes passed suggests that radical changes in the nature and popularity
of cable programming are not anticipated. Likewise, extrapolation of trends
in audience shares reported in table 6 above also suggests evolutionary

rather than revolutionary changes in cable programming.

In order to assess the plausibility of this pattern, it is worth
examining the range of cable offerings available today and identifying

developments that might change it in such a way as to affect the growth of

-75-


Viewers not passed by cable will also experience a loss of welfare if
broaccast service deteriorates. They can acquire a Partial substitute for
broadcast service with videocassettes or, in most cases, with home satellite
dishes, which, although now expensive, will Probably drop in price over the
coming decade. While both offer great quantities of programming, neither
Satellite dishes nor VCRs provide local service. On the other hand, uncabled
areas are frequently remote areas where broadcast reception is Poor, so the
lost over-the-air service may have had little value. This group of viewers
is small: 8.8 percent of television households are not passed by cable. About
20 percent of those households have home satellite dishes, and in future DBS

service will almost certainly be available in most cases.

In large markets, over-the-air service probably will remain plentiful.
Large populations will still be able to Support many stations, and good over-
the-air service will keep cable penetration lower than in other areas. In
smaller markets the loss of one station would have a much larger impact on
the overall quantity of over-the-air service. In these markets, where over-
the-air service offered less variety to begin with, the gap between what is
available from broadcasters and from multichannel providers will probably

widen. However, these developments will affect relatively few television

~ 166 -


band system cost. Similar equipment to adjust a much smaller DBS dish would
likely require additional precision and cost more. Moreover, it would
obviously rule out the scenario of a flat, unobtrusive antenna stuck onto
the living room window of one’s home. On the other hand, a four-to-one
compression ratio would yield 128 channels per orbital slot and an eight-
to-one ratio would yield 256. At this level of channel capacity, the
subscriber would not necessarily need to adjust the position of the dish.
Customers could, however, switch to a provider using another orbital slot,
but the new hookup might entail a service call from the satellite dealer to

"repoint" the antenna.

Compression also offers the possibility of substantial channel capacity
expansion to cable operators.50 It can be applied either with or without the
introduction of fiber optics into the system. On the other hand, fiber is
increasingly being used for high-capacity "backbone" in cable systems. This
allows significant expansion of channel capacity, because the coaxial cable
used to make the final connection to the subscriber’s home is capable of
carrying as many as 100 to 150 channels over a short distance. If the coaxial

cable link is short enough, the signal can be transmitted without

50 Firms that are developing compression technology for satellite use are
also seeking to adapt their systems for cable use. See Cable World, March
18, 1991, p. 66 and April 1, 1991, p. 27.

- 52 -


cable relative to broadcasting. Changes that might increase the popularity
of cable are more and better programming, innovations in payment mechanisms
such as pay-per-view, increased channel capacity, and increased timeshifting

capability. Miscellaneous other factors are also briefly discussed.

Prospects for New Programming

While basic cable channels as a group have a viewing share in the
range of those of network affiliates, individual cable channels have, in
general, much smaller audiences than network affiliates or stronger
independent stations. The smaller audiences and revenues of basic cable
networks have generally, despite viewer payment, resulted in less expensive
programming than is shown on broadcast stations. As discussed below,
increases in the revenues of existing cable networks, particularly their
advertising revenues, can be expected to permit them to invest in more
expensive programming. Such programming will further increase cable
penetration, attract larger audiences, and, in turn, erode broadcast

audience shares.

In 1990, program services available to cable systems included 73
nationwide basic networks, 14 regional networks, 24 regional sports

networks, 9 pay channels, 8 home shopping channels, and 8 pay-per-view

-76-


reduce audiences somewhat because of greater subscribership to multichannel

media.

- 111 -


direct-response advertising and special promotions.137 whatever the case in
the long term, video advertising expenditures are also in a short-term slump

due to the current recession.

The video advertising market consists broadly of two sub-markets, the
national market and the local market. The national market involves sales of
advertising time by networks, syndicators, and broadcast stations to national
advertisers. Broadcast networks sell time they receive from their affiliates
in return for programming and payments called "compensation." Syndicators
also sell time received from stations, usually through barter for programming.
Local stations, both affiliates and independents, sell time in the "national
Spot" market. Basic cable networks, some national and some regional, sell
advertising time.in the national market and also charge cable systems for

programming on a per-subscriber basis.

Broadcast stations also sell time to local advertisers. Local cable
systems currently do little program origination (with notable exceptions such
as local news channels), though they sell some advertising time on national

cable networks to local advertisers.

137 Jib Fowles, "The Upheavals in the Media," New York Times, January 6,
1991, p. 13.

- 114 -


altogether (table 5) .17 he greater total viewing of cable households almost
certainly results in part from differences in tastes, since those households
that use television most are most likely to subscribe to cable and to pay-
cable channels.18 The differences are likely to result also from
availability of a larger quantity of attractive programming in cable
households.

TABLE 5
TELEVISION VIEWING BY CABLE AND NON-CABLE HOUSEHOLDS
(Average Weekly Hours, Oct. 1989 - Sept. 1990)

Non-cable Cable
Households Households Difference % Difference
Total TV Viewing 42.41 55.8 413.7 432.5
Broadcast 42.1 34.2 7.9 18.8
Network Affiliates 30.1 24.6 $5 18.3
Independents 10.0 8.2 18 -18.0
Public 2.0 14 -0.6 -30.0
Cable - 21.6
Basic - 16.5
Pay - 5.1

SOURCE: Cable Televison Advertising Bureau, Inc., Gable TV Facts, 1991 ed., p. 11, citing
Nielsen Monthly Cable Status Report.

17 Video games and the use of videocassette recorders to view prerecorded
tapes also compete for viewers’ time and hence probably have cut into
broadcast televison viewing.

18 For definitions of basic and pay cable, see chapter VI.

-21-


PROGRAM PRICES

Both the number of channels to be Programmed and the funds available for
program purchase have increased greatly in recent years. The additional
expenditures have resulted both in Production of more programming and in
dramatically higher Program prices. As noted in chapter III, higher program
prices have contributed to the reduced profits of broadcast stations and

networks.

Prices of network programming are determined by negotiation bet ween
networks and studios, and the outcome depends to a large extent on their
relative bargaining power. To the extent that broadcast networks ever had
Market power in the program acquisition market, additional purchasers of
Programming have eliminated that market power, allowing program producers
to raise prices and reap more of the profits.188 To the extent that some
programs are uniquely popular and cannot be duplicated, increased demand can
allow producers to maintain high prices and profits for an indefinite period.
In such cases much of the profit generated by large audiences will be captured
by the talent (directors, actors, athletes, etc.) that create the programs.189

On the other hand, leaving aside the top hits, the long-run supply of

188 For an analysis of network program pricing see FCC, Network Inquiry
Special Staff, "An Analysis of Television Program Production, Acquisition and
Distribution, " in isi H isdicti i
Regulation, October 1980, pp. 591-602.

189 "NBC Faces Tough Decision on Its Costly, Aging Shows," New York Times,
February 18, 1991, p. 34.

- 146 -


compression techniques, for instance, could allow several channels of
programming to be offered on a single six-megahertz broadcast channel,
offering much more diversity and choice and a service more closely resembling
cable. Interactive technologies, permitting over-the-air shopping and opinion

polls, could increase the attractiveness of broadcast television.

Television broadcasters, and the networks that supply them, will clearly
decline in relative importance and probably in number or size as well over the
next decade. The power of the networks that the Commission has historically
sought to curb has succumbed to technology and competition. Broadcast
television, however, will remain a reasonably prominent feature of the

American landscape.
IMELICATIONS FOR REGULATION

Changes in regulation may permit television broadcasters to achieve
efficiencies that could allow them to become more effective competitors in
an increasingly multichannel environment. Rules imposed to curb net work or
station market power or concentration of control over programming when
television broadcasters were the video marketplace may be counterproduct ive
in today’s competitive market.

The business of broadcast television is attracting audiences for sale
to advertisers by purchasing, producing, scheduling, and distributing
programming. The technical aspects of delivering broadcast signals are a

small component of the business: in 1989, engineering expenses averaged less

- 169 -


EXECUTIVE SUMMARY

This study examines changes in the competitive situation of the
television broadcasting industry from 1975 to 1990 and presents some
predictions for the next decade.l over the past fifteen years the range of
broadcast, cable, and other video options available to the American viewer
has increased dramatically. Broadcast television, however, has suffered an
irreversible long-term decline in audience and revenue share, which will
continue throughout the current decade.

In the next ten years, broadcasters will face intensified competition as
alternative media, financed not only by advertising but also by subscription
revenues, and offering multiple channels of programming, expand their reach
and their audience. Television broadcasting will be a smaller and far less
profitable business in the year 2000 than it is now. Although broadcasting
will remain an important component of the video mix, small-market stations,
weak independents in larger markets, and UHF independents in general will find
it particularly difficult to compete, and some are likely to go dark. The
analysis supports the conclusion that in the new reality of increased
competition regulations imposed in a far less competitive environment to curb
perceived market power or concentration of control over programming are no
longer justified and may impede the provision of broadcast services.

