```
                                                                 
Telecommunications: Issues in Providing Cable and Satellite	 
Television Services (15-OCT-02, GAO-03-130).			 
                                                                 
Direct broadcast satellite (DBS) television service has grown to 
become the principal competitor to cable television systems. In  
October 2001, the two primary DBS companies, EchoStar and	 
DirecTV, proposed a merger plan that is pending before the	 
Department of Justice and that the Federal Communications	 
Commission (FCC) recently announced that it had declined to	 
approve. GAO was asked to examine several issues related to	 
competition in providing subscription video services, including  
the competitive impact of the availability of cable modem	 
Internet access, and the effects on cable prices and DBS	 
penetration rates of DBS' offering local broadcast channels. GAO 
also examined the technical capability of the individual DBS	 
companies to expand local channel services into more television  
markets. This report offers no opinion on the merits of the	 
proposed merger.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-130 					        
    ACCNO:   A05287						        
  TITLE:     Telecommunications: Issues in Providing Cable and	      
Satellite Television Services					 
     DATE:   10/15/2002 
  SUBJECT:   Cable television					 
	     Competition					 
	     Internet						 
	     Satellites 					 
	     Telecommunication					 
	     Television and television stations 		 
	     Television broadcasting				 

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GAO-03-130

                                       A

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

October 2002 TELECOMMUNICATIONS Issues in Providing Cable and Satellite
Television Services

GAO- 03- 130

Letter 1 Results in Brief 2 Background 4 For the Majority of Consumers,
Internet Access Technologies Do

Not Appear to Play a Major Role in Their Consideration of Video Service
Providers 6 DBS Provision of Local Broadcast Channels Associated with
Higher DBS Penetration Rates, but Not with Lower Cable Prices 9

Technical Considerations and Business Decisions Can Influence DBS
Companies* Expansion of Local Broadcast Services 10 Agency Comments 12

Appendixes

Appendix I: Scope and Methodology 14 Consumer Survey 14 Econometric Model
14

Appendix II: Results of Consumer Survey on Video Service Choices 17

Appendix III: GAO Econometric Model 28 Conceptual Development of the
Econometric Model 28 Data Sources Used for the Econometric Model 36
Merging Various Data Sources into a Single Data Set 38 Descriptive
Statistics for Variables Included in the Econometric

Model 41 Estimation Methodology and Results 42 Alternative Specifications
48

Appendix IV: Comments from the Federal Communications Commission 49

Appendix V: Comments from the Department of Justice 50

Appendix VI: GAO Contacts and Staff Acknowledgments 51 GAO Contacts 51
Staff Acknowledgments 51

Tables Table 1: Expected Effects of All Explanatory Variables on Cable
Prices and DBS Penetration Rates 33 Table 2: Descriptive Statistics 41
Table 3: 3SLS Model Results 43 Table 4: Regression Estimates of Reduced-
Form Cable prices and

DBS Penetration Equations 46

Figures Figure 1: Extent to Which Respondents Said That Cable Modem
Internet Access Would Make Them More Likely to Choose Cable Service over
Satellite Service 6 Figure 2: Reported *Major Reasons* for Selecting or
Considering Cable or DBS Video Services 8

Abbreviations

2SLS Two- Stage Least Squares 3SLS Three- Stage Least Squares BLS Bureau
of Labor Statistics CUID Community Unit Identification DBS direct
broadcast satellite DMA designated market area DSL digital subscriber line
DTV digital television FCC Federal Communications Commission HD high
definition MABLE Master Area Block Level Equivalency MSA metropolitan
statistical area MSO multiple system operator ORC Opinion Research
Corporation

Lett er

October 15, 2002 The Honorable Herb Kohl Chairman The Honorable Mike
DeWine Ranking Minority Member Subcommittee on Antitrust, Competition, and

Business and Consumer Rights Committee on the Judiciary United States
Senate

Since its introduction in 1994, direct broadcast satellite (DBS) service
has grown dramatically as a means of delivering television programs to U.
S. households and is now the principal competitor to cable companies for
subscription video services. Subscribers to DBS services use small
reception dishes to receive signals beamed down from satellites in orbit
over the equator. As of June 2002, more than 18 million households were

served by DBS. The ability of DBS companies to compete against cable was
bolstered when DBS companies gained the legal right to provide local
broadcast channels* that is, to offer the signals of local over- the- air
broadcast stations (such as affiliates of ABC or NBC)* via satellite to
their customers. 1 In addition to video services, DBS and cable also
compete for

subscribers to their broadband (i. e., high speed) Internet access
services, which is sometimes sold as a package with video services. There
are currently two primary DBS providers in the United States: Hughes
Electronics* DirecTV and EchoStar*s DISH Network. In October 2001, DirecTV
and EchoStar proposed a merger plan that is now pending before the U. S.
Department of Justice (Justice). On October 10, 2002, the Federal
Communications Commission (FCC) announced that it declined to approve the
merger because FCC found that the transaction would not serve the public
interest, convenience, and necessity. FCC provided for a full evidentiary
hearing before an Administrative Law Judge.

As agreed with the Subcommittee, this report provides information on (1)
whether the availability of cable modem Internet access service appears to
be affecting the competitiveness of DBS companies in the provision of
video services, (2) whether cable prices and DBS penetration rates appear
1 This is often referred to as the provision of *local- into- local*
because the signals of broadcasters within a specific television market
must be transmitted up to the satellite for transmission back down into
that same television market.

to be affected in areas where the DBS companies offer local broadcast
channels, and (3) whether the two individual DBS companies are
technologically capable of expanding local broadcast channel services into
all 210 television markets in the United States.

To address these questions, we developed a telephone survey, projectable
to the U. S. population, to explore consumers* reasons for selecting video
services. We also updated a prior GAO econometric model to examine whether
the availability of local channels from a DBS company, as well as other
factors, influenced the level of cable prices and DBS penetration

rates (measured as the ratio of DBS subscribers to housing units). 2
Finally, a GAO senior technologist analyzed technical information provided
by DirecTV and EchoStar and other interested parties on the capacity of
the DBS systems. A more detailed discussion of our scope and methodology
is provided in appendix I. The consumer survey questions and responses are
contained in appendix II. A complete discussion of the econometric model
development, including data sources, a table of descriptive statistics for
all variables, estimation design, model results, and alternative
specifications, is contained in appendix III. We conducted our review from
February 2002 through September 2002 in accordance with generally accepted
government auditing standards.

Our objectives did not include an assessment of the proposed merger of
DirecTV and EchoStar and, therefore, this report offers no opinion on the
merits of the proposed merger.

Results in Brief Responses to our consumer survey suggest that the
availability of Internet access services is important for some consumers*
although not the majority of consumers* when they are considering various
video service providers. In particular, just over half of the respondents
to our survey said that when thinking about purchasing television
programming service, the availability of cable modem Internet service
would not make them more likely to consider cable video service over DBS
video service. However,

almost one- third of respondents said that when thinking about purchasing
television programming service, the availability of cable modem Internet
service would make them *moderately more likely* or *much more likely* to
consider cable over DBS, and these respondents were more likely to 2 See
U. S. General Accounting Office, Telecommunications: The Effect of
Competition From Satellite Providers on Cable Rates, GAO/ RCED- 00- 164
(Washington, D. C.: July 18, 2000).

have a higher household income and to be younger than respondents not
influenced by the availability of cable modem service. Most respondents
(88 percent) said they had never considered satellite Internet service.
According to results from our econometric model, the provision of local

broadcast channels by DBS companies is associated with significantly
higher DBS penetration rates, although we found no evidence that DBS
provision of local channels influences cable prices. Specifically, our
model results indicate that in areas where DBS subscribers can receive
local broadcast channels from both DBS companies, the DBS penetration rate
is approximately 32 percent higher than in areas where subscribers cannot
receive local broadcast channels via satellite. Thus, it appears that DBS
is

able to compete more effectively for subscribers with cable in areas where
the DBS companies offer local channels than in areas where the DBS
companies do not offer local channels, although this competitiveness had
not led to lower cable prices by 2001. On the basis of our expert*s review
of current DBS technologies and

deployed assets, it appears that neither company, at this time, would be
able individually to offer all of the local broadcast channels in all 210
television markets while simultaneously maintaining a competitive national
subscription television service. Over time, however, each company could
make a business decision to introduce local channels in more markets than
they currently plan to serve by deploying additional assets and new

technologies. Whether the business case* the costs of deploying additional
assets versus the benefits of gaining additional subscribers* would
justify the individual companies* introduction of local channels in all
210

television markets is not clear. Additionally, the ongoing transition of
all broadcast television stations from analog to digital television
technologies allows broadcasters to provide high definition television
signals, which require more satellite capacity to transmit than
traditional analog signals. At this time, the DBS companies* business
decisions about local digital broadcast carriage at the completion of the
DTV transition is also unclear. We provided a draft of this report to FCC
and Justice for their review and

comment. FCC staff provided minor technical comments that were
incorporated as appropriate. Both FCC and Justice declined to comment on
the substance of our report due to the merger proceedings. Letters from
FCC and Justice are included in appendixes IV and V, respectively.

Background According to FCC, as of June 2001, just over 86 percent of
television households purchased a subscription television service, as
opposed to

relying solely on free, over- the- air broadcast television. Of these
subscription households, 78 percent received their service from a
franchised cable operator while 18 percent received their service from a
DBS company. 3 DBS historically has been popular in rural areas where
cable service is unavailable to many households. Until a few years ago,

there was a significant difference between the programming packages of
cable and DBS: cable systems could offer the local broadcast channels,
while DBS companies generally could not because of technological
limitations and legal constraints. In 1999, following advances in
satellite technologies, Congress enacted the Satellite Home Viewer
Improvement

Act 4 to, among other things, allow DBS companies to offer local broadcast
channels via satellite. Today, EchoStar and DirecTV, the two primary
providers of DBS services, each offer local broadcast channels to their
subscribers in about 45 of the 210 television markets in the United
States. 5 DBS and cable also compete for subscribers to their broadband
Internet access services. 6 Many cable companies have recently upgraded
their

cable systems and now offer a selection of digital services, including
cable modem Internet access. Cable modem service is generally considered
one of the fastest methods for home Internet access and is currently the
most popular broadband service. DirecTV offers a two- way satellite
Internet access service called DirecWay. 7 Few consumers subscribe to the
current satellite Internet service, although future satellite Internet
access

3 The remaining 4 percent of subscription television households obtained
service through other means, such as terrestrial wireless systems,
satellite master antenna television systems (usually used in apartment
buildings or other multiple- dwelling units), open video

systems, and large *C- band* home satellite dishes. 4 P. L. 106- 113, 113
Stat. 1501, 1501A- 526 to 1501A- 545 (Nov. 29, 1999).

