Telecommunications: Issues in Providing Cable and Satellite Television Services
Published: 2002-10-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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.  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  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).  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.
subsections: section_title: Background
paragraphs: 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. 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 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.
DBS and cable also compete for subscribers to their broadband Internet  access services.  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. Few consumers subscribe to the current  satellite Internet service, although future satellite Internet access  technologies are expected to be faster and more competitive with cable  modems.
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). 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  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.
section_title: For the Majority of Consumers, Internet Access Technologies Do Not Appear to Play a Major Role in Their Consideration of Video Service Providers
paragraphs: In our random telephone survey of consumers, we asked all of our survey  respondents if, when thinking about purchasing television programming,  the availability of cable modem Internet service would make them more  likely to choose cable video service over satellite video service (see fig. 1).  Fifty-one percent of those responding said “not more likely” while 16  percent said “much more likely.”  We also asked all of our survey  respondents (excluding those few with satellite Internet access) if they had  considered purchasing Internet service through a satellite provider; 88  percent said they had not.
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). 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  DBS was cheaper than cable and because DBS offered special rates or  promotions.
section_title: DBS Provision of Local Broadcast Channels Associated with Higher DBS Penetration Rates, but Not with Lower Cable Prices
paragraphs: According to our econometric model, the provision of local broadcast  channels by DBS companies is associated with significantly higher DBS  penetration rates. Specifically, our model results indicate that in cable  franchise areas where consumers can receive local channels from both  DBS providers, the DBS penetration rate is approximately 32 percent  higher than in areas where consumers cannot receive local channels via  satellite. Thus, in areas where the DBS companies offer local channels, it  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. 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.
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.
section_title: Technical Considerations and Business Decisions Can Influence DBS Companies’ Expansion of Local Broadcast Services
paragraphs: In 1999, the Satellite Home Viewer Improvement Act provided DBS  companies with the legal right to provide local broadcast station  programming. To date, DirecTV and EchoStar have each introduced local  broadcast service in about 45 markets, although DirecTV plans to offer  local channels in about 70 markets and EchoStar plans to offer local  channels in about 50 markets. However, providing local channels uses a  satellite’s transmission capacity—a limited resource on each satellite.  Thus, there is an important trade-off that DBS companies face in deciding  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 channels. 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.
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. 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  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. 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. 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.
section_title: Agency Comments
paragraphs: 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.
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.
section_title: Scope and Methodology
subsections: section_title: Consumer Survey
paragraphs: 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.
section_title: Econometric Model
paragraphs: 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. 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.  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.
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.
section_title: Results of Consumer Survey on Video Service Choices
paragraphs: 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)
Over the air, through an antenna Direct broadcast satellite, such as DirecTV or EchoStar’s  DISH Network, for all your channels Direct broadcast satellite for all channels except local  broadcast channels Big dish, C-band satellite  You don’t own a television Other (Specify) [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)
Question 3:   Did  you begin subscribing to your current cable provider within the past 2  years?  (n=1,854)
Question 4:    What  method did you previously use for your main television viewing?  (n=555)
Over the air, through an antenna Other (Specify)
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   cable. Again, please rate each of these as a major  reason, a minor reason, or not a reason.
Question 5a: Because your area cable company offered special rates or  other promotions, such as free installation or 3 months free. (n=785)
Question 5b: Because you wanted more channels than you were receiving.  (n=785)
Question 5c: Because you wanted to purchase special features (like sports  packages, pay-per-view, or movie options). (n=785)
Question 5d: Because you heard or saw that the picture and audio quality  with cable was better than you were receiving. (n=785)
Question 5e: Because you were interested in receiving high definition  television channels. (n=785)
Question 5f: Because you thought that cable was cheaper than satellite  service. (n=785)
Question 5g: Because you thought cable offered better customer service  quality than you were receiving. (n=785)
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)
Question 5i: Because you wanted to get both your local broadcast channels  and cable channels from the same company. (n=785)
Question 5j: Because family and friends recommended cable. (n=785)
Question 5k: Because cable was the only television option available to you  other than over-the-air broadcasting. (n=785)
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)
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)
Question 8:   What  method did you previously use for your main television viewing?  (n=241)
Over the air, through an antenna A big dish, C-band satellite Other (Specify)
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   satellite service. Again, please rate each of these as  a major reason, a minor reason, or not a reason.