THE 1975-1990 PERIOD

In 1975, the United States had three commercial broadcast television
networks and no cable networks; cable television was solely a broadcast
retransmission medium. Only 17 percent of television households subscribed to
cable in 1976; over 56 percent subscribed in 1990. By 1990, there were four
commercial broadcast networks and over 100 national and regional cable
networks. The number of broadcast stations had increased by 50 percent, with
independent stations accounting for three-quarters of the growth. The number
of off-air stations available to the median household increased from six in
1975 to ten in 1990, and by 1990 94 percent of television households were
located in markets with five or more television stations. In 1975, there
were no home satellite dish systems and no home videocassette recorders

1 This paper presents only the views of members of the staff of the Office
of Plans and Policy. It does not represent the views of the Commission or
any individual Commissioner, and has not been considered by or voted upon by
the Commission.

- vii -


Stations that are imported as distant signals by cable systems reduce
local station audiences but benefit little, in general, from their additional
audiences because much of their advertising is local. However, superstations
that have wide cable audiences (e.g., WTBS, WGN) can sell advertising in a
national market and charge commensurate prices. So, for purposes of
advertising, the audiences of distant stations are in some cases lost to
broadcasters and in some cases transferred from local stations to

superst ations.
CABLE ADVERTISING

Inflation-adjusted cable advertising revenues are shown in the final
column of table 25. Unlike broadcast advertising, cable advertising grew
rapidly--bet ween 9 and 22 percent a year in real terms, according to McCann-
Erickson--over the late 1980’s, though it started from a low base. (See figure
11.) Cable advertising can be divided into network and spot categories. The
revenues of cable network advertising are, by various estimates, between 18
and 25 percent as large as the revenues of national spot broadcast
advertising, its closest broadcast substitute. Cable spot advertising consists
mainly of time sold by the cable operator, primarily to local advertisers, and
is most likely to be a substitute for local television or radio advertising.
Such advertising generates between 5 and 8 percent as much revenue as local

television broadcast advertising, by various estimates, but is growing very

- 129 -


In the current market, however, audiences may not respond to
additional network program expenditures as they have in the past. Because of
changes in demographics and work behavior, viewing per houshold appears to
have peaked. Additional mass-appeal programming by Fox and some cable channels
has divided the audience into smaller shares, and specialized programming
on cable channels has diverted some of the audience from middle-of-the road
programming. Even among the networks, more diversity seems to be appearing.
Fox, for instance, aims programming at a younger audience than the-
conventional networks. These changes appear to be permanent. In this
environment, increasing program expenditures almost certainly will not bring
back the networks’ old audience shares, as CBS’s unsuccessful attempt to
increase its audience share by purchasing expensive sports programming

suggest s.

At the same time, the inputs used to produce network programming also
can be used to produce programming for other outlets.173 The increased demand
for programming to fill additional channels has bid up the prices of the
inputs into programming, leaving networks facing higher prices for programs of
similar quality. Increased expenditures on programming probably buy smaller

increments in program attractiveness than in the past.

173 See John Dempsey, "Star-studded cable stable," Variety, June 10, 1991,
pp. 1, 25, 32, and Reply Comments of the Association of Independent Television
Stations, Inc. in MM Docket No. 89-600 (filed April 2, 1990) (INTV Reply
Qamments, pp. 34-37.

- 137 -


profitable to increase expenditures on local programming in competition with
other stations in the market. Increased expenditures may be effective in
picking up audiences from rival broadcast stations even though such

expenditures could not halt long-term erosion to other media.
CABLE PROGRAMMING

The growth in the number of cable networks has resulted in a major
increase in the quantity of programming produced, and a qualitative change ~
in the types of programming offered as well. Where large numbers of channels
are available, particularly with viewer payment, a profitable strategy for
programmers is to offer kinds of programming that are highly valued by
relatively small segments of the audience, rather than competing with
programming similar to what is already being offered for a share of the
mainstream audience.181 fhe final distribution of programming will, of
course, depend on the distribution of viewers’ tastes. But to the extent that
programming tailored to the tastes of smaller groups in the audience becomes
available, these viewers’ preferences will be met more closely, and many
viewers will be made better off. Mainstream viewers also will be made better
off if more choice becomes available within highly popular program categories.
On the other hand, to the extent that viewer payment causes programming that

would otherwise be available over the air to move to cable, viewers that do

181 Bruce M. Owen, Jack H. Beebe, and Willard G. Manning, Television
Eooomics (Lexington, MA: D.C. Heath and Company, 1974), pp. 81-90.

- 143 -


In smaller markets profits were lower than in large markets.
Aggregate losses occurred in most size classes of markets below the top
100.36 At least 50 percent of independents in all market classes below the
top ten experienced losses.37

r in Profi

Average profits of network affiliates have been extremely high, over
20 percent of net revenues, throughout the period studied (table 11).
TABLE 11

PROFITS OF COMMERCIAL TELEVISION STATIONS AS A
PERCENTAGE OF NET REVENUES, 1975-1989

500 Largest Industrial

Year Affiliates* Independents* Corporations**
1975 26.2 81

1980 29.1 17.1 45

1985 29.9 13.3 3.9

1986 27.9 (0.6) 44

1987 26.4 (1.8) 5.4

1988 25.0 (3.2) 5.5

1989 21.8 15 4.7

SOURCES: 1975 and 1980, FCC, Public Notice, “TV Broadcast Financial Data,” August 2, 1976
and August 10,1981; other years, NAB, Television Financial Report, 1986 through 1990; for 500

largest corporations, 1980-88, U.S. Bureau of the Census, Statistical Abstract of the United States:
1990 (110th ed.) Washington, D.C. 1990, p. 542; 1989, Fortune, April 23, 1990, p. 339.
NOTE: Parentheses denote loss.

“Average for ail reporting stations in class. **Median return on sales.

36 This is not to say, however, that many stations, especially net work
affiliates, were not profitable in small markets.

37 NAB, Television Financial Report, 1990, pp. 1-16.

-~36-




TABLE 9
VIEWING OF NETWORK AFFILIATES IN NETWORK AND NON-NETWORK DAYPARTS
(All Day Viewing Shares)

1984/85 1989/90
All TV Households
Affiliate Share 63 52
Network Dayparts 41 35
Non-Network Dayparts 22 17

Cable Households
Affiliate Share 53 43
Network Dayparts 34 31
Non-Network Dayparts 19 12

Pay Cable Households

Affillate Share 47 39
Network Dayparts 31 28
Non-Network Dayparts 17 12

SOURCE: Cabie Television Advertising Bureau, Cable TV Facts, 1991 ed., pp. 12-13;
1986 ed., p. 14; both cite the Nielsen Monthly Cable Status Report.

NOTE: Figures are percentages, not commonly-reported household shares.

syndicated programming.26 For all households, the decline was five
percentage points in non-network dayparts and six percentage points in
network dayparts, though the base for network dayparts was almost twice as
big. For cable and pay cable households the difference was even more
pronounced. On an absolute level, viewing of non-network dayparts is
relatively small, 17 percent of all-day viewing in all households in 1989/90
and 12 percent of the comparable total for cable households.

26 On the other hand, the network comments in the Financial Interest
and Syndication proceeding show the network share of total day viewing
declining faster than the affiliate local share between 1980 and 1989.
Joint Comments of Capital Cities/ABC, Inc., CBS Inc. and National
Broadcasting Company, Inc. in MM Docket No. 90-162 ("Network Fin/Syn_
Comments"), filed June 14, 1990, Vol. I, p. 114.

-30-


Wireless cable systems use frequencies originally allocated to the
Instructional Television Fixed Service (ITFS) and the Private Operational
Fixed Service (OFS) in addition to the MMDS channels. Wireless cable
Providers may lease excess capacity on ITFS channels from the licensees, which
are schools and other educational institutions. Aggregating enough channels
for acommercially viable service, however, is often difficult. In
addition, the maximum number of channels is much smaller than that provided
by the majority of cable systems. Expansion of wireless cable systems has
been hindered by lack of access to programming, allegedly because programming
has been withheld by cable programmers 132

Wireless cable systems’ penetration has been modest to date, but has
grown rapidly, more than doubling since 1988. Current subscribership is about
180,000, or about 0.2 percent of television households, and current revenues
are $54.4 million.133 at least for the next several years, wireless cable
systems are expected to succeed in niche markets rather than as major
competitors to cable.134 To the extent that they offer competition to
cable systems, however, they will constrain cable systems to offer better

service at lower prices. The effect on over-the-air broadcasting will be to

132. For an extensive discussion of program availability to wireless cable
systems, see EOC Cable Report, paras. 100, 114.

133 Channels, December 3, 1990, p. 59, citing Paul Kagan Associates, Inc.
134 Thid.

- 110 -


Sale of advertising appears able to support less programming than
viewers would like and would be willing to pay for.7 Intuitively, it
seems plausible that in most cases, advertisers value viewer exposure to
commercials less than viewers value the associated programming. With large
numbers of channels, however, the value to viewers of an additional channel
probably falls rapidly.