5 The market for a broadcast station is known as its designated market
area (DMA). According to Nielsen Media Research, DMAs are used to identify
television stations whose broadcast signals reach a specific area and
attract the most viewers. Nonoverlapping DMAs cover the entire contiguous
United States, Hawaii, and parts of Alaska. 6 Digital subscriber line, or
DSL, broadband Internet access and terrestrial wireless Internet access
are also available in some areas. 7 EchoStar previously offered an
Internet access service called StarBand.

technologies are expected to be faster and more competitive with cable
modems. 8 Each DBS company is inherently limited in the number of
programming channels and other services it can provide by the technical
capacity constraints of its satellite fleet. Each satellite contains a
certain number of transponders, or relay equipment, and each transponder
can transmit a limited amount of information (i. e., video, audio, and
data). 9 DBS companies have increased the capacity of their satellites
through various technologies, such as digital compression and frequency
reuse.

Compression technologies conserve capacity by reducing the number of bits
required to send digital information. For example, when transmitting video
programming, compression eliminates the transmission of identical bits
from frame to frame. Frequency reuse allows different programming to be
transmitted over the same frequencies in different geographic areas. This
is accomplished through the use of *spot beam* satellites that, rather
than transmitting a signal nationwide, transmit to specific cities or
other smaller geographic regions. As long as spot beams using the same
frequency are at least a certain distance apart, interference among
signals is avoided. Both digital compression and frequency reuse
technologies have steadily improved since the launch of DBS in 1994.
Satellite companies are also constrained by the number of orbital slots
available for DBS services. Currently, DirecTV and EchoStar have the
rights to all of the allocated frequencies at the three full- CONUS (i.
e., the satellite footprint covers the entire contiguous United States)
DBS orbital slots.

In October 2001, the two DBS companies signed an agreement wherein
EchoStar would merge with DirecTV. One of the main arguments the companies
put forth in support of the merger is that it would enable them to offer
local broadcast channels to subscribers in all 210 television markets,
something the companies say they cannot do independently. The companies
have stated that their main competitor is cable* not each

other* and that the ability to carry all local broadcast channels will
make DBS a stronger competitor to cable systems. Opponents of the merger
have stated that the companies could individually offer many more, if not
all, local broadcast channels if they chose to do so and that the merger
would

8 Several companies are currently planning to introduce Ka- band satellite
systems for broadband Internet access services for use by both consumers
and businesses. 9 A transponder will receive a signal, amplify it, change
its frequency, and send it back to earth. Individual DBS transponders
typically have a bandwidth capacity of 24 MHz.

create a monopoly in DBS service provision, which is of particular concern
to rural consumers who do not have access to a cable system. The proposed
merger is under review by Justice. FCC recently announced that it had
declined to approve the proposed merger, although DirectTV and EchoStar
have 30 days to file an amended application and to file a petition to
delay the hearing. Congress has held several hearings on the matter.

For the Majority of In our random telephone survey of consumers, we asked
all of our survey Consumers, Internet

respondents if, when thinking about purchasing television programming, the
availability of cable modem Internet service would make them more Access
Technologies likely to choose cable video service over satellite video
service (see fig. 1). Do Not Appear to Play

Fifty- one percent of those responding said *not more likely* while 16 a
Major Role in Their percent said *much more likely.* We also asked all of
our survey respondents (excluding those few with satellite Internet
access) if they had Consideration of Video

considered purchasing Internet service through a satellite provider; 88
Service Providers

percent said they had not.

Figure 1: Extent to Which Respondents Said That Cable Modem Internet
Access Would Make Them More Likely to Choose Cable Service over Satellite
Service

Source: GAO consumer survey (May * June, 2002).

As shown in figure 1, almost one- third of respondents said that the
availability of cable modem service was *moderately more likely* or *much
more likely* to make them choose cable over satellite service. We also
found the following:  Respondents with higher household incomes were more
likely to say

that the availability of cable modem Internet access would influence their
decision to buy cable video service.

 Respondents who were younger (from 18 to 34 years old) were more likely
than older respondents to say that the availability of cable modem
Internet access would influence their decision to buy cable video service.

In addition to asking all respondents about the impact of Internet access
on their video service decisions, we asked respondents who had begun
purchasing or considered purchasing either cable or DBS service within the
past 2 years to rate various reasons why they considered or purchased
these services (see fig. 2). 10 Of those who began purchasing or
considered purchasing cable, 61 percent said the availability of cable
modem service was *not a reason* in their consideration or purchase of
cable video

programming services, although approximately one- fifth said cable modem
service was a *major reason* for considering cable. The responses from
those who had begun purchasing or considered purchasing DBS within the
past 2 years were similar: 64 percent said satellite Internet access
service was not a reason for consideration of DBS video services while 12
percent

said it was a major reason. Other factors appeared to be important in
consumers* consideration of video providers. Fifty- seven percent of cable
respondents and 61 percent of DBS respondents said that a major reason for
selecting or considering a video services provider was because they wanted
more channels than they were receiving. Those who recently selected or
considered cable also rated highly the ability to get local broadcast
channels from the cable company and a better signal quality. Those who
recently selected or considered DBS often reported that they considered
satellite service because they believed

10 Respondents were asked to rate a series of possible reasons as either a
*major reason,* a

*minor reason,* or *not a reason* in why they considered or selected
either a cable or DBS provider. See appendix II for the detailed questions
and responses.

DBS was cheaper than cable and because DBS offered special rates or
promotions.

Figure 2: Reported *Major Reasons* for Selecting or Considering Cable or
DBS Video Services

a *Addition of local channels* was not asked of respondents who had
selected or considered cable in the last 2 years. b *Wanted local and
cable from the same provider* was not asked of respondents who had
selected or considered DBS in the last 2 years. Source: GAO consumer
survey (May * June, 2002).

DBS Provision of Local According to our econometric model, the provision
of local broadcast Broadcast Channels channels by DBS companies is
associated with significantly higher DBS

penetration rates. Specifically, our model results indicate that in cable
Associated with Higher

franchise areas where consumers can receive local channels from both DBS
Penetration Rates, DBS providers, the DBS penetration rate is
approximately 32 percent but Not with Lower

higher than in areas where consumers cannot receive local channels via
satellite. Thus, in areas where the DBS companies offer local channels, it
Cable Prices appears that DBS is more effectively able to compete for
subscribers.

In addition to using an econometric model to study the competitive impact
of DBS provision of local channels, we also examined the growth in the
number of DBS subscribers between 1998 and 2001. This analysis was based
on the percentage change in the number of DBS subscribers in almost all
zip codes throughout the country. We found that in areas where both DBS
companies introduced local broadcast channels, DBS

subscribership grew by approximately 210 percent over this time period,
while in areas where local channels were not available, it grew by 174
percent in the same time frame.

Our model results do not indicate that the provision of local broadcast
channels by DBS companies is associated with lower cable prices. 11 In
contrast, the presence of a second cable franchise (known as an
overbuilder) does appear to constrain cable prices. In franchise areas
with a second cable provider, cable prices are approximately 17 percent
lower

than in comparable areas without a second cable provider. 12 11 In some
areas, cable companies have begun offering promotions to entice current
DBS subscribers to switch to cable. For example, DBS subscribers in one
area who turn in their satellite equipment to the cable company receive
free cable installation and an approximately $25 per month reduction in
their cable price for 1 year. Although these

promotions can be thought of as a form of price discounting by cable
operators, we do not know the extent to which such programs were in place
during the time of our study.

12 This was a larger effect than that found by FCC in its 2002 Report on
Cable Industry Prices (FCC 02- 107). Using an econometric model, FCC found
that cable prices were about 7 percent lower in franchise areas when there
was an overbuilder. One possible explanation for the difference in results
is that we conducted further analysis of the competitive status of
franchises that were reported by FCC to have an overbuilder. We found
several instances where overbuilding may not have existed although FCC
reported the presence of an overbuilder, and we found a few cases where
overbuilders appeared to exist although FCC had not reported them. We
adjusted our measurement of overbuilder status accordingly.

Finally, we found that the provision of local broadcast channels by DBS
companies is associated with nonprice competition. In areas where both DBS
companies provide local channels, our model results indicate that cable
companies offer subscribers approximately 6 percent more channels. This
result indicates that cable companies are responding to DBS provision of
local channels by improving their quality, as reflected by the greater
number of channels. In our July 2000 report, we also found that cable
companies responded to DBS competition by increasing the number of
channels.

Technical In 1999, the Satellite Home Viewer Improvement Act provided DBS
companies with the legal right to provide local broadcast station

Considerations and programming. 13 To date, DirecTV and EchoStar have each
introduced local Business Decisions broadcast service in about 45 markets,
although DirecTV plans to offer

Can Influence DBS local channels in about 70 markets and EchoStar plans to
offer local Companies* Expansion

channels in about 50 markets. However, providing local channels uses a
satellite*s transmission capacity* a limited resource on each satellite.
of Local Broadcast Thus, there is an important trade- off that DBS
companies face in deciding Services how many markets to target for local
service. As DBS companies roll out local channels in more markets,
satellite capacity that could otherwise

have been used to provide services to all subscribers (such as national
cable networks or interactive services) would be used to offer local
channels to select groups of subscribers.

The two DBS companies have stated that one of the reasons they want to
merge is to engender economies in the provision of local broadcast
channels. In particular, the companies have stated that if they merge,
they will, as a combined entity, have sufficient capacity to provide local
broadcast programming in all 210 television markets and add new services,
while continuing to provide their current number of cable programming

13 DBS companies have a requirement somewhat analogous to cable*s must-
carry requirement. The Satellite Home Viewer Improvement Act allows DBS
companies to provide local broadcast signals but requires in most
circumstances that if they do so, they must

provide subscribers with all of the local broadcast signals in that
market, including stations affiliated with smaller networks and
independent and public stations.

channels. 14 Several opponents of the merger contend that each of the DBS
companies on its own has sufficient capacity to expand the provision of
local broadcast channels into even more, if not all, television markets.