Question 9a: Because the satellite company offered special rates or other  promotions, such as free installation or 3 months free. (n=854)
Question 9b: Because you wanted more channels than you were receiving.  (n=854)
Question 9c: Because the satellite company added local broadcast  channels, such as ABC or FOX, in your area. (n=854)
Question 9d: Because you wanted to purchase special features (like sports  packages, pay-per-view, or movie options). (n=854)
Question 9e: Because you heard or saw that the picture and audio quality  with satellite were better than you were receiving. (n=854)
Question 9f: Because you were interested in receiving high definition  television channels. (n=854)
Question 9g: Because you thought that satellite was cheaper than cable.  (n=854)
Question 9h: Because you thought that satellite offered better customer  service quality than you were receiving. (n=854)
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)
Question 9j: Because family and friends recommended satellite. (n=854)
Question 9k: Because satellite was the only television option available to  you other than over-the-air broadcasting. (n=854)
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)
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)
You have a computer, but don’t access the  Internet You don’t have a computer Other (Specify)
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)
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)
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)
section_title: GAO Econometric Model
paragraphs: 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.
subsections: section_title: Conceptual Development of the Econometric Model
paragraphs: In response to a congressional request, we developed an econometric  model to examine the influence of satellite companies’ provision of local  broadcast channels, along with other factors, on cable prices and DBS  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. 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.
subsections: section_title: Examination of Competitive Effects in the Subscription Video Market
paragraphs: To examine the influence of the DBS companies’ provision of local  channels on cable prices and DBS penetration rates, we employed a model  that is based on the subscription video market, rather than on the narrower  market for cable television. 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.
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.
section_title: Specification of Econometric Model of Cable-Satellite Competition
paragraphs: Estimating the influence of DBS companies’ provision of local channels on  cable prices and DBS penetration rates is complicated by the possibility  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 channels, and the DBS penetration rate were jointly determined. 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). The  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 high- quality 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. 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.
section_title: Data Sources Used for the Econometric Model
paragraphs: We required several data elements to build the data set used to estimate  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 (multiple- dwelling 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.
section_title: Merging Various Data Sources into a Single Data Set
paragraphs: The level of observation in our model is a cable franchise. Many of the  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  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 subdivision (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), we acquired additional  information on the geographic boundaries of the franchise areas. 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  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. 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.  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.
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. 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.
section_title: Descriptive Statistics for Variables Included in the Econometric Model
paragraphs: Table 2 provides basic statistical information on all of the variables  included in the cable–satellite competition model. We calculated these  statistics using all 722 observations in our data set.
section_title: Estimation Methodology and Results
paragraphs: We employed the Three-Stage Least Squares (3SLS) method to estimate our  model. Table 3 includes the estimation results for each of the four  structural equations. All of the variables, except dummy variables, are  expressed in natural logarithmic form. 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  with the economic reasoning that underlies our model as well as with the  results from several previous studies, including our 2000 report.
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. 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  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. 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  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.
section_title: Alternative Specifications
paragraphs: We considered an alternative specification under which we expanded the  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. 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.
section_title: Comments from the Federal Communications Commission
section_title: Comments from the Department of Justice
section_title: GAO Contacts and Staff Acknowledgments
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section_title: Staff Acknowledgments
paragraphs: In addition to those named above, Wendy Ahmed, Stephen M. Brown,  Michael Clements, Michele Fejfar, Rebecca L. Medina, Hai Tran, and Mindi  Weisenbloom made key contributions to this report.
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