Where both advertiser support and viewer payment exist, we expect that
the role of advertiser-supported channels will be to provide mass-taste
programming to a general audience. This audience will include both cable
subscribers and those who, because of low income or lack of interest, are
unwilling to pay for either higher-cost programming or programming for
specialized tastes.8 Existence of viewer-supported options, and of larger
numbers of channels, will reduce the audiences and the advertising revenues

of advertiser-supported channels, and may reduce the number of advertiser-

7 The fact that consumers will pay for cable services in areas where
unused over-the-air allotments exist suggests that advertiser support
results in an undersupply of programming. In 42 of the top 100 television
markets there is at least one commercial television channel within 55 miles
for which no license application has been filed. Federal Communicat ions
Commission, "Television Channel Utilization," Public Notice, September 9,
1990. :

8 Broadcast network programming is currently more expensive than
cable programming in the aggregate, but not necesarily at the level of
individual programs. There is some evidence of efforts by broadcast networks
to move to less expensive types of programming. "NBC Outlines Disturbing
Trends in Network Finances," Los Angeles Times, January 7, 1991, p. F-4;
"Network News Divisions Are Developing Programs in Effort to Lure More
Viewers," Wall Street Journal, September 24, 1990, p. B-ll. Fora discussion
of cable and broadcast programming see chapter X below.


The next chapter discusses the economics of advertiser and viewer
support of video programming. Chapter III gives an overview of the market
for video services. Chapter IV examines the current state of broadcast
television. Chapter V considers new technologies that may affect the video
market. The following three chapters examine, in order, cable television,
satellite television delivery, and other video media that may affect
broadcasting. Chapters IX and X examine the operation of two markets that
are central to the broadcasting business, the advertising market and the
program acquisition market, to see how they are likely to be affected by
changed competitive conditions. Finally, conclusions concerning the future

of televison broadcasting are presented in Chapter XI.

This paper presents only the views of members of the staff of the Office
of Plans and Policy. It does not represent the views of the Commission or any
individual Commissioner, and has not been considered by or voted upon by the

Commission.


10.

11.

12.

13.

14.
15.
16.
17.
18.
19.
20.
21.

LIST OF TABLES

Households With Television Equipment and Services, 1975-1990... .

Expenditures on Video Media, 1984 and 1989. .......--.

Commercial Television Stations, 1975-1990...

Households in ADI’S With Various Numbers of Over-the-Air Signals. .

Television Viewing by Cable and Non-Cable Households. .. .

All-Day Viewing Shares, Cable and Non-Cable Households. . .

Prime-Time Viewing of the Three Major Commercial Networks .

Commercial Television Prime-Time Viewing Shares by Channel

Type, 1982/83 - 1989/90... 6. ee ee ee

Viewing of Network Affiliates in Network and

Non-Network Dayparts. 2 6. ee ee ee ee ee ee

Average Revenues, Expenses, and Profit of Commercial TV

Stations, 1989... 6 6 ee ee ee ee ee

Profits of Commercial Television Stations as a Percentage of

Net Revenues, 1975-1989... .. - «= eee

Average Real Net Revenues of Commercial TV Stations, 1975-1989.

Expense Items of Commercial Broadcast Stations by

Market Size, 1989 2... 6 eee ee ee ee ee

Programming Expenses of Commercial Broadcast Stations, 1975-1989. .

Cable Subscribers and Homes Passed... +--+ +--+ ++
Cable Operator Revenues... 6 ee ee ett tees

Cable Network Ratings, First Quarter 1991......

Pay-Per-View (PPV) Subscribership ...-. + es ees

Channel Capacity of Cable Systems, Selected Years . .
VCR Penetration... ee eee ee eee wee
TV Usage of Non-VCR and VCR Households. ..-.-+.+-

-iv-

Page

12
14
15
18
21
23
26

28
30
33

36

41

42
44
68
73
77
82
85
106
107


307-7 -7- EZ

A

FIGURE 9
TOTAL VIDEO AND NETWORK ADVERTISING REVENUE
(1982-84 Dollars) (millions)

217204
19548
17376),
15204]
13032|
10860]
sese]
6516]
wee] ee
2172,

oly 1 n n n } 4 n er py 1 } n
T T T T T T T T T T T T T qT T

Uy
1975 1977, 19791981 = 1983-1985 = 1987 ~— 1989
YEAR

Total Video Advertising’ 0 Network (non-Fox) @ Television Station

“Total includes network, television station, national syndication and cable advertising.

During the fifteen years between 1975 and 1990, network viewing declined
steadily and by a much larger proportion than advertising revenues. Network
prime-time ratings fell 12.0 percent (not points) between 1980 and 1984 and
13.6 percent between 1984 and 1988. Households reached in prime time fell 6.5
percent and 9.6 percent in the two periods, respect ively .147 Clearly changes
in advertising revenues have trailed declines in network audiences.

147 Communications Industry Forecast, p. 45. See also chapter III, table 7.

- 122 -


as planned to two degrees ,120 ; As the size of the antenna declines, more
households will likely find HSD systems attractive. It is not clear, however,
whether a drop in dish size from ten to four feet or so would spark a
substantial increase in the demand for HSD systems. While the industry appears
to believe that a drop in size to 18 inches or under would cause a substantial

increase in demand, this belief is not based on actual market experience.

With or without a decline in dish size, relaxation of local zoning
regulations could result in additional penetration of satellite equipment .121

In 1986, the Commission preempted certain state and local zoning regulations

120 C-band satellite operators are currently in the process of implementing
a Commission decision, made in 1983, to reduce the spacing bet ween
Satellites from three degrees to twa degrees. That is, new C-band
satellites are launched into orbital slots spaced two degrees apart.
Elements of the HSD industry, principally makers of home reception
equipment, have petitioned the Commission to retain three degree spacing, at
least for the satellites used for video distribution. They believe that
this would permit good reception by HSD systems with four to five foot
antennas. See Petition for Rulemaking In the Matter of Amendment of C-
Band Satellite Orbital Spacing Policies to Promote the Development of Video
Distribution to the Home, filed Jan. 25, 1991, RM-7628, esp. pp. 11, 21-22,
and Reply Comments of General Instrument Corporation in RM-7628, filed April
19, 1991, pp. 17-18 and Attachment A. There is some disagreement on the
engineering analysis of the minimum antenna size needed for adequate
reception with three degree spacing.

121 The FCC Cable Report notes that the use of HSD antennas is restricted
by zoning regulations (para. 103), records the impressions of some
commenters that there was "uncertainty at the local level" regarding the
Commission’s preemption of regulations (para. 135), and recommends that
Congress act to prohibit "local governments from regulating installation of
reception equipment beyond those provisions reasonably related to a clearly
defined health, safety or reasonable aesthetic objective" (para. 142).

- 100 -


among broadcasters or between broadcasting and other media because the

changes could be adopted readily by all the media.
INTERACTIVE TELEVISION

Interactive television is a service in which the viewer communicates
with the programmer/transmittor, whether to select program content or to send
some other message. Interactive services could include transactions such as
banking or home shopping. One special case of home shopping is the pay-per-
view event. Viewers can choose, in advance or on the spur of the moment, to
watch a recent movie or sporting event. Currently, most pay-per-view revenue
comes from sporting events, such as boxing matches, ®3 but the advent of near
video on demand or video on demand could well increase interest in pay-per-
view movies.

One frequently mentioned future interactive application is viewers
choosing camera angles in sporting event telecasts. Interactive video plus
video compression could allow the viewer to "direct" his or her own telecast
of a football game or other sporting event. Interactive television could also

be used for polling viewers on various subjects, ranging from local or

63 A Paul Kagan Associates study indicates that, in 1990, boxing and
wrestling accounted for 89 percent of gross pay-per-view revenues. The total
gross revenues for the events studied was $136.5 million, with wrestling
accounting for $72.5 million and boxing $48.6 million. See Broadcasting, Feb.
18, 1991, p. 49. Table 16 below shows 1990 pay-per-view revenues to cable

of $417 million. Presumably the $136.5 million represents revenues
to the rights holders.

-59-


TABLE 2
EXPENDITURES ON VIDEO MEDIA, 1984 AND 1989

1984 Gross 1989 Gross % Change
Expenditures Expenditures 1984-1989
($ Billion) ($ Billion)

Broadcast Television 19.8 24.1 21
Networks 8.3 9.1 10
Stations 10.5 15.0 42

Cable Television 8.3 17.3 109
Advertising* 06 2.0 241
Subscriptions 7.2 14.1 97

Other 0.5 Ww 127

Filmed Entertainment 10.8 23.8 120
Box Office 7 4.0 5.0 25
Home Video 1.4 9.6 586
Television Programs 5.0 7.9 58
Barter Syndication** 0.4 1.2 200

GNP 39

SOURCES: Broadcast Television, McCann-Erickson, Inc., “Estimated Annuai U.S.
Advertising Expenditures,” prepared for Advertising Age, April 1991; cable television,
Paul Kagan Associates, Inc., The Kagan Cable TV Financia! Databook (June 1990), p. 70;
and Paul Kagan Associates, Inc., Cable TV Investor, Nov. 21, 1990, p. 9; filmed
entertainment, and GNP, The Veronis, Suhler & Associates Communications Industry
Forecast ("Communications Industry Forecast”) (New York: Veronis, Suhler & Associates,
Inc., 1990), pp. 13, 22.