Key assumptions about the technical capabilities of the DBS companies*
satellite fleets varied among those with whom we spoke. Opponents of the

merger made assumptions about key technical factors* such as frequency
reuse capability and advances in digital compression technologies* that
were optimistic. The DBS companies held more conservative views about the
technical capabilities of their fleets today and considered some

possible enhancements to be based on technologies that are not currently
available to them nor proven in terms of quality. We found that some of
the assumptions of the merger opponents focused on potential capabilities
that could not be readily incorporated into satellites already deployed
and that would involve substantial replacement of consumers* DBS
equipment. 15 Our examination of various documents related to the two DBS
companies* satellite capacity indicates that* given current technologies
and deployed

assets* neither company would individually be able to offer all of the
local broadcast channels in all 210 television markets while
simultaneously maintaining a competitive national subscription television
service. Were either company to offer local channels in all 210 markets
today, it would have to use much more of its current capacity for local
channels, thus reducing its ability to offer the large numbers of national
cable networks, pay- per- view channels, and other services that each
company currently provides. 16 This would compromise the competitiveness
of a DBS company with cable. In the long term, however, with the launch of
additional satellites and the

deployment of or transition to new technologies, both DBS companies could
choose to provide local channels in more television markets than they
currently plan to serve. Of course, these decisions would involve

14 Currently, the two DBS providers offer much of the same programming,
such as the same national cable networks (e. g., CNN and MTV), and offer
local broadcast channels in most of the same markets. A merger would allow
the new company to increase its current capacity by ending this
duplication of services. 15 EchoStar and DirecTV acknowledge that a
proportion of DBS subscribers will also need to replace their equipment if
they merge. 16 Additionally, DBS companies have contracts with national
cable networks. Dropping these networks to expand local channels could
prompt legal challenges by the cable networks.

weighing the cost of such satellites or new technologies against the
number of projected additional subscribers and other benefits that
increased local broadcast offerings would bring to DBS. 17 That is, the
decision of whether

to introduce more local channels is essentially a business decision.
Whether the benefits would outweigh the costs for the individual companies
to roll out local channels in all 210 television markets is not clear.

Finally, it is also not clear how the transition of all local broadcast
stations from analog to digital television (DTV) technologies will affect
the offering of local broadcast channels by DBS companies. 18 The
broadcast DTV transition is under way and will eventually culminate in the
discontinuation of all analog broadcast signals. The DTV transition allows
broadcast stations to provide high definition (HD) television signals*
that is, a

sharper television picture with roughly twice the lines of resolution of
traditional analog pictures. However, even with digital compression
technologies, the transmission of HD signals takes up far more satellite
capacity than the transmission of traditional analog signals. If many of
the roughly 1,600 broadcast stations across the country provide HD signals
at

the end of the digital transition (when the analog signals have been
discontinued), it will take considerably more satellite capacity to
provide the signals of the digital stations than it currently takes to
provide the signals of the analog stations. However, the DTV transition
may take several years, during which time advances in satellite
technologies might

mitigate this need for increased capacity. Nonetheless, at this time, the
DBS companies* business decisions about local digital broadcast carriage
at the completion of the DTV transition is unclear.

Agency Comments We provided a draft of this report to FCC and Justice for
their review and comment. FCC staff provided minor technical comments that
were incorporated as appropriate. Both FCC and Justice declined to comment

17 Our model results indicate that there are benefits such as increased
penetration rates in areas where local channels are offered. EchoStar and
DirecTV have noted other reasons that the companies desire to serve all
210 markets, such as the ability to market their

service* including local channels* nationally. 18 For more information on
the DTV transition, see U. S. General Accounting Office,
Telecommunications: Many Broadcasters Will Not Meet May 2002 Digital
Television Deadline, GAO- 02- 466 (Washington, D. C.: Apr. 23, 2002). We
expect to release a second report on the DTV transition in November 2002.

on the substance of our report due to the merger proceedings. Letters from
FCC and Justice are included in appendixes IV and V, respectively. As
agreed with your offices, unless you publicly release its contents
earlier, we plan no further distribution of this report until 30 days
after the date of this letter. At that time, we will provide copies to
interested congressional committees; the Assistant Attorney General,
Antitrust Division,

Department of Justice; the Chairman, FCC; and other interested parties. We
will also make copies available to others upon request. In addition, this
report will be available at no charge on the GAO Web site at http:// www.
gao. gov. If you have any questions about this report, please contact me
at (202) 512- 2834 or guerrerop@ gao. gov. Key contacts and major
contributors to this report are listed in appendix VI.

Peter Guerrero Director, Physical Infrastructure Issues

Appendi Appendi xes x I

Scope and Methodology Consumer Survey To provide information on the impact
of the availability of cable modem Internet access on consumer video
service choice, we contracted with Opinion Research Corporation (ORC), a
national research firm, to include questions on three of its national
telephone surveys. The survey contained a set of 14 questions that asked
people about their television and Internet use (e. g., how they access the
Internet from their home) as well as questions designed to gauge the
importance of receiving Internet service and video service from the same
provider. The questions and response options were read to the respondents.
A total of 3,000 adults in the continental United States were interviewed
between May 23 and June 2,

2002. The population was taken from the contractor*s random- digit-
dialing sample of households with telephones, stratified by region. In
order to use the survey results to make estimates about the entire
population 18 years and older in the continental United States, ORC
weighted the responses to represent the characteristics of all adults in
the general public according to four variables: age, gender, geographic
region, and race. Because our results are from a sample of the population,
the

resulting estimates have some sampling errors associated with them.
Sampling errors are often presented at a certain confidence interval. The
percentage estimates we present in this report have a 95 percent
confidence interval of plus or minus 5 percentage points or less. The
practical difficulties of conducting any survey may introduce nonsampling
errors. As in any survey, differences in the wording of questions, the
sources of information available to respondents, or the types of people
who do not respond can affect results. We took steps to minimize
nonsampling errors. For example, we developed our survey questions with
the aid of a

survey specialist and pretested the survey questions before submitting
them to ORC.

Econometric Model We developed an econometric model to examine the
influence of direct broadcast satellite (DBS) companies* provision of
local broadcast channels, among other factors, on cable prices and the DBS
penetration rates in a large sample of cable franchise areas across the
country in 2001. In 2000, we developed a similar econometric model to
examine the impact

of DBS penetration rates on cable prices. 19 In this report, we extended
the previous econometric model by adding new variables to account for the
recent emergence of local broadcast channels via satellite. In particular,

this model sought to determine whether and how two categories of key
factors affected cable prices and DBS penetration rates: (1) factors that
relate to subscribers* demand for cable and DBS services and the
companies* costs of providing service and (2) factors that relate to the

degree of competition in the market. The availability of local channels
via satellite is one variable included in the model that can influence
both subscribers* demand for DBS service and the competitiveness of the
market. We discussed the development of our model with the Federal
Communications Commission (FCC), the Department of Justice (Justice), and
several industry trade groups. There are some important limitations to the
interpretation of our model results. Generally, econometric models measure
statistical relationships between explanatory factors and the factor to be
explained and do not

imply causation between these factors. Also, some specific limitations of
our model relate to the characteristics of the sample of cable franchise
areas chosen by FCC. We performed our statistical analysis on a sample of
722 cable franchise areas included in a yearly survey conducted by FCC.
The survey included a sample of *competitive* franchise areas (as defined
under statute) and a sample of *noncompetitive* franchise areas, selected
within several size classifications (or *strata*). Although FCC conducts
the

survey annually, different cable franchises report every year because
cable franchises are sampled. 20 Since data were not available for every
cable franchise for several continuous years, we conducted a cross-
sectional

analysis, which gave us an observation from 722 different cable franchises
at a single point in time. The cross- sectional analysis would not allow
us to examine dynamic changes that occur through time, such as the
influence of an increasing DBS penetration rate on cable prices. Rather,
we were limited to describing the nature of the subscription video market
in a single time period, namely 2001. However, certain limited analyses
were conducted that incorporated a time- series element.

19 See U. S. General Accounting Office, Telecommunications: The Effect of
Competition From Satellite Providers on Cable Rates, GAO/ RCED- 00- 164
(Washington, D. C.: July 18, 2000). 20 Some cable franchises are selected
with a probability of one, therefore continuous yearly data are generally
available for these franchises. However, in the 2001 survey, only 297
cable franchises were selected with a probability of one.

Appendix III contains (1) a complete discussion of the model development,
data sources, estimation design, and model results and (2) a table of
descriptive statistics for all variables included in the model.

Results of Consumer Survey on Video Service

Appendi x II

Choices The following results are based on the responses to a random
telephone survey of 3, 000 adults, age 18 and older, in the continental
United States. After each question, the number of respondents (n) is
noted. Percentages may not add to 100 percent because of rounding.
Question 1: What method is currently used for viewing on the main
television in your home? (n= 3, 000)

Answer Percentage of respondents

Over the air, through an antenna 16. 0 Cable 62. 0 Direct broadcast
satellite, such as DirecTV or EchoStar*s

12. 4 DISH Network, for all your channels Direct broadcast satellite for
all channels except local

4.2 broadcast channels Big dish, C- band satellite 1. 4

You don*t own a television 1.9 Other (Specify) 0. 8 Don*t know 1.3

[If respondent answered *you don*t own a television,* *other,* or *don*t

know,* the survey was ended for that respondent.] Question 2: [Only asked
of those who answered *over the air,* *direct broadcast satellite,* or *C-
band satellite* in question 1.] Have you considered purchasing cable
service for your main television viewing within the past 2 years? (n=
1,018)

Answer Percentage of respondents

Ye s 22. 7 No 66. 5 Cable is not available to me 10. 4 Don*t know 0.5

Question 3: [Only asked of those who answered *cable* in question 1.] Did
you begin subscribing to your current cable provider within the past 2
years? (n= 1,854)

Answer Percentage of respondents

Ye s 29. 9 No 69. 2 Don*t know 0.9

Question 4: [Only asked of those who answered *yes* to question 3.] What
method did you previously use for your main television viewing? (n= 555)

Answer Percentage of respondents

Over the air, through an antenna 32. 3 Another cable provider 49. 8 A
satellite provider 12. 4 Other (Specify) 2. 7 Don*t know 2.8

Question 5: [Only asked of those who answered *yes* to question 2 or
question 3.] I am now going to read you a list of reasons that someone may
think of when purchasing cable service. For each of these, please tell me
if it was a major reason, a minor reason, or not a reason in why you

[considered/ purchased] cable. Again, please rate each of these as a major
reason, a minor reason, or not a reason. 21 Question 5a: Because your area
cable company offered special rates or

other promotions, such as free installation or 3 months free. (n= 785)

Answer Percentage of respondents

Major reason 32. 5 Minor reason 27. 8 Not a reason 39. 0 Don*t Know 0.7

21 Questions 5a through 5j were read in a random order. Question 5k was
always read as the last question of the set.

Question 5b: Because you wanted more channels than you were receiving. (n=
785)

Answer Percentage of respondents

Major reason 57. 2 Minor reason 19. 8 Not a reason 22. 7 Don*t know 0.3

Question 5c: Because you wanted to purchase special features (like sports
packages, pay- per- view, or movie options). (n= 785)

Answer Percentage of respondents

Major reason 27. 6 Minor reason 24. 9 Not a reason 47. 3 Don*t know 0.3

Question 5d: Because you heard or saw that the picture and audio quality
with cable was better than you were receiving. (n= 785)

Answer Percentage of respondents

Major reason 39. 3 Minor reason 22. 4 Not a reason 37. 4 Don*t know 0.9

Question 5e: Because you were interested in receiving high definition
television channels. (n= 785)

Answer Percentage of respondents

Major reason 25. 4 Minor reason 24. 2 Not a reason 49. 9 Don*t know 0.6

Question 5f: Because you thought that cable was cheaper than satellite
service. (n= 785)

Answer Percentage of respondents

Major reason 31. 3 Minor reason 22. 0 Not a reason 44. 7 Don*t know 2.0

Question 5g: Because you thought cable offered better customer service
quality than you were receiving. (n= 785)

Answer Percentage of respondents

Major reason 30. 4 Minor reason 22. 8 Not a reason 45. 8 Don*t know 1.0

Question 5h: Because you were interested in purchasing your Internet
service through a cable provider and wanted to purchase television service
from the same company. (n= 785)

Answer Percentage of respondents

Major reason 18. 6 Minor reason 19. 4 Not a reason 61. 4 Don*t know 0.6

Question 5i: Because you wanted to get both your local broadcast channels
and cable channels from the same company. (n= 785)

Answer Percentage of respondents

Major reason 46. 9 Minor reason 20. 5 Not a reason 31. 9 Don*t know 0.9

Question 5j: Because family and friends recommended cable. (n= 785)

Answer Percentage of respondents

Major reason 11. 6 Minor reason 25. 0 Not a reason 62. 9 Don*t know 0.5

Question 5k: Because cable was the only television option available to you
other than over- the- air broadcasting. (n= 785)

Answer Percentage of respondents

Major reason 33. 5 Minor reason 20. 2 Not a reason 46. 0 Don*t know 0.3

Question 6: [Only asked of those who answered *over the air,* *cable,* or
*C- band satellite* in question 1.] Have you considered purchasing direct
satellite service, such as DirecTV or EchoStar*s DISH Network, within the
past 2 years? (n= 2, 375)

Answer Percentage of respondents

Ye s 25. 8 No 72. 2 Satellite is not available to me 1. 3 Don*t know 0.7

Question 7: [Only asked of those who answered *direct broadcast satellite*
in question 1.] Did you begin subscribing to your current direct satellite
service within the past 2 years? (n= 497)

Answer Percentage of respondents

Ye s 48. 5 No 51. 1 Don*t know 0.4

Question 8: [Only asked of those who answered *yes* to question 7.] What
method did you previously use for your main television viewing? (n= 241)

Answer Percentage of respondents

Over the air, through an antenna 24. 2 A cable provider 57. 6 Another
direct satellite provider 10. 7 A big dish, C- band satellite 4. 3 Other
(Specify) 1. 3 Don*t know 1.8

Question 9: [Only asked of those who answered *yes* to question 6 or
question 7.] I am now going to read you a list of reasons that someone may
think of when purchasing satellite service. For each of these, please tell
me if it was a major reason, a minor reason, or not a reason in why you
[considered/ purchased] satellite service. Again, please rate each of
these as a major reason, a minor reason, or not a reason. 22

22 Questions 9a through 9j were read in a random order. Question 9k was
always read as the last question of the set.

Question 9a: Because the satellite company offered special rates or other
promotions, such as free installation or 3 months free. (n= 854)

Answer Percentage of respondents

Major reason 45. 4 Minor reason 27. 7 Not a reason 26. 3 Don*t know 0.6

Question 9b: Because you wanted more channels than you were receiving. (n=
854)

Answer Percentage of respondents

Major reason 61. 4 Minor reason 19. 7 Not a reason 18. 4 Don*t know 0.5

Question 9c: Because the satellite company added local broadcast channels,
such as ABC or FOX, in your area. (n= 854)

Answer Percentage of respondents

Major reason 37. 5 Minor reason 23. 2 Not a reason 37. 8 Don*t know 1.4

Question 9d: Because you wanted to purchase special features (like sports
packages, pay- per- view, or movie options). (n= 854)

Answer Percentage of respondents

Major reason 38. 8 Minor reason 25. 4 Not a reason 35. 2 Don*t know 0.6

Question 9e: Because you heard or saw that the picture and audio quality
with satellite were better than you were receiving. (n= 854)

Answer Percentage of respondents

Major reason 40. 4 Minor reason 25. 6 Not a reason 33. 1 Don*t know 1.0

Question 9f: Because you were interested in receiving high definition
television channels. (n= 854)

Answer Percentage of respondents

Major reason 32. 0 Minor reason 23. 9 Not a reason 43. 0 Don*t know 1.2

Question 9g: Because you thought that satellite was cheaper than cable.
(n= 854)

Answer Percentage of respondents

Major reason 46. 0 Minor reason 21. 9 Not a reason 31. 1 Don*t know 1.0

Question 9h: Because you thought that satellite offered better customer
service quality than you were receiving. (n= 854)

Answer Percentage of respondents

Major reason 33. 9 Minor reason 25. 2 Not a reason 39. 4 Don*t know 1.5

Question 9i: Because you were interested in purchasing your Internet
service through a satellite company and wanted to purchase your television
service from the same company. (n= 854)

Answer Percentage of respondents

Major reason 11. 8 Minor reason 23. 0 Not a reason 64. 4 Don*t know 0.8

Question 9j: Because family and friends recommended satellite. (n= 854)

Answer Percentage of respondents

Major reason 18. 6 Minor reason 32. 7 Not a reason 48. 4 Don*t know 0.3

Question 9k: Because satellite was the only television option available to
you other than over- the- air broadcasting. (n= 854)

Answer Percentage of respondents

Major reason 26. 6 Minor reason 16. 1 Not a reason 56. 7 Don*t know 0.7

Question 10: [Only asked of those who answered *yes* to question 6 or
question 7.] When you considered purchasing direct satellite service,
which service did you consider? (n= 854)

Answer Percentage of respondents

Both DirecTV and EchoStar*s DISH Network 17. 2 DirecTV only 62. 3
EchoStar*s DISH Network only 9.0 Don*t know 11. 6

Question 11: How do you currently access the Internet in your home? (If
you use more than one method, please tell me which one you use most.) (n=
2,872)

Answer Percentage of respondents

Standard phone line modem 46. 4 DSL service 4.8 Cable modem service 10.1
Satellite Internet service 0. 5 You have a computer, but don*t access the

8.5 Internet You don*t have a computer 26. 6

Other (Specify) 0. 5 Don*t know 2.6

Question 12: [Not asked of those who answered *cable modem service* in
question 11.] Does your area cable provider offer Internet access through
a cable modem service? (n= 2,583)

Answer Percentage of respondents

Ye s 56. 9 No 14. 3 Don*t have an area cable provider 5. 8 Don*t know 22.
9

Question 13: When thinking about purchasing TV programming, would the
availability of cable modem Internet access make you more likely to choose
cable service over satellite service? (n= 2,872)

Answer Percentage of respondents

Not more likely 51. 4 Slightly more likely 12. 9 Moderately more likely
13. 7 Much more likely 16. 0 Don*t know 6.0

Question 14: [Not asked of those who answered *satellite Internet service*
in question 11.] Have you considered purchasing Internet access service
through a satellite provider? (n= 2,857)

Answer Percentage of respondents

Ye s 9.2 No 87. 8 This is not available 1. 0 Don*t know 2.1

Appendi x I II

GAO Econometric Model This appendix describes our econometric model of
cable- satellite competition. Specifically, we discuss (1) the conceptual
development of the model, (2) the data sources used for the model, (3) the
merger of various data sources into a single data set, (4) the descriptive
statistics for variables included in the model, (5) the estimation
methodology and results, and (6) alternative specifications.

Conceptual In response to a congressional request, we developed an
econometric Development of the

model to examine the influence of satellite companies* provision of local
broadcast channels, along with other factors, on cable prices and DBS
Econometric Model

penetration rates in a large sample of cable franchise areas in 2001. This
request represented a follow- up to a previous report that we issued which
analyzed the impact of DBS penetration rates on cable prices. 23 Relying
on our previous model, the existing empirical literature, and our
assessment of the current subscription video marketplace, we developed a
model that included a variety of explanatory variables that were included
in our

previous model, as well as other models, but that also extended those
analyses by adding new variables to account for the recent provision of
local broadcast channels by DBS companies as an important factor in

competition between cable and DBS companies. Examination of Competitive To
examine the influence of the DBS companies* provision of local Effects in
the Subscription channels on cable prices and DBS penetration rates, we
employed a model Video Market

that is based on the subscription video market, rather than on the
narrower market for cable television. 24 In 2001, the national market
share of cable systems (as measured by subscribership) in what we call the
subscription

video market was about 78 percent, and the share of the DBS providers was
about 18 percent. The remaining 4 percent of subscription television
households obtained service through other means such as terrestrial
wireless systems, satellite master antenna television systems (usually
used

in apartment buildings or other multiple- dwelling units), open video
systems, and large *C- band* home satellite dishes.

23 GAO/ RCED- 00- 164. 24 This is consistent with FCC*s approach to
analyzing the market. See Federal Communications Commission, Annual
Assessment of the Status of Competition in Markets for the Delivery of
Video Programming, CS Docket No. 01- 129, Eighth Annual Report, FCC 01-
389 (Washington, D. C.: Jan. 14, 2002).