NOTE: Expenditures on filmed entertainment cannot be added to those for TV and
cable because television program and barter syndication expenditures are inputs
into those services. Also, totals reflected rounding error.

“Includes local and network cable advertising.

**Programming traded for television advertising time.

-14-


OTHER ADVERTISING MARKETS

Advertising alternatives to the video market include radio, newspapers,
magazines, direct mail, yellow pages, and outdoor advertising. More distant
alternatives include promotions such as coupons, conventions and trade shows,
and point-of-purchase displays. Direct mail is the only national advertising
medium with a share of advertising volume in the range of television’s, 18.2
percent as compared with 22.1 percent. Expenditures on direct-mail and
yellow-page advertising have in fact increased as a percentage of total
advertising. The percentage of video advertising, which rose continuously
through 1984, has fallen slightly since that time.170 still, none of the
alternatives is believed to have the immediacy and effectiveness of television
commercials. In addition some of the advertising substitutes for television,
such as magazine publishing, have experienced a proliferation of outlets and
audience fragmentation similar to that in television. Nevertheless, magazines
are reportedly being considered as an alternative by many network

advertisers ,171

170 Television Bureau of Advertising, "Trends in Advertising Volume," May
1991.

171 "rupfront’ Study Finds Weakness For Net works," Wall Street Journal,
April 2, 1991, p. Bl.

- 133 -


the audiences they can command. Further, in the short run, despite declining
profitability, the three major networks in most cases will attract larger
audiences than the alternatives and overall outspend their competitors on
programming. Broadcast networks and stations will likely attempt to expand
the application of their programming, packaging, and scheduling skills by
diversifying into nonbroadcast media.

Viewers who do not subscribe to cable or other multichannel media will
be made worse off by a decline in the quantity and quality of broadcast
service. Because of its mandate to provide a nationwide communications
system, the Commission should be concerned, in particular, with viewers who
valve television, but, in effect, have no substitutes for broadcast service,
either because they lack access to multichannel media or because they cannot
afford to subscribe to multichannel services. But viewers who subscribe to
multichannel video services almost certainly will benefit from access to a
greater quantity and diversity of programming.

IMLICATIONS FOR REGULATION

Existing broadcast regulations may prevent broadcasters from adopting
more efficient forms of organization and offering services the public would
value. Relaxing or eliminating such rules would allow broadcasters to compete
more effectively, and would facilitate the continued provision of valued over-
the-air services.

The regulatory challenges of the next decade are to develop an equitable
and efficient regulatory framework for all video service providers and to
give single-channel advertiser-supported television broadcasters flexibility
to compete more effectively with multichannel rivals that benefit from a dual
revenue stream. Broadcasters should not be hindered excessively from
diversifying to make efficient use of their core skills--production,
acquisition, and scheduling of programming, as well as selling advertising.
The physical distribution of the broadcast signal is, in fact, a small part
of the broadcasters’ business.

Thus, the Commission should eliminate its broadcast multiple ownership
and network-cable crossownership rules, relax its duopoly rules, and seek
Congressional authority to relax its cable-broadeast crossownership
prohibition. Moreover, many of the Commissionr’s network-affiliate regulations
are ripe for re-examination, as is the forced sale of broadcast programming
to cable via the statutory compulsory license. Fewer broadcast stations also
means that there will be fewer areas in which broadcast service provides a
competitive check on cable rates.


advertisers .166 So far, cable advertising has had a far lower cost per

thousand viewers than broadcast advertising.167

Cable offers advertisers an opportunity to target advertising more
efficiently by delivering audiences with specialized interests, while the
economics of broadcasting requires mass-appeal programming and advertising.
Many of the most successful cable channels, however, have been those with the
most middle-of-the-road programming, and some cable channels are attempting to .
widen their audiences by showing more general-interest programming. To the
extent that they succeed, they will become closer advertising substitutes for
the broadcast networks. The extent to which the two strategies achieve
success will depend in the long run on the distribution of program tastes in
the population. With many channels, cable systems can pursue both strategies

and attract both general~interest and niche audiences.

Cable systems cover smaller geographic areas than broadcast stations, so
local cable advertising can target a narrower geographic audience. Because of
its narrow reach and low cost, local cable advertising is considered a
substitute for radio and even newspaper advertising as much as for local
television advertising. Many local advertisers who would never advertise on
broadcast television many find cable an attractive medium.

166  Cabletelevision Advertising Bureau, Inc., Cable TV Facts 90, pp. 20-23.

167 “Changing Nature of Cable Advertising," Broadcasting, April 15, 1991, p.
78.

- 131 -


percent per year. Fewer births and growing life expectancy have resulted in
an aging population: the median age rose from 28.7 years in 1975 to 32.7
years in 1987.

The population of the United States is projected to grow much more
Slowly over the next decade than in the past. Total population growth,
according the the Census Bureau's mid-range projections, will be 3.9 percent
between 1990 and 1995 and 3.1 percent bet ween 1995 and 2000. About 30
Percent of the growth will result from immigration.214 the median age will
continue to rise to 36.5 years in 2000. The Proportion of working-age
people in the population will rise slightly relative to the numbers of
children and the elderly.215

Family structure continues to change. As shown in Table 27, young
people are marrying later, marriage rates continue to fall, and divorce
rates remain close to the historic peak. 216 As a result, a larger

percentage of the population is single or divorced. Birth rates remain low

214 U.S. Bureau of the Census, Current Population Reports, Series P-25,
No. 1017, Projections of the i i
1988 to 2010, U.S. Government Printing Office, Washington, D.C., 1988, p.
27.

215 Ibid., p. 10.

216 = Statistical Abstract, 1989, p. 85.

-174-


FIGURE 2 .
NUMBER OF BROADCAST TV SIGNALS AVAILABLE TO SHARE OF HOUSEHOLDS

1975 1980-81

20+
15 to 19
10 to 14

5 to9
1to4

Hebe a

TELEVISION VIEWING
Time spent watching television has increased by almost an hour per
day per household since 1975. Total household viewing reached a peak in

1985, however, and has declined slightly since:15

Year Hours
1975 6.1
1980 6.6
1985 7.2
1989 7.0
15 "Trends in Television," Television Bureau of Advertising, Inc.,

April 1990, p. 7. Data for 1975 through 1985 are based on NTI Audimeter
sample; data for 1989 are based on NTI People Meter sample.

-19-


television broadcast stations, as compensation for the programming, such as

rews, that they produce themselves .207

The compulsory copyright license allows cable systems to acquire the
programming of broadcast stations for license fees that are believed to be, in
in general, below the market price for the programs.208 Local stations are
essentially free to cable systems, and fees for distant signals appear, in
most cases, to be below the market price. Cable systems thus benefit from
programming that broadcasters paid for but that the cable systems, for the
most part, did not. This underpriced programming gives cable systems a
competitive advantage relative to broadcasters. It also distorts program
choices by giving cable systems an incentive to offer distant signals rather
than cable networks, and creates more competition to local stations from
distant signals than otherwise would be the case. If the cable systems had to
pay the market price for the programming, they might choose to purchase

original programming, presenting viewers with a different range of choices.

Because a substantial amount of the viewing of cable households is of
television broadcast signals, were the compulsory license to be eliminated
and full copyright liability imposed on cable systems, the potential would
exist for a "second revenue stream" for television broadcast stations and

networks. An end to the compulsory license and imposition of retransmission

207 Copyright Royalty Tribunal, "Summary Fact Sheet," February 1991.
208 Report in General Docket 87-25, 4 FOC Red 6562 (1989), paras. 67-75.

- 156 -


TABLE 28
HOUSEHOLDS OF VARIOUS TYPES, 1975-2000
{Percent of All Households)

Nonfamily
Year Families Households Total
Married Single
Coupie Householder
1975 66.0 12.1 21.9 100
1960 60.8 12.9 26.3 100
1985 58.0 14.3 27.7 100
1990° 56.3 14.5 29.2 100
1995° 54.7 14.8 30.4 100
2000° 53.1 15.1 31.8 100

SOURCE: Statistical Abstract, 1989, p. 45.

“Projected

The proportion of individuals living alone and of single-parent
families is expected to continue to rise, as shown in Table 28. According
to the Census Bureau’s mid-range projections, which assume a reduction in
the rate of change in marriage and divorce rates, married-couple families

will fall to 53.1 percent of total households by 2000.

Work behavior is changing as well. As shown in Table 29, the
Proportion of women in the labor force has risen strikingly, from 46.3
percent of women over 16 in 1975 to 56.0 percent in 1987. Even more
dramatic has been the change among women of child-rearing age. By various
measures labor force participation rates for this group, even those with
young children, have risen by about 20 percentage points over the period

since 1975. Labor force participation rates are higher for divorced than

- 176 -


timeshifting one step further.100 It will provide three separate channels of
HBO and Cinemax (a total of six chanmels). Cable operators will have access
to them at no additional charge. Each channel of HBO will carry the same
programming, but it will be transmitted at different times. The Cinemax
channels will operate the same way. At a recent cable industry convention,
the chairman of the Fox network suggested that viewers would place a high
value on timeshifted broadcast network primetime programming.101 This could
comprise multiple broadcasts of programs or episodes during a week102, as
PBS frequently does now, or making available the entire prime time schedule,

with staggered starting times, on multiple cable channels.
Other Factors

Many cable subscribers may watch local broadcast channels rather than
cable channels out of habit and ignorance of what is available on cable.
Over time greater familiarity with cable offerings can be expected to cause
viewers increasingly to turn to cable. Events that draw attention to
cable, however, such as CNN coverage of the Persian Gulf War, may accelerate

the process of change, increasing both cable subscribership and viewing of

100 "HBO and Cinemax to Offer 3 Channels Each for Price of One,"
Communications Daily, May 9, 1991, p. 3. The Disney Channel plans to test a
second channel to provide time diversity. Broadcasting, June 3, 1991, p. 52.

101 Communications Daily, March 26, 1991, p. 2.
102 ABC and Nick at Nite, a cable channel, have agreed to share a new

situation comedy. Episodes will appear first on ABC and then, later in the
same week, on Nick at Nite. Broadcasting, June 3, 1991, p. 33.

- 88 -


FIGURE 11
CABLE ADVERTISING REVENUE (1982-84 DOLLARS)

1370,
1233
ae
1o96|
959]
22]
685 |
548]
ait]
274]

137]

o30-—-—--—z
T

A
T

te) n n nl 4 nl 1 n n | n
T T qT t T T T t T T T

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990
YEAR

Cable Advertising

rapidly.165 so to date, cable advertising has succeeded better in competing
with broadcast advertising at the national than at the local level.

As noted above, cable advertising remains an imperfect substitute for
broadcast television, and Particularly network, advertising, though that
situation may be changing. Cable advertising has major advantages for some
advertisers. Cable subscribers have higher incomes and more education, on
average, than the general population, and consume more of Many advertised

goods and services, making cable subscribers desirable targets for

165 The lower estimates are based on McCann-Erickson data presented in table
24; the higher estimates are from Paul Kagan Associates, The Kagan Cable TV

Financial Databook (June 1990), p. 70.

- 130 -


Local programming, particularly news and public affairs, remains the
single programming service provided by local broadcast stations that is not
yet widely offered by cable, Recently, however, local cable news channels
have begun to appear, making clear that cable systems can perform all the
functions of local broadcasters. Some planned local cable news channels
have delayed their launch for economic reasons, but it appears that many of ©
these channels will, in fact, provide service in the future.90 At the same
time, economic factors have impelled some television broadcast stations to

cut back their own news operations, 91
Pay-Per-View

Pay-per-view programming may also affect the broadcast-cable balance.
By charging for single highly-valued events, pay-per-view services come
closer than conventional cable services to measuring consumers’ tastes for
programming, and can generate more revenues per viewer. Because of the
higher revenues pay-per-view services generate, they may provide more

expensive and more attractive programming. But since per-program fees

90 "Mooney Urges Reregulation Fight," Broadcasting, April 1, 1991, p. 31.
See also “Hearst Mines for Gold in California News," Broadcasting, April 22,
1991, p. 50; "Cox Hopes To Launch Cable News Channel This Year --With
Broadcasters," Communications Daily, May 20, 1991, p. 4; "Time Warner Unveils
Local News Channel," and "Other Hopefuls Still at Starting Gate," Cable World,
May 20, 1991, pp. 1, 6. Most of these proposed channels appear to be in urban
areas. It may be that access to a fairly large and concentrated audience is
needed to make them viable.

91 Kevin Goldman, "More Stations are Signing Off on 11 p.m. News," Wall
Street Journal, May 22, 1991, pp. Bl, B9.

= 8l-


I. INTRODUCTION

Over the past several years, new services and technologies have
produced vast changes in the television marketplace. Cable television
systems, videocassette recorders (VCRs), home satellite receivers, and
additional over-the-air television stations have given television viewers
far greater program choice and viewing convenience. Direct broadcast
satellite (0BS) systems may shortly add a nationwide multichannel service.
Viewers find the additional choice and convenience highly valuable, as
expenditures of $24 billion a year for cable subscriptions and videocassette
rentals and purchases attest. The expansion of video service in the past
fifteen years has also dramatically changed the competitive environment for
broadcasters, resulting in a substantial decline in the audience shares and

advertising revenues of conventional over-the-air television stations.

The purpose of this study is to document these changes and to assist
the Federal Communications Commission (FCC) in determining to what extent the
economic and technological changes in the marketplace call for changes in its
existing rules. A primary goal of the FOC’s regulation of broadcasting is to
create an environment in which the services that viewers want are delivered in
the most efficient manner. In serving viewers’ interests, the FCC
historically has considered as important goals diversity of programming,
service to local communities, and provision of public interest programming,
such as news and public affairs. This study is based on the belief that, in

pursuit of these goals, the Commission should foster development of a


capacity, and the lower per-channel costs that it will make possible, will
likely permit the development of new networks, in particular those aimed at

narrow "niche" audiences as well as near video on demand services.
I Ti ifting ¢ ili

Enhanced channel capacity (and enhanced satellite transponder
capacity) will allow cable operators to offer significantly greater time
diversity of programming to their customers.98 For example, pay-per-view
services could be enhanced by "near video-on-demand," a mode of delivery
featuring multiple, staggered starts of programming such as recent movies.
This would not provide viewers with instant access to the movie of their

choice, but would make it available with a limited waiting time.29

Increased channel capacity also offers the potential for timeshifting
of cable network schedules, or of broadcast network and even station
schedules. Premium networks such as HBO and Showtime currently offer two
time zone feeds each (keyed to the Eastern and Pacific time zones). Added
satellite capacity could make it economical for them to transmit Central and

Mountain time zone feeds as well. HBO has announced an experiment to take

98 Cable networks and operators have touted the time diversity advantages
of their service for a long time. Cable networks frequently exhibit the same
program more than once per week.

99 Video on demand, discussed briefly in note 47 above, is unlikely to
be available to many subscribers this decade. Currently, most pay-per-view
revenues come from boxing and wrestling matches, for which there is not
substantial demand for timeshifting. See note 63 above.

- 87 -


TABLE 29
CIVILIAN LABOR FORCE PARTICIPATION RATES, 1975-2000

(Percent)
Year Total Maie Female Wife, Husband Present
Total 25-34 Years 35-44 Years Children < 2 yrs. Children «< 1 yr.

1975 612 779 46.3 54.9 55.8 ws 44g

1980 63.8 774 515 65.5 65.5 39.0 54.3

1985 648 76.3 545 70.9 718 49.4 61.0

1987 65.6 76.2 56.0 72.4 745 519 65.2

1995" 672 75.3 59.8 79.2 81.0

2000° 67.8 747 615 82.3 84.2

SOURCE: Statistical Abstract. 1989, pp. 376, 386.

NOTE: Civilian noninstitutional population 16 years old and older.

“Projected.
for married women. In 1987, 56.8 percent of married women with preschool
children and 70.5 percent of divorced women with preschool children worked
at least part time outside the home.220 Labor force participation rates of
men have declined slightly during this time period. As shown in Table 29,
labor force participation rates for women are projected to continue to

increase through 2000, but at a decreasing rate.

Family structure has a major effect on family income. In 1987, the
median income of all families was about $31,000. For married couples with
the wife employed, it was $41,000; with the wife out of the labor force,
it was $27,000. Married couples with children had a median income of
$36,000; female family heads with children had a median income of

$11, 000.221

220 Ibid., p. 386.
221 Ibid., p. 448.

-111-


VIL, DIRECT-TO-HOME SATELLITE TRANSMISSIONS

Satellite-to-home service is a potentially significant multichannel
video service that could increase competition to terrestrial television by
offering large numbers of channels of programming directly from a satellite
to a home receiving dish without an intervening cable system or terrestrial
broadcast station. Direct-to-home satellite transmissions are a significant
force today in areas not passed by cable and are likely to become more

important in those areas.

In addition to serving uncabled areas, satellite services potentially
could aggregate minority-taste audiences on a nationwide basis, thus
offering programming that could not be supported otherwise and providing
highly-targeted advertising opportunities. Moreover, the ability to
aggregate small audiences from many different areas, coupled with the
expense of HDTV transmission equipment, makes it likely that HDTV
programming will be available via satellite before it is available
terrestrially. On the other hand, unlike cable systems, satellites probably
could not offer local broadcast channels.106 Direct broadcast satellite
systems, using high-powered signals that would permit use of small,

inexpensive receiving equipment, may be able to challenge cable television

106 =©Satellites are now used to deliver regional channels, mostly sports,
but the potential is there for more, e.g., statewide news channels. The
expanded channel capacity that signal compression may bring, plus spot beam
technology, could eventually permit services targeted to narrower geographic
areas.