Cable providers and satellite providers can be regarded as
*differentiated,* not so much because they use different technologies but
because the services they provide are perceived as different by
subscribers and because these varied providers face different laws and
regulations that influence their cost structures as well as the type of
product they provide. For example, in 2001, satellite subscribers in only
42 television markets could receive local broadcast signals from either
DBS provider. Also, cable companies must pay local franchise fees and are
required to provide

capacity for public, educational, and government channels. In sum, cable
and satellite providers are differentiated in consumers* perception, in
their legal context, and in their product offerings.

In our model, cable prices and DBS penetration rates will depend broadly
on the demand and cost conditions affecting both the cable and noncable
providers of subscription video services. With the passage of the
Satellite

Home Viewer Improvement Act, DBS providers were granted authority to
distribute local broadcast television channels in the broadcast stations*
local markets, perhaps allowing DBS providers to compete more fully with
cable companies. To measure the influence of local channels, we used a
variable that indicates whether local channels were available from both
DBS providers in each franchise area. 25 Specification of

Estimating the influence of DBS companies* provision of local channels on
Econometric Model of cable prices and DBS penetration rates is complicated
by the possibility Cable- Satellite Competition that the DBS penetration
rate in an area is itself determined, in part, by the cable price in that
area and that the cable price is determined, in part, by the DBS
penetration rate. One statistical method applicable in this situation is
to estimate a system of structural equations in which certain variables
that may be simultaneously determined are estimated jointly. In our
previous report, we estimated a four- equation structural model in which

cable prices, the number of cable subscribers, the number of cable 25 We
also considered a variable that indicates whether either DBS provider
offered local broadcast channels. There were seven markets where only one
DBS company offered local channels. We discuss the results of this
specification in the last section of this appendix.

channels, and the DBS penetration rate were jointly determined. 26 We
modify this four- equation structural model to incorporate the influence
of local channels via satellite on cable prices and DBS penetration rates.
One implication of this estimation technique is that the estimated effects
we report for the influence of DBS companies* provision of local channels
on cable prices and DBS penetration rates must be interpreted as direct
effects on price and penetration. At the same time, there are indirect
effects of local channels on cable prices and DBS penetration rates
wherein these effects on cable prices and DBS penetration rates work
through their effects on other endogenous variables. For instance, a DBS
company*s provision of local channels may influence a cable operator*s
decision about the number of channels to include in programming packages,
which can, in turn, affect its cable price and the DBS penetration rate.
We later present a table with results from reduced- form cable price and
DBS penetration rate equations to show how the exogenous variables in the
system of equations affect, both directly and indirectly, cable prices and
DBS penetration rates.

We estimated the following four- equation structural model of the
subscription television market:

 Cable prices are hypothesized to be related to (1) the number of cable
channels, (2) the number of cable subscribers, (3) the DBS penetration
rate, (4) the DBS companies* provision of local channels in the franchise
area, (5) the size of the television market as measured by the number of
television households, (6) horizontal concentration, (7) vertical
relationships, (8) the presence of a nonsatellite competitor, (9)

regulation, (10) average wages, and (11) population density. The cable
price variable used in the model is defined as the total monthly rate
charged by a cable franchise to the *typical subscriber,* including the
fees paid for the most commonly purchased programming tier and rented
equipment (a converter box and remote control). 27 The

26 In previous studies that defined the market more narrowly to be cable
television, equations for cable rates, the number of cable subscribers,
and the number of cable channels were estimated jointly. For example, see
Ford, G. S. and J. D. Jackson, *Horizontal Concentration and Vertical
Integration in Cable Television Industry,* Review of Industrial
Organization,

12( 4) (1997), pp. 501- 518; and Rubinovitz, R. N., *Market Power and
Price Increases for Basic Service Since Deregulation,* RAND Journal of
Economics, 24( 1) (1993), pp. 1- 18. 27 The cable price does not reflect
special introductory monthly rates, such as those offered

to current DBS subscribers when they switch to cable service.

explanatory variables in the cable price relationship are essentially cost
and market structure variables.

 Number of cable subscribers is hypothesized to be related to (1) cable
prices (per channel), (2) the DBS penetration rate, (3) the DBS companies*
provision of local channels in the franchise area, (4) the size of the
television market as measured by the number of television households, (5)
the number of broadcast channels, (6) urbanization, (7) the age of the
cable franchise, (8) the number of homes passed by the cable system, (9)
the median income of the local area, and (10) the presence of a
nonsatellite competitor. The number of cable subscribers

is defined as the number of households in a franchise area that subscribe
to the most commonly purchased programming tier. This represents the
demand equation for cable services, which depends on rates and other
demand- related factors.

 Number of cable channels is hypothesized to be related to (1) the number
of cable subscribers, (2) the DBS penetration rate, (3) the DBS companies*
provision of local channels in the franchise area, (4) the size of the
television market as measured by the number of television households, (5)
the median income of the local area, (6) cable system capacity in terms of
megahertz, (7) the percentage of multiple- dwelling units, (8) vertical
relationships, and (9) the presence of a nonsatellite competitor. The
number of cable channels is defined as the number of channels included in
the most commonly purchased programming tier.

The number of cable channels can be thought of as a measure of cable
programming quality and is explained by a number of factors that influence
the willingness and ability of cable operators to provide highquality

service and consumers* preference for quality.  DBS penetration rate in a
television market is hypothesized to be related to (1) cable prices (2)
the DBS companies* provision of local channels in the franchise area, (3)
the size of the television market as measured by the number of television
households, (4) the age of the cable franchise,

(5) the median income of the local area, (6) cable system capacity in
terms of megahertz, (7) a dummy variable for areas outside metropolitan
areas, (8) the percentage of multiple- dwelling units, (9) the angle* or
elevation* at which a satellite dish must be fixed to receive a satellite
signal in that area, and (10) the presence of a nonsatellite competitor.
The DBS penetration rate variable is defined as the number of DBS
subscribers in a franchise area expressed as a proportion of the

total number of housing units in the area. As hypothesized, the DBS

penetration rate is expected to depend on the prices set by the cable
provider as well as on the demand, cost, and regulatory conditions in the
subscription video market that directly affect DBS. Many of the
explanatory variables appeared in our 2000 report as well as in previous
studies of cable prices prepared by others. 28 The explanatory variables
included in these studies fall into two general categories: (1) demand and
cost factors and (2) market structure and regulatory conditions. Table 1
presents the expected effects of all the explanatory

variables in the structural model on cable prices and DBS penetration
rates.

28 For example, see Goolsbee, A. and A. Petrin, The Consumer Gains from
Direct Broadcast Satellite and the Competition with Cable TV (Feb. 26,
2002); Crandall, R. W. and H. Furchtgott- Roth, Cable TV: Regulation or
Competition? (Washington, D. C.: Brookings Institution, 1996); Emmons III,
W. M. and R. A. Prager, *The Effects of Market Structure and

Ownership on Prices and Service Offerings in the U. S. Cable Television
Industry,* RAND Journal of Economics, 28( 4) (Winter 1997), pp. 732- 750;
Ford and Jackson (1997); Mayo, J. W. and Y. Otsuka, *Demand, Pricing, and
Regulation: Evidence from the Cable TV Industry,* RAND Journal of
Economics, 22( 3) (1991), pp. 396- 410; and Rubinovitz (1993).

Table 1: Expected Effects of All Explanatory Variables on Cable Prices and
DBS Penetration Rates Included in Explanatory previous GAO Expected effect
on cable Expected effect on DBS variable Definition of variable

report prices penetration rates

Cable price The monthly rate charged Yes Not applicable. We expect that
higher cable for the Basic Service Tier,

prices should encourage more Cable Programming Service customers to choose
DBS Tier (the most commonly service instead of cable service, purchased
tier), and rental thereby increasing the DBS of a converter box and
penetration rate. remote control.

Number of cable The number of subscribers

Yes Costs per subscriber of If cable and DBS service are

subscribers to the Basic Service Tier providing cable services can
substitute services, we expect a and Cable Programming increase or
decrease with the

lower DBS penetration rate Service Tier. number of subscribers, where
there are more cable depending on scale subscribers.

economies. Number of cable

The number of channels Yes Consumers should be willing

In areas where cable companies channels provided with the Basic to pay
more for a greater

offer more channels (a measure Service Tier and Cable

number of channels. Also, of quality), we expect lower DBS Programming
Service Tier.

costs should be greater for penetration rates. the cable operator to
provide more channels.

DBS penetration rate The fraction of housing units Yes We expect the
presence of Not applicable. in a cable franchise area DBS to restrain
cable prices that have satellite service.

if cable and satellite were close substitutes in 2001. DBS provision of
local A binary variable that No If local channels make DBS

If local channels make DBS channels equals 1 if both DBS

service a closer substitute for service a more attractive providers offer
local cable service, we expect the alternative for subscribers, we
channels in the cable

presence of local channels to expect the presence of local

franchise area. be associated with lower channels to be associated with
cable prices.

higher DBS penetration rates. Homes passed by The number of homes Yes As
the number of homes DBS providers will be more or cable system passed by
the cable sysem passed increases, the costs less competitive with cable

that serves the franchise of operation could increase franchises,
depending on the area, including homes or decline depending on the cable
companies* costs of outside of the franchise scale economies.

operation. area.

Age of cable 2001 minus the year that

Yes Subscribers could have a Because consumers are more franchise the
cable franchise began

higher demand in franchise likely to be aware of the operation.

areas with older cable availability and quality of cable, franchises
because they are

we expect lower DBS penetration more likely to be aware of the rates in
areas where the cable availability and quality of the

franchise is older. cable system. Therefore, cable prices could be higher.

(Continued From Previous Page)

Included in Explanatory previous GAO Expected effect on cable Expected
effect on DBS variable Definition of variable

report prices penetration rates

Cable system The capacity, measured in Yes Higher- megahertz systems We
expect more capacity to be megahertz megahertz, of the cable may enable
the provider to associated with a lower DBS system that serves the offer
more channels and to penetration rate if cable providers franchise area.
bundle services, such as are able to offer more channels video, voice, and
broadband

and bundled services, such as Internet access, together. telephony and
broadband This could increase demand Internet services. for cable, leading
to higher prices. Alternatively, cable

prices may be discounted to attract consumers to the other (new) services.
Horizontal A binary variable that Yes If large MSOs have some If MSO
ownership imposes a concentration equals 1 if the franchise

cost advantages, rates could competitive disadvantage on area is served by
1 of the 10 be lower; if MSO ownership DBS providers, DBS penetration
largest national multiple imposes a competitive

rates could be lower. system operators (MSO). disadvantage to potential

entrants, cable prices could be higher.

Vertical relationships A binary variable that Yes A vertical relationship
could If a vertical relationship imposes equals 1 if the cable lower cable
system costs if a competitive disadvantage on operator is affiliated with
an programming costs are

DBS providers, DBS penetration MSO that has an ownership reduced or
efficiencies are rates could be lower. interest in a national or gained,
but vertical regional video programming relationships could signify
service.

market power that would tend to lead to higher cable prices.

Presence of A binary variable that Yes Cable prices should be lower The
presence of a nonsatellite

nonsatellite equals 1 if a second wireline where a nonsatellite

competitor increases the number competitor company provides cable
competitor provides service. of firms providing multichannel service
(including, for

video service, possibly implying a example, a local exchange

lower DBS penetration rate. telephone carrier offering video services) in
the franchise area.

Regulation A binary variable that Yes Regulation may be DBS penetration
rates could be equals 1 if the cable associated with lower cable

higher or lower, depending on franchise is subject to prices when compared
with how regulation influences the regulation of the rate

prices that would prevail competitiveness of the cable charged for the
Basic

under profit- maximizing company.

Service Tier. pricing by monopoly cable

systems. However, cable prices could be higher under regulation if the
unregulated cable systems were more competitive.

(Continued From Previous Page)

Included in Explanatory previous GAO Expected effect on cable Expected
effect on DBS variable Definition of variable

report prices penetration rates

Television market size The number of television No In larger markets, more
In larger markets, more households in the market. alternative forms of
alternative forms of entertainment compete with

entertainment compete with DBS, cable, which should lead to which should
lead to lower DBS lower cable prices. penetration rates. Number of local
The number of over- the- air Yes Consumers would pay more Over- the- air
television could be broadcast channels broadcast stations in the

for a greater number of more competitive with DBS in

television market. broadcast channels on the areas where there are many
cable system. Alternatively, stations. over- the- air television could be
more competitive with cable in areas where there

are many stations. Average weekly wage The average weekly wage

Yes Areas with higher average Cable franchises in areas with for
telecommunications

wages should have higher relatively high average wages

equipment installers and costs of operation, which would be less
competitive with repairers in the state where would make cable prices
national DBS providers. the cable franchise is higher.

located. Median household

The median household Yes As consumers* incomes rise, As consumers* incomes
rise, income income in the franchise demand for cable services demand for
DBS service should area.

should increase, which would increase, implying a greater DBS increase
cable prices. penetration rate.

Nonmetropolitan area A binary variable that Yes We expect the competitive
We expect nonmetropolitan

equals 1 if the franchise impact of DBS on cable

status to be associated with area is outside of a prices to be stronger in
higher DBS penetration rates if metropolitan statistical area franchise
areas that lie DBS is a closer substitute for

(MSA). outside of MSAs.

cable in nonmetropolitan areas. Population density The ratio of population
to No Because more customers

Cable franchises in more densely square miles in the can be served per
mile of

populated areas would be more franchise area.

cable, areas with higher competitive with DBS providers population density
should

because of possible lower costs have lower costs of operation and line-
of- sight problems for and therefore lower cable

DBS subscribers. prices.

Urbanization The percentage of the Yes Because consumers in more We expect
lower demand for DBS

county's population that is urban settings have many service in urban
areas because classified as urban by the alternative forms of consumers
have alternative Census Bureau. entertainment competing

forms of entertainment and are with cable, their demand for less likely to
have the necessary cable services would be line- of- sight to the
satellite

lower, which would lead to because of obstructions. lower cable prices.

(Continued From Previous Page)

Included in Explanatory previous GAO Expected effect on cable Expected
effect on DBS variable Definition of variable

report prices penetration rates

Percentage of The percentage of housing Yes Where there are more We expect
lower DBS penetration multiple- dwelling units accounted for by multiple-
dwelling units, the rates where there are more

units structures with five or more

market has been found to be multiple- dwelling units because housing
units.

more naturally competitive consumers* line- of- sight is more because
cable systems may

likely to be blocked and face greater actual or consumers may face more
potential competition, which restrictions on where they can would lead to
lower cable

mount the dish at their residence. prices.

Dish angle or The angle relative to the No If satellite dishes must be In
markets in which a satellite elevation ground that a DBS

mounted in a more vertical dish must be set in a more subscriber must
mount the

position, we expect that DBS vertical position, we expect lower satellite
dish to *see* the providers will be less DBS penetration because of the
satellite. A more vertical

competitive with cable greater likelihood that obstacles mounting is
defined to be a companies.

would block the line- of- sight to lower *angle.*

the satellite. Source: GAO (2002).

Data Sources Used for We required several data elements to build the data
set used to estimate

the Econometric Model this model. The following is a list of our primary
data sources:

 We obtained data on cable prices and service characteristics from a 2001
survey of cable franchises that FCC conducted as part of its mandate to
report annually on cable prices. FCC*s survey asked a sample of cable

franchises to provide information about a variety of items pertaining to
cable prices, service offerings, subscribership, franchise area reach,
franchise ownership, and system capacity. We used the survey to define
measures of each franchise area*s cable prices, number of subscribers, and
number of cable channels as described above. In addition, we used the
survey to define variables measuring (1) system megahertz (the

capacity of the cable system in megahertz), (2) homes passed by the cable
system serving the franchise area and perhaps other franchises in the same
area, (3) competitive status* a dummy variable equal to 1 if the franchise
faced *nonsatellite* competition from an unaffiliated

subscription video company (or *overbuilder*) or from a local telephone
company, (4) regulation* a dummy variable equal to 1 if the franchise is
subject to rate regulation of its Basic Service Tier, and (5) horizontal

concentration* a dummy variable equal to 1 if the franchise is affiliated
with 1 of the 10 largest MSOs.  From SkyREPORT, we obtained an estimate
of DBS subscriber counts

as of year- end 2001 for each zip code in the United States. We used this
information to calculate the number of DBS subscribers in a cable
franchise area, which, when used in conjunction with the number of housing
units, was used to define the DBS penetration rate.

 We used the most recent data from the U. S. Census Bureau to obtain the
following demographic information for each franchise area: median
household income, proportions of urban and rural populations, housing
units accounted for by structures with more than five units
(multipledwelling

units), population density, and nonmetropolitan statistical areas.

 For average wage, we used year 2000 state estimates for
Telecommunications Equipment Installers and Repairers from the Bureau of
Labor Statistics* (BLS) Occupation and Employment Statistics Survey.

 We used data from BIA MEDIA AccessPro to determine the number of
broadcast television stations in each television market.

 To define the dummy variable indicator of vertical integration, we used
information on the corporate affiliations of the franchise operators
provided in FCC*s survey. We used this information in conjunction with
industrywide information on vertical relationships between cable operators
and suppliers of program content gathered by FCC in its 2001 annual video
report.

 We used information from the National Association of Broadcasters to
identify in which television markets local channels were available from
both DBS companies.

 From Nielsen Media Research, we acquired information to determine the
number of television households in each designated market area (DMA) and
to determine in which DMA each cable franchise was located.

 On the basis of a zip code associated with each cable franchise, we were
able to determine the necessary satellite dish elevation for each cable

franchise area from information available on the Web pages of DirecTV and
EchoStar.

Merging Various Data The level of observation in our model is a cable
franchise. 29 Many of the

Sources into a Single variables we used to estimate our model, such as
each cable franchise*s price, came directly from FCC*s survey of
franchises. However, we also

Data Set created variables for each franchise from information derived
from other sources. For example, median income and the extent of multiple-
dwelling

units were obtained from Census data, and the number of DBS subscribers
was provided by SkyREPORT.

The assignment of these variables to each franchise required identifying
the geographic extent of each franchise area because Census and DBS data
are reported within geographic definitions that differ from cable
franchise

areas. Census data can be obtained at several geographic levels, including
communities or counties. Additionally, some information* most notably DBS
subscriber counts* is at a zip code level. FCC*s survey and other FCC data
on cable franchises contain information on the franchise community name,
type (such as city or town), and county, which can be used to link
franchises to Census areas. One complicating factor in using community
names to assign non- survey- derived information to each franchise is that
some cable franchises are in areas, such as unnamed, unincorporated areas,
that do not correspond to geographic areas for which Census or other data
are readily available. Another complicating factor is that FCC*s 2001
survey did not contain information on the zip codes served by particular
franchise areas.

We first attempted to determine the geographic area associated with each
cable franchise. Our general approach was to combine each franchise*s
community name field with an indicator of community type, such as city or
town, and then match these names to census place or, alternatively, county

29 We define a cable franchise in terms of its Community Unit
Identification (CUID) number.

subdivision 30 (minor civil division) files. Since many of the franchises
in our sample correspond to recognizable local entities* such as cities,
towns, and townships* we were able to make the link directly to Census
data sources and assign demographic and other census data gathered at the

level of the associated community. Of the 722 franchises used in the
model, 442 were linked to census place files, and 126 were linked to
census county subdivision files. For other franchises, however, the link
to Census records was not as direct. For franchises in unincorporated,
unnamed areas and those whose franchise areas represent a section of the
associated community (which occurs in some large cities), 31 we acquired
additional information on the geographic boundaries of the franchise
areas. 32 For purposes of assigning demographic and other census data to
each of these

franchises, we identified a key zip code that we used to link to census
data organized at the zip code level. Of the 722 franchises used in the
model, 28 were in large cities with multiple franchises, 94 were in
unincorporated areas of counties for which we obtained more specific
boundary information, and 32 were in unincorporated areas for which we did
not obtain more specific boundary information.

The satellite subscriber information we obtained was organized by zip
code. In order to match these counts to franchises, we determined the zip
code or zip codes associated with each franchise. Because zip codes often
do not share boundaries with other geographies, one zip code can be 30
Places consist of what are known as census- designated places and places
that are incorporated according to the laws of their respective states.
Generally, incorporated places can be thought of as cities, boroughs,
towns, townships, and villages. However, towns and townships in some
states are not considered places in terms of census reporting, even though
they might both serve some local government purpose and have large
populations. Census data for many franchise areas designated as towns in
FCC*s master file of franchises are found in the county subdivisions file
rather than the places file.

31 Many large cities, such as New York City, Los Angeles, and Chicago,
have multiple cable franchise areas. 32 For those jurisdictions for which
there were multiple franchises, including counties with franchises in
unincorporated unnamed areas, we attempted to define more precise
geographical boundaries for each franchise. Specifically, we contacted
local government offices responsible for cable franchise oversight and
received maps or other descriptive

information linking the specific franchise areas to zip codes, census
tracts, local government districts, or some other boundary information.