-92-




however, the numbers remain small: time spent playing a VCR was only 8.0
percent as great as time spent directly watching broadcast or cable
television, and time apparently spent watching prerecorded programming was
3.7 percent as great. So even if the number of households with VCRs
increases as projected, the effect on aggregate viewing of broadcast
television will be modest, probably not more than an additional 1 percent.
Prerecorded videocassettes appear to be a closer substitute for pay cable than
for broadcast programming, and the fact that pay cable’s share of viewing
has not increased since the 1982/83 season suggests that VCRs have primarily
affected pay cable viewing rather than advertiser-supported cable or
broadcast viewing.
TABLE 22

TIME SPENT RECORDING AND PLAYING VCRS
(Average Hours Per Week)

Year Record Play Difference
1986 29 46 1.7
1987 26 43 17
1988 240 44 20
1989 24 39 18

SOURCE: Television Bureau of Advertising, Inc., “Trends in
VCR Usage,” April 1990, p. 7.

Expenditures on video programming, however, are large. Consumer

spending on rental and purchase of videocassettes in 1989 was reported to be
$9.6 billion, which is two-thirds of the amount spent on cable subscriptions

- 108 -


the leading candidates for the American HDTV transmission standard are now

digital.
HIGH-DEFINITION TELEVISION

High-definition television is a term used to describe technologically-
advanced television systems now under development that will greatly improve
the picture and sound quality of television signals. HDTV systems will have
a larger number of horizontal scanning lines, better color fidelity, freedom
from various artifacts of the transmission system, and a wider aspect ratio
(ratio of width to height) than conventional television. New television
receivers will be needed to view the improved-quality signal, though FCC
rules require that the programming be receivable on conventional receivers
through simulcasting.56 HDTV has been hailed as the first major

improvement in television technology since the advent of color.

The likelihood of success for HDTV has been a subject of controversy.
Some advocates have seen HDTV as an engine for revitalizing the American
consumer electronics industry, and many see a large consumer market for

HDTV.97 On the other hand, the receiving equipment will be expensive-~

56 Tentative Decision and Further Notice of Inquiry, MM Docket No.
87-268, 3 FOC Red 6520 (1988) at 6531; statement of Chairman Alfred C. Sikes
to the Advisory Committee for Advanced Television, March 21, 1990.

57 she High-Defi

i i , Congressional Budget Office Staff Working
Papers, July 1989.

-~55 -


integrated or non-integrated return channels, telephone return channels are

the only means of interaction currently available for satellites.

The value of the return channel is related to the range of interactive
services offered, which is, in turn, a function of the distribution system's
channel capacity or switching capability. For example, in the broadcast
television case, a single channel of video is being transmitted to all
viewers, so the transmission cannot be customized on a household-by-household
basis in response to information provided via the return channel. Hence,
interactive broadcasting will most likely be used for home shopping or

polling, 66

With multichannel media such as cable or satellite, the return channel
can serve the additional purpose of selecting a particular transmission for
reception by a particular viewing household. Thus, in the case of a pay-per-
view movie or near video on demand service, the return channel is used to
place an order. The viewer’s camera angle choice example is similar. One
might order this service for the Super Bowl, and have the ability to choose at

will among eight or ten different "feeds" of the game.

66 However, the interactive video data service that the Commission has
proposed could be used for two-way communications, and the Commission has
it to interactive computer services such as PRODIGY and COMPUSERVE
that provide information and services via telephone lines to personal computer
users. See Notice of Proposed Rulemaking in Gen. Docket No. 91-2, 6 FCC Red
1368 (1991), para. 9; Reply of TV Answer, Inc., RM-6196, filed July 13, 1990;
TV Answer, Inc.,
Staff, RM-6196, filed Nov. 16, 1990; DBS News, May 1991, p. 6.

-61-


viewer payment would entail economic inefficiences because, once a broadcast
signal is transmitted, the cost of serving an additional viewer is zero.2
Therefore, assuming transmission of the signal, consumer welfare is
maximized when the price is zero.3 A zero price is efficient because
otherwise potential viewers for whom the value of the service is greater
than or equal to the (zero) cost of providing it to them would be denied
service. By allowing programs to be delivered to viewers free, advertiser
support achieves economic efficiency in program distribution and provides

benefits to viewers who otherwise would not receive television service.

At the same time, inefficiencies result from advertiser support because
viewers cannot directly express their preferences for various kinds of
programming. Advertisers pay for advertising time, roughly speaking, on
the basis of the number of viewers attracted to adjacent programming,

regardless of whether viewers like a program intensely or only slightly

2 The marginal cost is zero only within a given service area. Expanding
the geographic area of service may require additional expenditures for
greater power, a higher antenna, or other technical improvements.

3 Econemists call goods and services with this characteristic "public
goods." Because the market will not supply them in optimal quantities, a
theoretical case can be made for subsidy or public provision. Paul A.
Samuelson, “Diagrammatic Exposition of a Theory of Public Expenditure,"
Review of Economic Statistics 37 (November 1955): 350-356. Of course,
given the potential ‘inefficiencies of providing goods through subsidy or
direct government. provision, these methods may be no more efficient than a
pure market system.


Though the data are limited, rough comparisons can be made of revenues
and program expenditures between broadcast and cable networks. Data on gross
advertising revenues for the three broadcast networks are available from
McCann~Erickson. The Television Bureau of Advertising makes projections of
expenditures based on these data.196 Total program expenses can be estimated
by extrapolating the proportion of gross revenues expended for programming
from earlier years, assuming that, in the future, networks will be able to
Spend at least as large a proportion of gross revenues on programming as they
have in the past. An assumed ratio of programming expenditures to gross
advertising revenues of 0.65 was used to estimate current program expenditures
and to project programming expenditures out to 1995,197 Three-net work
revenues are $9.4 billion in 1990 and projected to be $12.2 billion in 1995.
Network program expenditures are estimated at $6.1 billion in 1990 and $7.9
billion in 1995.

196 The projections assume growth of GNP of 24.7 percent between 1990 and
1995. During that period three-net work advertising revenues are projected to
grow 30.1 percent.

197 Data from the FCC TV Broadcast Financial Data compilation show that for
networks the ratio of program expenses to gross advertising revenues rose
from 0.59 to 0.65 between 1975 and 1980. The networks are now reported to
spend between 75 and 85 percent of their budgets on programming. John
Lippman, "Networks Push for Cheaper Shows, " Lles_Angeles Times, February 19,
1991, p. D-1. In 1980, according to FCC data, networks’ net revenues were
80.6 percent of gross advertising revenues. If budgets are based on 100
percent of net revenues, estimated program expenditures are calculated to lie
between 60.5 and 68.5 percent of gross revenues.

~- 150 -


cable by subscribers. 103 A gradual shift in viewing patterns, however, is
more likely than a radical change in the relative popularity of broadcast

television and cable.

Willingness to subscribe to cable may also be sensitive to income.
A small amount of evidence is available to support the conclusion that a
smaller fraction of the very poor than of other income groups subscribes
to cable.104 This suggests that cable subscribership may rise over time
with rising income. On the other hand, press reports indicate that the
demand for basic cable has continued to increase rapidly despite the current
recession, while pay cable revenues have stagnated and, in some cases,
declined.105 It is, of course, possible that increased videocassette
rentals have cut into pay cable subscriptions and revenues. Basic cable
may be a relatively affordable source of entertainment, even for those in
the lowest income classes. For them, as well as for many with higher
incomes, basic cable may have come to be considered a necessity, perhaps
because it can substitute for more expensive forms of entertainment. As

such, consumption may not vary substantially with the business cycle.

———_-

103 But see Joan Sanchez, "Signs of Peace at CNN: Ratings Dropping, Tour
Lines Hopping," Associated Press Wire, March 11, 1991. This article notes
that CNN rtings have dropped from 9.4 on the night that the Persian Gulf war
began to 2.2 by March 7, 1991. On the other hand, this still compares
favorably with the network’s 1990 average rating of 0.7.

104 Cabletelevision Advertising Bureau, Cable TV Facts, 1990 ed., p. 22.

105 Thomas R. King, "Slump Leads Pay TV to Fight Frill Image," Wall Street
Journal, Feb. 7, 1991, p. B-l.

- 99 -


Il. THE MARKET FOR VIDEO MEDIA

In most of the United States in the mid-1970’s the only sources of
visual entertainment and information were movie theaters and broadcast
television. Television service was almost universally available; as shown
in table 1, 97.4 percent of households had television sets in 1976. The
percentage has grown slightly in the period since. The percentage of
television households during this period has been far higher than the .
percentage of households having telephones .9 By 1990, almost two-thirds
of households had more than one television receiver, and the average number

of sets per household was two.

The past fifteen years have seen the advent of alternative sources of
video programming, primarily through the increasing penetration of cable
television and the introduétion and diffusion of the home videocassette
recorder. As shown in table 1, cable subscribership has grown from 17 percent
of households in 1976 to 56 percent in 1990. Home satellite dishes provide
multichannel service in about 3 percent of households; roughly 20 percent of
households not passed by cable have home satellite dishes.10 Additional

households receive video service from so-called wireless cable systems and

9 U.S. Bureau of the Census, Statistical Abstract of the United States:
1989 (109th edition). Washington, D.C., 1989, p. 544.

10 Home satellite dishes make available much of the same programming that
is typically available on cable systems.

-li-


independents, in particular UHF independents, has grown rapidly over the
period. In the early years, growth in numbers of stations was relatively
slow, so the losses during that period cannot be attributed, for the most
Part, to new stations with large startup costs. One can conclude that,
while the trend of declining profits or increasing losses is clear, the
absolute level of profits or losses, and the implications for the ability of

markets to support the existing number of stations, are not.

The industry’s expectations concerning future profits are reflected in
television station trading prices. The price for which a station sells
represents what buyers and sellers believe to be the Present discounted
value of the station’s future profit stream. Television stations typically
sold at prices between 10 and 12 times cash flow during the 1980’s, but now
are reported to be selling at seven to eight times cash flow.42 Clearly
beliefs concerning future profits of television stations have adjusted

downward in the recent past.

Tnends_in Revenues and Costs

Affiliates and independents both enjoyed large increases in real
(inflation-adjusted) average revenues between 1975 and 1985, followed by
slow growth for affiliates and a slight decline for independents (table 12).

42 Kevin Galdman, “Sellers Are Finding the Price Isn’/t Right For Their
Television Stations These Days," Wall Street Journal, May 7, 1981, p. B-1.

- 40 -


30 or more channels, while 21.9 percent had access to 12 or fewer
channels.9° In 1990, the comparable figures were 89.3 percent and 1.3
percent. Almost one-quarter of cable subscribers in 1990 had access to 54
or more channels. A small number of cable systems today offer 100 or more
channels.

TABLE 19
CHANNEL CAPACITY OF CABLE SYSTEMS, SELECTED YEARS

Percentage of Total Systems Percentage of Total Subscribers
1975 1980 1985 1990 1975 1980 1985 1990
Channel Capacity
54 and Over 8.6""" 5.8 84 - ” 98 24.0
30-53 41.2" 35.9 50.4 - - 54.8 65.3
20-29 18.1 27.5 14.3 ” - 12.3 7.3
13-19 10.4°" 25 47 29 ” - 23 04
6-12 70.9 66.8 17.6 11.3 - - 19.4 1.3
1-5 67 36 0.9 03 ” - 0.1 veer
Not Available 08 0.4 77 12.4 - ~ 1.4 V7
Total Number of
Systems/Subscribers 3,405 4,180 6,844 9,612 - - 31,274,771 48,613,439
SOURCES: Warren Publishing, Inc., Television Factbook, 1990 ed., Cable and Services Volume, p. C-385;

1985 ed., Cable and Services Volume, p. 1385; 1980 ed., Cable and Services Volume, p. 86-a; 1976 ed.,
Services Voiume, p. 73-a.

NOTE: 1985, 1990 are as of April 1; 1980 is October 15, 1979; and 1975 Is September 1.

"21 and over "13-20 **°30 and over ****Less than 0.05

95 Warren Publishing, Inc., Television and Cable Factbook, 1982-83 ed.,
Services Vol., p. 1548.

- 85 -


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-23-


for broadcast network programming, though cable expenditures are rising and
basic cable has begun to present first-run series and other programming
resembling that of the broadcast networks. Cable is estimated to account for
only 16 percent of total program expenditures but about 32 percent of

audiences.

Broadcast networks and stations will continue to have access to
sufficient funds to outspend cable for programming--at least until the end of
this decade--but their ability to do so is declining, and program expenditures
do not necessarily translate into audiences. The ability of broadcasters to
compete on even terms for programming would be enhanced by an end to the

compulsory copyright license and imposition of retransmission consent.

- 158 -


The networks may retain an ability to attract mass audierces for special
events, such as the Super Bowl, and smaller but still relatively large
audiences in prime time, but for much of their schedule, the networks’
audiences are in the range of those of some of their competitors in prime
time. The daytime three-network rating (percentage of all television
households) averaged 4.8 each, and the late-night three-network rating
averaged 3.7 each, in the 1989-90 season.148 In 1990 the Fox network had a
prime-time average rating of 6.2, while the ratings of the three major —
networks ranged between 11.0 and 12.3. Thus Fox’s prime-time rating was more
than half of any of the big three networks’ prime-time ratings and
considerably larger than their ratings in other time periods. In 1990, four
basic cable channels had prime-time ratings of 1.0 or better.149 By the
first quarter of 1991, three basic cable networks had prime-time ratings of
2.0 or better, and six more had ratings of 1.0 or better. 150 Of course the
demographic characteristics of audiences in other time periods may be
different from those in prime time, so the ratings are not exactly comparable.
But while still lower than the three networks’ in most cases, the ratings of

other media clearly offer plausible alternatives for advertisers.

148 M-F daytime and M-F late night, September-April, 1989-90. CBS,
citing Nielsen Television Index.

149 Household prime-time averages, January 1-November 2, 1990, Los Angeles
Times, November 11, 1990, Calendar, p. 7, citing Nielsen Television Index and
network estimates.

150 Multichannel News, May 6, 1991, p.19, citing Nielsen Media Research.
See table 17.

- 123 -


more than the alternatives. As a consequence, the number and type of
programs that viewers would choose if they could pay for programming may not
be produced.4

Viewer payment for programs, on the other hand, improves the
incentives for program production but creates inefficiencies by causing
programming to be denied to viewers who would value it more than the cost
of delivering it. An inherent conflict thus exists between efficient

production and efficient distribution of programming.>

Spence and Owen have examined the effects of television financing
methods on program production incentives.6 They show that both advertiser

support and viewer fees undersupply programs that have high value to a small

———_

4 See Jora R. Minasian, "Television Pricing and the Theory of Public
Goods, " Journal of Law and Economics 71 (1964): 71-80; Paul A. Samuelson,
" te Goods and Subscription TV: A Correction of the Record,"

haw_and Economics 71 (1964): 81-83.

5 Another source of inefficiency in broadeasting is nonmarket spectrum
allocation techniques, which prevent the number of channels from adjusting
in response to changes dn demand. Spectrum-using services could be provided
more efficiently, and licensees land users would be better off, if channels
could be shifted from lower-valued to higher-valued uses, for instance
between television and land mobile or cellular radio, without cumbersome
administrative procedures.

6 Michael Spence and Bruce Owen, “Television Programming, Monopolistic
Competition, and Welfare," Quarterly Journal of Economics 91 (February
1977): 103-126.


special interest or "niche" channels will develop. A related possibility is
the "home shopping mall," which would consist of a group of home shopping

channels, perhaps as many as 20 or 30, specialized by product offered.

Compression will also likely facilitate the introduction of HDTV. HDTV
will require transmission of much more information per frame than standard
NTSC. At present, it appears that no more than two, and possibly only one,
HDTV signal can be transmitted per terrestrial channel or satellite
transponder .48 However, compression can free up capacity for HDTV
transmissions by allowing consolidation of the NTSC transmissions onto fewer
channels. It is worth noting that most of the contenders for the United

States HDTV terrestrial transmission standard are now digital systems.

In the satellite arena, compression could interact with other technical
factors to make DBS more feasible. One of the selling points of DBS is
compact, inexpensive receiving equipment. Hence, in the absence of
compression, to receive more than the 32 channels assigned to each orbital
slot,49 DBS reception equipment would have to be "tunable," i.e., it would
have to be possible to adjust the dish antenna so it pointed at different
satellites. It is, of course, possible to adjust the position of the dish

antenna. However, equipment to do so accounts for a significant share of C-

48 RAND [BS Report, p. 51.

49 E. Reinhart, "Satellite Broadcasting and Distribution in the United
States," Telesonmunicat ions Journal 57, No. VI (June 1990) ("Reinhart"), p. 413.

-51-


indicate that the networks no longer are able to increase the price per

viewer, thus indicating a shift in advertiser thinking.145

Table 25 shows the rate of growth of revenues for various
categories of video advertising, adjusted for inflation. Total video
advertising appears in the first column. Trends in advertising revenues must
be interpreted with caution because video advertising fluctuates with the
business cycle and tends to increase in Olympic years election years.
Nevertheless, table 25 shows that total inflation-adjusted video advertising
grew rapidly over the early 1980’s but much more slowly later in the

decade, and fell slightly from 1988 on.

Network advertising revenues reached a peak in real terms in 1984 and
have declined since. (See figure 9). Real network advertising revenues
increased 28.6 percent between 1980 and 1984 Sut decreased 3.2 percent between
1984 and 1988, and continued to fall through 1990.146 Since 1979, network
advertising has fallen steadily relative to GNP, except in 1982-84. The
networks’ share of national television advertising has fallen from 59 percent

in 1975 to 47 percent in 1990.

145 "Neck and Neck at the Networks," Business Week, May 20, 1991, p. 36;
"Nervous Nets Wheel Early Deals," Variety, May 20, 1991, p. 21.

146 These years were chosen for comparison because net work advertising
revenues are believed to peak in years of the Olympics and the Presidential
election campaigns. Based on data from McCann-Erickson, Inc., "Estimated
Annual U.S. Advertising Expenditures," April 1990, and Cabletelevision

Advertising Bureau, Cable TV Facts, 1989, pp. 12-13.