When local governments did not directly provide zip code or census tract
information, we used the information they did provide in conjunction with
zip code overlay maps to assign zip codes to the franchise areas. For some
franchises in unincorporated unnamed areas, we were unable to approximate
the

franchise area with any more geographic specificity than the
unincorporated portion of the county.

associated with more than one cable franchise area. Also, many franchises,
particularly larger ones, span many zip codes. Therefore, we needed to
identify the zip code or codes in each franchise area as well as the
degree to which each of those zip codes is contained in each franchise
area to

calculate the degree of satellite penetration for each franchise. We
accomplished this by using software designed to relate various levels of
census geography to one another. 33 For most franchise areas* that is,
those that correspond to census places, county subdivisions, or entire
counties as well as some of those franchises in multiple- franchise
jurisdictions* we

were able to use this software to relate census places, county
subdivisions, and in some cases, census tracts or whole counties, directly
to the zip codes that corresponded to those areas (places, etc.) and to
calculate the share of each zip code*s population according to the 2000
Census that was contained in that area. We used these population shares to
allocate shares of each zip code*s total DBS subscribers to the relevant
franchise area. 34 For some franchise areas in unincorporated areas, we
used the zip code or codes we identified as part of our investigation of
the geographic extent of these franchises, and we used the software to
estimate the proportion of the population in those zip codes living in
unincorporated areas and to allocate DBS subscribers on the basis of these
population proportions. 35 33 Specifically, we used the MABLE/ Geocorr
correspondence engine (http:// mcdc2. missouri. edu/ websas/ geocorr2k.
html). MABLE is an acronym for Master Area Block Level Equivalency file.
34 As an illustration, assume that we had a cable franchise area in the
town of Anytown,

which the MABLE software identifies is served by zip codes 12345 and
12346. Assume further that zip code 12345 had a population of 10, 000
people in 2000, of which 8, 000 were in Anytown proper and 2,000 were in
the surrounding unincorporated area, and zip code 12346 had a population
of 12, 000 people of which 6,000 were in Anytown. In this case, 80 percent
of the 12345 zip code and 50 percent of the 12346 populations are
associated with Anytown, so that our approach would assign 80 percent of
the satellite subscribers in zip code 12345 and 50 percent of those in
12346 to the cable franchise in the town of Anytown. Because we defined
the DBS penetration rate as the number of subscribers divided by the
number of housing units, our approach would divide this estimate of the
number of DBS subscribers in

Anytown by the number of housing units reported in the 2000 Census for the
town of Anytown.

35 As another illustration, suppose there is a cable franchise in an
unincorporated area that we identified as being near the town of Anytown.
In this case, we would treat the franchise area as being the
unincorporated portion of zip code 12345. In the case where there is only
one zip code involved, we would approximate the DBS penetration rate for
this franchise as the number of DBS subscribers in the zip code divided by
the number of housing units in the zip code as reported in the 2000
Census. In other cases where more than one zip code is involved, we would
approximate the DBS penetration rate on the basis of the shares in all of
the identified zip codes.

For some other franchise areas in unincorporated areas, we approximated
DBS penetration using population proportions in the unincorporated
portions of all zip codes in the relevant counties.

We assigned other information to each franchise on the basis of the
franchise*s county, state, or the key zip code that we identified. Wage
data from BLS were assigned at the state level; nonmetropolitan status,
percentage of urban population, and the Nielsen television market of each
franchise were assigned at the county level. 36 As part of the process
used to match zip codes to franchises, we defined a key zip code for each
franchise

as that zip code with the largest franchise area population. We used this
zip code to assign dish elevation for each franchise.

Descriptive Statistics Table 2 provides basic statistical information on
all of the variables

for Variables Included included in the cable* satellite competition model.
We calculated these

statistics using all 722 observations in our data set. in the Econometric
Model

Table 2: Descriptive Statistics Variable Mean Standard deviation Minimum
value Maximum value

Cable price (dollars per month) 35. 89 5. 31 14. 00 47. 84 Number of cable
subscribers 21,008.5 43,256. 2 4. 0 302,964. 0 Number of cable channels
58.0 14. 1 10. 0 99. 0 DBS penetration rate (percentage) 15.8 11. 2 1. 6
63. 6 DBS provision of local channels 0. 51 0. 50 0. 00 1. 00 Homes passed
by cable system 177,114.4 233,678. 7 30. 0 1,260,734. 0 Age of cable
franchise (years) 23.9 9. 6 2. 0 50. 0 Cable system megahertz 637.6 172. 3
216. 0 870. 0 Horizontal concentration 0. 83 0. 37 0. 00 1. 00 Vertical
relationships 0. 54 0. 50 0. 00 1. 00

36 In the Nielsen data, some counties are split between different
television markets. In cases where a franchise*s county was not uniquely
placed in one television market, we used additional information on zip
codes to assign the franchise to a television market.

(Continued From Previous Page)

Variable Mean Standard deviation Minimum value Maximum value

Presence of nonsatellite competitor 0.14 0.35 0.00 1.00 Regulation 0. 35
0. 48 0. 00 1. 00 Television market size (households in thousands) 1,
432.1 1, 655. 3 50. 0 7,301. 0

Number of local broadcast channels 11.9 5. 7 1. 0 25. 0 Average weekly
wages (dollars) 788. 38 101.80 575.38 1,045.58 Median household income
(dollars in thousands) 43.7 16. 1 13. 5 140. 0

Nonmetropolitan area 0.26 0.44 0.00 1.00 Population density 2, 843.9 7,
066. 2 2. 3 87,139. 8 Urbanization (percentage) 72.8 28. 4 0. 0 100. 0
Percentage of multiple- dwelling units 14.28 13.57 0.00 98. 12 Dish angle
or elevation (degrees) 40.3 6. 6 27. 2 57. 3

Source: GAO (2002).

Estimation We employed the Three- Stage Least Squares (3SLS) method to
estimate our model. 37 Table 3 includes the estimation results for each of
the four

Methodology and structural equations. All of the variables, except dummy
variables, 38 are Results

expressed in natural logarithmic form. 39 This means that coefficients can
be interpreted as *elasticities** the percentage change in the value of
the dependent variable associated with a 1 percent change in the value of
an independent, or explanatory, variable. The coefficients on the dummy
variables are elasticities in decimal form. Most of our results are
consistent 37 We preferred the 3SLS to Two- Stage Least Squares (2SLS)
because the 3SLS accounts for the contemporaneous relationships among
cable rates, cable subscribers, cable channels, and DBS penetration by
using all available information. Also, we assumed that price per channel
in the subscriber equation is exogenous because cable providers
simultaneously decide how many channels to provide and what to charge for
a package of channels, rather than deciding how much to charge for each
channel.

38 A dummy variable takes a value of 1 if a certain characteristic is
present and a value of 0 otherwise. 39 The dummy variables in the model
include the following: horizontal concentration of cable systems, vertical
relationship, regulation, presence of nonsatellite competitor, DBS
provision of local channels, and nonmetropolitan area. Also, because the
natural log of 0 is undefined, we added 1 to the observed value of any
continuous variable that can take the value of 0.

with the economic reasoning that underlies our model as well as with the
results from several previous studies, including our 2000 report. Table 3:
3SLS Model Results

Cable Cable

Cable DBS prices

subscribers channels

penetration Variable

equation equation

equation equation

Cable price -0.2335 [0.6076]

Cable price per channel -2.1239 [0.0001] a

Number of cable subscribers 0. 0166 0. 0544 [0.0816] c [0. 0001] a

Number of cable channels 0.2030 [0. 0001] a

DBS penetration rate -0.0340 -2.0759

-0. 0245 [0. 2060] [0.0001] a [0. 4237]

DBS provision of local channels 0. 0002 0.3175

0. 0567 0.2772

[0. 9930] [0.1753] [0. 0240] b [0. 0001] a Homes passed by cable system
0.2211

[0.0001] a Age of cable franchise 0. 3870

-0.1253 [0.0052] a [0.0062] a

Cable system megahertz 0. 5073 -0.3134 [0. 0001] a [0.0014] a

Horizontal concentration 0.0661 [0. 0001] a

Vertical relationships -0.0051 -0. 0399 [0. 6753] [0. 0116] b

Presence of nonsatellite -0.1837

-1.4497 0. 0221

-0.4989 competitor [0. 0001] a [0.0001] a [0. 3852] [0.0001] a

Regulation 0. 0008 [0. 9564]

Television market size 0.0085 -0.2599

-0. 0060 -0.1025 [0. 3074] [0. 0887] c [0. 5989] [0. 0018] a

Number of local broadcast 0.6181 channels [0.0050] a

Average weekly wages 0.0033 [0. 9408]

Median household income -0.5452 0. 0788

0.1278 [0.0100] a [0. 0005] a [0.0404] b

(Continued From Previous Page)

Cable Cable

Cable DBS

prices subscribers

channels penetration

Variable equation

equation equation

equation

Nonmetropolitan area 0. 4555 [0.0001] a

Population density -0.0098 [0. 0819] c

Urbanization 0.0817 [0.2982]

Percentage of multiple- dwelling -0. 0148 -0.2286 units [0. 1555] [0.0001]
a

Dish angle or elevation 0. 5883 [0. 0001] a

Intercept 2. 6627 14.6489

-0. 3877 3.2390 [0.0001] a [0. 0001] a [0. 2350] [0.0180] b

Sample size 722 722 722 722 Notes: System- weighted R- square: 0.63.

P- values are in brackets. a Significance at the 1 percent level.

b Significance at the 5 percent level. c Significance at the 10 percent
level.

Source: GAO (2002).

We found that DBS companies* provision of local channels is associated
with significantly higher DBS penetration rates. As shown in table 3, our
model results indicate that in cable franchise areas where local channels
are available from both DBS providers, the DBS penetration rate is
approximately 32 percent higher than in areas where local channels are not

available via satellite. 40 This finding suggests that in areas where
local channels are available from both DBS providers, consumers are more
likely to subscribe to DBS service, and therefore DBS appears to be more
able to compete effectively for subscribers than in areas where local
channels are

not available from both DBS providers. Several additional factors also
influence the DBS penetration rate. Our model results indicate that the
DBS penetration rate is greater in nonmetropolitan areas and in cable

40 For dummy variables (those variables that can take a value of 0 or 1
depending on the presence of a condition (e. g., DBS providers offering
local broadcast channels)), we report the percentage change arising from a
discrete change from 0 to 1. We calculated this

percentage change as: [exp( parameter estimate)- 1] times 100.