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Should significant DBS competition to cable develop, cable systems would
likely respond by reducing prices and improving service, thus making cable
more attractive relative to over-the-air viewing. DBS competition therefore
could cause broadcast viewing shares to fall faster than current projections

indicate.

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By early 1991, 76.6 percent of television households had vers.126 The

Television Bureau of Advertising predicts that penetration will exceed

90 percent by the end of the decade.

TABLE 20
VCR PENETRATION

vcR % ot TV

Year Households (1000's) Households
1975 ” -

1980 840 Wt
1985 17,660 20.8
1990 63,180 68.6
1995* 82,270 84.3
1999* 93,500 91.7

SOURCE: Television Bureau of Advertising, Inc., "Trends in VCR Usage,”

April 1990, pp. 3, 5.

NOTE: 1975-1990, VCR's, February of each year; households, January
of year; 1995-1999, beginning of year.

“Projected.

Table 21 shows that television households with VCRs use their television

sets to view nonrecorded material directly or to record it slightly more

hours than other households use their television sets.127 This result would

126 "VCR penetration climbs to 76.6%," Variety, May 31, 1991, p. 45.

127 The differences are small and are unlikely to be statistically

significant.

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Table

22.
23.
24.
25.
26.
27.
28.
29.

LIST OF TABLES (cont)

Page
Time Spent Recording and Playing VR... - ++ eee rrr 108
Video Advertising and GP. we ee et ee ee tS 113
Components of Video Advertising... ee eee ee es 116
Inflation-Adjusted Video Advertising Revenues, 1975-1990... +. 121
Population of the United States, 1975-2000... - ++ eee eee 173
Selected Family Characteristics, 1975-1987, 2 ee ee ee tt 175
Households of Various Types, 1975-2000... + s+ seer ere 176
Civilian Labor Force Participation Rates, 1975-2000... 2 eee 177


representing 30 percent of basic cable subscribers, purchased some pay-per-
view service. Many of these subscribers purchased very little service; the
average monthly pay-per-view revenue per pay-per-view subscriber in 1990 was
only $2.25.93 This is equivalent to at most one event per subscriber per
month. However, as table 16 indicates, the total amount of cable operator

pay-per-view revenues was a substantial $417 million.

The projected monthly revenue per pay-per-view subscriber in 1999 is
only $6.51. Considering inflation, this is probably equivalent to about two
events per month. While the number of pay-per-view subscribers is projected
to increase substantially, to roughly three-quarters of basic subscribers
and one-half of total homes passed, total pay-per-view revenue of cable
operators is projected to be only $3.9 billion, or 11.6 percent of total

cable operator revemes, up from 2.6 percent in 1990.

Technical factors will undoubtedly affect the growth of pay-per-view
service. One is the availability of the necessary addressable converters.
In 1990, only 38 percent of basic subscribers had addressable converters; in
1999, 84.4 percent are projected to be so equipped. Also, since programmers
and cable operators find it advantageous to be able to cater to the impulse
buyer, the ability to process a large number of orders almost

instantaneously is important. Various methods, including automatic number

—

93 The Kagan Cable TV Financial Databook, June 1990, p. 10.

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prime-time viewing has a particularly large impact on networks because their
advantage to advertisers historically resided in their ability to deliver

the mass audiences that watch television during prime time.

At the same time, the prime-time viewing shares of independents and

affiliates of the Fox network have increased (table 8).25 In fact,

TABLE 8
COMMERCIAL TELEVISON PRIME-TIME VIEWING SHARES BY CHANNEL TYPE
1982/83-1989/90

Yoars 3 Networks Independents Fox Basic Cable Pay Cable
1982/83 73 14 a e
1983/84 71 15 5° 6"
1984/85 69 18 e 6
1985/86 68 16 7 e
1986/87 66 17 7 e
1987/88 62 19 2 9° e
1988/89 59 19 3 12 6
1989/90 58 19 4 14 6

SOURCE: 1982/83-1987/88, Nielsen Television Index and Nielsen Monthly Cable Status
Reports (Oct. - Nov.); 1988/89-1989/90, Nielsen Television Index.

NOTE: Figures are percentages of viewing, not commonly reported household shares.
Totais do not sum to 100 because viewing of PBS stations is not included. Moreover, Fox
shares are also included in the independents column, e.g., the 1989/90 share for non-Fox
independents was 15.

*Monday - Sunday 8:00 - 11:00 PM.

25 The Fox network began service in the 1987/88 season and distributes
programming five evenings a week to formerly independent stations. For
most purposes Fox stations are grouped with independents in this paper.

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marginal programming in small markets, where the cost of distributing a

program may approach the revenue it can produce, are exceptions.) 192

As prices broadcasters can afford to pay fall, however, it seems likely
that outlets having both advertising and subscription revenues will
increasingly be able to outbid broadcasters for some programming, particularly
that which is highly valued by large audiences. Broadcast network executives
believe that cable networks will be able to outbid them for major sports
events, and public television is already losing some programs to cable.193
Again cable networks’ ability to outbid broadcasting networks depends on the
distribution of audience tastes. But because prices broadcasters face for
programs depend in part on the audiences they can attract, and because the
long-run supply of much broadcast programming appears easily expanded, we
expect that much programming will remain available at prices broadcasters can
afford to pay, though the most popular talent and programming may be lured

away to competing media.
REVENUES FOR PROGRAM PURCHASE

Large-scale participation of cable networks in the market for program

acquisition may both bid up prices of inputs and increase the general level

192 For programming produced in house, such as news, the price of program
inputs, with the possible exception of salaries of a few stars, does not vary
with audience size as does the price of purchased programming.

193 “Public TV’s once-unique niche threatened by cable look-alikes,"
Electronic Media, October 22, 1990, p. 3.

- 148 -


According to McCann-Erickson, Inc., broadcast network advertising makes
up about a third of total video advertising.138 Cable accounts for only about
6 percent (table 24) 139 At least since 1980, the network share has dropped
continuously and substantially. Since 1980 the cable network and national
syndication shares have each risen from close to zero to roughly 5 and 6
percent of the market, respectively.140 National spot and local advertising
have been more stable, with the share of the former falling slightly and the
latter rising slightly. While the components of video advertising are all
predicted to grow, the rates of increase are expected to vary greatly, with
the cable and national syndication categories gaining in share at the expense

of the others.

Television advertising revenues are a function, broadly speaking, of the
size of the audience watching the medium or the program in question. While
the demographic composition of the audience also affects advertising sales,

advertisers apparently purchase time on the basis of a small number of

138 MoCann-Eriskson is viewed as the most authoritative source of data on
advertising revenue, and is the basis for standard statistical sources such as
the Statistical Abstract of the United States. The McCann-Erickson time
series goes back to 1935.

139 Paul Kagan Associates’ estimate of cable advertising revenue is about 40
percent higher than the McCann-Erickson estimate. Paul Kagan Associates, Inc.,
The Kagan Cable TV Financial Databook, June 1990, p. 70.

140 The national syndication category has grown rapidly, largely because it
includes Fox Network advertising revenue.

- 115 -


Nevertheless, changes in the services offered by either cable or broadcast
television, or reductions in basic cable rates, could attract additional

subscribers.
SUMMARY

Now that most homes are passed by cable, future growth is likely to
come primarily from expansion in penetration of homes passed. , Therefore,
the most likely scenario is gradually increasing cable penetration and
viewing and additional gradual declines in the broadcast audience share.
This is consistent with the projected doubling (in nominal terms) of cable
operators’ basic subscription revenues. Pay-per-view and advertising
revenues will increase in relative importance, helping to produce a greater
Proportional increase in total cable operator revenues than in basic

revenues.

On the other hand, it is possible that substantial expansion in cable
channel capacity, the crucial technical development on the horizon, could
change substantially the viewing habits of the American public. If demand
for pay-per-view services or new niche services increases dramatically,
then the competitive position of broadcasting would deteriorate more
rapidly. (Of course, viewing of prerecorded material and standard cable
channels, basic and pay, would also be affected by such developments.)

Other programming developments, not tied so closely to technical

factors, could also cause departure from the evolutionary pattern.

- 90 -


The data do not permit identification of viewing shares for locally-
produced programming such as news and public affairs, or for syndicated
programming that could be interpreted as contributing to the affiliated
stations’ fulfillment of their mandate to program in the public interest.
Nevertheless, the figures in table 9 raise the question of how much value

consumers place on the local component of a network affiliate’s service .27

The relative value of network and local programming to viewers is
important because the projections of cable subscribership given below
implicitly assume that the broadcast system will remain stable in its
current form. If the networks ever chose to deliver programming directly to
the home viewer by cable, satellite, or other non-broadcast means, the
future of local television broadcasting would look much bleaker,
particularly if viewers place a low value on affiliates’ local programming.
Viewers’ valuation of local programming will also affect the competitive
balance between cable and satellite service, since satellite systems

probably will be unable for technical reasons to deliver local signals.

27 Independent stations also provide some local programming, including
news, but viewing shares of this programming cannot be disaggregated.
However, as we shall see below, independents as a groups provide much less
of such programming than cb affiliates.

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