franchise areas that are outside the largest television markets, as
measured by the number of television households in the market. These two
factors can be associated with the historical development of satellite
service, which had been marketed for many years in more rural areas.
Additionally, the DBS penetration rate is higher in areas that require a
relatively higher angle or elevation at which the satellite dish is
mounted and is lower in areas where there are more multiple- dwelling
units. These two factors can be associated with the need of DBS satellite
dishes to *see* the satellite: a dish aimed more toward the horizon (as
opposed to being aimed higher in the sky) is more likely to be blocked by
a building or foliage and people in multiple- dwelling units often have
fewer available locations to mount their dish.

We did not find that DBS companies* provision of local broadcast channels
is associated with lower cable prices. In table 3, the estimate for this
variable is not statistically significant, and we therefore cannot reject
the hypothesis that provision of local channels has no impact on cable
prices. However, we found that cable prices were approximately 17 percent
lower in areas where a second cable company* known as an overbuilder*

provides service. Additionally, cable prices were higher when the cable
company was affiliated with 1 of the 10 largest MSOs. This result
indicates that horizontal concentration could be associated with higher
cable system prices. Finally, cable prices are higher in areas where the
cable company provides more channels, indicating that consumers generally
are willing to pay for additional channels and that providing additional
channels raises a

cable company*s costs. We also found several interesting results in the
cable subscriber and cable channel equations. In the cable subscribers*
equation, we obtained an estimate of the price elasticity of demand for
cable services that was lower (in absolute value) than the estimate in our
previous report. 41 In the cable channels equation, our model results
indicate that local service is associated with improved cable quality, as
represented by an increase in the number of channels provided to
subscribers. In areas where both DBS

companies provide local channels, we found that cable companies offer
subscribers approximately 6 percent more channels. This result indicates
that cable companies are responding to DBS provision of local channels by
41 The price elasticity of demand is estimated to be *2. 12, which is
elastic; this means that a 1 percent decrease in cable rates results in a
2.12 percent increase in the quantity demanded of cable. In our previous
study, we found the price elasticity of demand to be *3.22.

improving their quality, as reflected by the greater number of channels.
Also, cable franchises offered fewer channels (approximately 4 percent
fewer) when the company was vertically integrated with a programming

network. Finally, we present reduced- form cable price and DBS penetration
equations (see table 4) in which the exogenous variables in the system are
included to show the net effects on cable prices and DBS penetration rates
of the exogenous variables. In the reduced- form equation, the estimates
for local broadcast service include both the direct effects* as measured
in the

3SLS system of structural equations* and indirect effects. Consistent with
the 3SLS system, local channels are associated with significantly higher
DBS penetration rates. Where local channels are offered by both DBS
providers, DBS penetration rates are approximately 33 percent higher than
in areas where local channels are not available. Also, DBS penetration
rates are higher in nonmetropolitan areas, smaller television markets, and
places where the dish elevation is at a greater angle. Again, we cannot
reject the hypothesis that provision of local channels via satellite has
no impact on

cable prices. But cable prices are approximately 15 percent lower in
franchise areas where a second cable company provides service, while
prices are approximately 6 percent higher when the cable company is
affiliated with 1 of the 10 largest MSOs. Table 4: Regression Estimates of
Reduced- Form Cable prices and DBS Penetration Equations

DBS Cable prices

penetration Vari able equation

equation

DBS provision of local channels -0.0118 0.2827 [0.5011] [0.0001] a

Homes passed by cable system 0.0190 -0.0515 [0. 0001] a [0.0001] a

Age of cable franchise 0. 0368 -0.1144 [0. 0012] a [0.0046] a

Cable system megahertz 0. 1321 -0.3025 [0. 0001] a [0.0001] a

Horizontal concentration 0.0589 0.2493 [0. 0005] a [0.0001] a

Vertical relationships -0.0293 -0.0718 [0. 0192] b [0.1066]

(Continued From Previous Page)

DBS Cable prices

penetration Vari able equation

equation

Presence of nonsatellite competitor -0.1613 -0.4329 [0. 0001] a [0.0001] a

Regulation -0. 0020 -0.0784 [0.8610] [0. 0574] c

Television market size 0.0230 -0.1274 [0.0661] c [0.0043] a

Number of local broadcast channels -0.0079 0.1823 [0.6928] [0.0103] b

Average weekly wages -0.0004 0.0106 [0.9931] [0.9535]

Median household income -0.0036 0.1646 [0.8407] [0.0096] a

Nonmetropolitan area -0. 0157 0.3090 [0.3294] [0.0001] a

Population density -0.0068 -0.0973 [0.1473] [0.0001] a

Urbanization 0.0069 -0.0680 [0.3246] [0.0068] a

Percentage of multiple- dwelling units 0. 0079 -0.1095 [0.1951] [0.0001] a

Dish angle or elevation -0.0329 0.9525 [0.3917] [0.0001] a

Intercept 2. 4292 1.3639 [0. 0001] a [0.4397]

Sample size 722 722 Notes: Adjusted R- square: 0.40 for price equation and
0.57 for DBS penetration equation. P- values are in brackets.

a Significance at the 1 percent level. b Significance at the 5 percent
level. c Significance at the 10 percent level.

Source: GAO (2002).

Alternative We considered an alternative specification under which we
expanded the

Specifications definition of local channels to include markets where only
one DBS provider offered local channels. In 2001, there were seven markets
where

only one DBS provider, but not both, offered local channels. 42 By
expanding our definition of local channels to include markets where either
DBS company offered local channels, our data set contained an additional
35 observations (4. 9 percent of all observations) defined to have local
channels. The results are generally consistent with our primary
specification. In both the 3SLS system of structural equations and the
reduced- form equation, DBS provision of local channels is associated with
significantly higher DBS penetration rates. Further, the estimate for the

local channels variable is not statistically significant in the cable
price equation, and we therefore cannot reject the hypothesis that
provision of local channels has no impact on cable prices.

We considered another alternative specification using 3 years of cable
rate and channel data in a single- equation specification. As part of its
annual survey, FCC requested that cable companies report their cable rates
and number of channels provided for 1999 to 2001. Using these data, we
regressed cable rates on the number of cable channels provided, dummy
variables for DBS provision of local broadcast channels (on the basis of
the amount of time the service was available), and year and cross- section
(i. e., cable franchise) dummy variables. In this panel model, we found
that DBS provision of local broadcast channels was associated with higher
cable rates. Because we lacked DBS penetration rate data for the 3- year
period,

we were unable to examine the impact of local channels on DBS penetration
rates. 42 These television markets were Albuquerque, Baltimore, Columbus,
Greensboro, Memphis, Milwaukee, and West Palm Beach.

Comments from the Federal Communications

Appendi x V I Commission

Appendi x V Comments from the Department of Justice

Appendi x VI

GAO Contacts and Staff Acknowledgments GAO Contacts Amy Abramowitz, (202)
512- 4936 Faye Morrison, (202) 512- 6448 Staff

In addition to those named above, Wendy Ahmed, Stephen M. Brown,
Acknowledgments

Michael Clements, Michele Fejfar, Rebecca L. Medina, Hai Tran, and Mindi
Weisenbloom made key contributions to this report.

(545021)

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GAO United States General Accounting Office

Why GAO Did This Study

Direct broadcast satellite (DBS) television service has grown to become
the principal competitor to cable television systems. In October 2001, the
two primary DBS companies, EchoStar and DirecTV, proposed a merger plan
that is pending before the Department of Justice and that the Federal
Communications Commission (FCC) recently announced that it had declined to
approve. GAO was asked to examine several issues related to competition in
providing subscription video services, including the competitive impact of
the availability of cable modem Internet access, and the effects on cable
prices and DBS penetration rates of DBS* offering local broadcast
channels. GAO also examined the technical capability of the individual DBS
companies to expand local channel services into more television markets.
This report offers no opinion on the merits of the proposed merger.

October 2002 TELECOMMUNICATIONS Issues in Providing Cable and Satellite
Television Services

The full report, including GAO's objectives, scope, methodology, and
analysis is available at www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 130.
For additional information about the report, contact Peter Guerrero (202-
512- 2834).

Highlights of GAO- 03- 130, a report to the Subcommittee on Antitrust,
Competition, and Business and Consumer Rights, Committee on the Judiciary,
U. S. Senate. United States General Accounting Office

What GAO Found

DBS and cable companies compete for subscribers to their video services
and to their Internet access services, although to date, cable modem
service is the most popular method of broadband home Internet access. On
the basis of a random survey of 3,000 individuals, it appears that the
availability of Internet access services is important for some consumers*
although not the majority of consumers* when they are considering various
video service providers.

In 1999, DBS companies began to offer local broadcast channels in select
television markets across the country. According to results from GAO*s
econometric model, the provision of local broadcast channels by DBS
companies is associated with significantly higher DBS penetration rates,
although GAO found no evidence that DBS provision of local channels
influences cable prices. In general, GAO*s model results suggest that DBS
is able to compete more effectively for subscribers with cable in areas
where DBS subscribers can receive local broadcast channels.

The two DBS companies have stated that if they merge, they will, as a
combined entity, have sufficient satellite capacity to provide local
broadcast programming in all 210 television markets and to introduce new
services. GAO*s technical expert*s review of various documents related to
the two DBS companies* satellite capacity indicates that* given current
technologies and deployed assets* neither company would individually be
able to offer all of the local channels in all markets. However, the
decision of whether to introduce more local channels is, in the long term,
a business decision. Whether the benefits would outweigh the costs for the
individual companies to eventually offer local channels in all 210
television markets is not clear.

Both FCC and the Department of Justice declined to provide comments on the
substance of this report because of the merger proceedings. G A O
Accountability Integrity Reliability

Highlights

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Contents

Contents

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Page 1 GAO- 03- 130 Telecommunications United States General Accounting
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Appendix I

Appendix I Scope and Methodology

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Appendix I Scope and Methodology

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Appendix II

Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix II Results of Consumer Survey on Video Service Choices

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Appendix III

Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix III GAO Econometric Model

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Appendix IV

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Appendix V

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Appendix VI

United States General Accounting Office Washington, D. C. 20548- 0001

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