Telecommunications: Subscriber Rates and Competition in the Cable Television Industry
Published: 2004-03-25T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In recent years, rates for cable service have increased at a faster pace than the general rate of inflation. GAO agreed to (1) examine the impact of competition on cable rates and service, (2) assess the reliability of information contained in the Federal Communications Commission's (FCC) annual cable rate report, (3) examine the causes of recent cable rate increases, (4) assess the impact of ownership affiliations in the cable industry, (5) discuss why cable operators group networks into tiers, and (6) discuss options to address factors that could be contributing to cable rate increases. GAO issued its findings and recommendations in a report entitled Telecommunications: Issues Related to Competition and Subscriber Rates in the Cable Television Industry (GAO-04-8). In that report, GAO recommended that the Chairman of FCC take steps to improve the reliability, consistency, and relevance of information on cable rates and competition in the subscription video industry. In commenting on GAO's report, FCC agreed to make changes to its annual cable rate survey, but FCC questioned, on a cost/benefit basis, the utility of revising its process to keep the classification of effective competition up to date. GAO believes that FCC should examine whether cost-effective alternative processes could help provide more accurate information. This testimony is based on that report.
section_title: What GAO Found
paragraphs: Competition leads to lower cable rates and improved quality. Competition from a wire-based company is limited to very few markets. However, where available, cable rates are substantially lower (by 15 percent) than in markets without this competition. Competition from direct broadcast satellite (DBS) companies is available nationwide, and the recent ability of these companies to provide local broadcast stations has enabled them to gain more customers. In markets where DBS companies provide local broadcast stations, cable operators improve the quality of their service. FCC's cable rate report does not appear to provide a reliable source of information on the cost factors underlying cable rate increases or on the effects of competition. GAO found that cable operators did not complete FCC's survey in a consistent manner, primarily because the survey lacked clear guidance. Also, GAO found that FCC does not initiate updates or revisions to its classification of competitive and noncompetitive areas. Thus, FCC's classifications might not reflect current conditions. A variety of factors contribute to increasing cable rates. During the past 3 years, the cost of programming has increased considerably (at least 34 percent), driven by the high cost of original programming, among other things. Additionally, cable operators have invested large sums in upgraded infrastructures, which generally permit additional channels, digital service, and broadband Internet access. Some concerns exist that ownership affiliations might indirectly influence cable rates. Broadcasters and cable operators own many cable networks. GAO found that cable networks affiliated with these companies are more likely to be carried by cable operators than nonaffiliated networks. However, cable networks affiliated with broadcasters or cable operators do not receive higher license fees, which are payments from cable operators to networks, than nonaffiliated networks. Technological, economic, and contractual factors explain the practice of grouping networks into tiers, thereby limiting the flexibility that subscribers have to choose only the networks that they want to receive. An ` la carte approach would facilitate more subscriber choice but require additional technology and customer service. Additionally, cable networks could lose advertising revenue. As a result, some subscribers' bills might decline but others might increase. Certain options for addressing cable rates have been put forth. Although reregulation of cable rates is one option, promoting competition could influence cable rates through the market process. While industry participants have suggested several options for addressing increasing cable rates, these options could have other unintended effects that would need to be considered in conjunction with the benefits of lower rates.

section_title: Letter
paragraphs: I am pleased to be here today to report on our work on cable rates and  competition in the cable television industry. In recent years, cable  television has become a major component of the American entertainment  industry, with more than 70 million households receiving television service  from a cable television operator. As the industry has developed, it has  been affected by regulatory and economic changes. Since 1992, the  industry has undergone rate reregulation and then in 1999, partial  deregulation. Additionally, competition to cable operators has emerged  erratically. Companies emerged in some areas to challenge cable  operators, only to halt expansion or discontinue service altogether.  Conversely, competition from direct broadcast satellite (DBS) operators  has emerged and grown rapidly in recent years. Nevertheless, cable rates  continue to increase at a faster pace than the general rate of inflation. As  you know, on October 24, 2003, we issued a report to you on these issues,  and issued a subsequent report to the Senate Judiciary Subcommittee on  Antitrust, Competition Policy and Consumer Rights on similar issues. My  statement today will summarize the major findings from our October 2003  report, and additional findings from our February 2004 report.
At the request of this committee, we have (1) examined the impact of  competition on cable rates and service; (2) assessed the reliability of the  information contained in the Federal Communications Commission’s  (FCC) annual cable rate report on the cost factors underlying cable rate  increases, FCC’s current classification of cable franchises regarding  whether they face effective competition, and FCC’s related findings on the  effect of competition; (3) examined the causes of recent cable rate  increases; (4) assessed whether ownership of cable networks (such as  CNN and ESPN) may indirectly affect cable rates through such  ownership’s influence on cable network license fees or the carriage of  cable networks; (5) discussed why cable operators group networks into  tiers, rather than package networks so that customers can purchase only  those networks they wish to receive; and (6) discussed options to address  factors that could be contributing to cable rate increases.
To address these issues, we developed an empirical model (our cable- satellite model) that examined the effect of competition on cable rates and  service using data from 2001; conducted a telephone survey with 100  randomly sampled cable franchises that responded to FCC’s 2002 cable  rate survey, and asked these franchises a series of questions about how  they completed a portion of FCC’s survey that addresses cost factors  underlying annual cable rate changes; interviewed representatives of the  cable operator, cable network, and broadcast industries; and developed  empirical models that examined whether ownership of cable networks by  broadcasters or by cable operators influenced (1) the level of license fee  (our cable license fee model) or (2) the likelihood that the network will be  carried (our cable network carriage model) based on data from 2002. For a  more detailed description of our scope and methodology, see appendix I.
This testimony is based on our report issued October 24, 2003, for which  we did our work from December 2002 through September 2003. We  provide additional information based on our report issued February 2,  2004, for which we did our work from May 2003 to December 2003. We  preformed our work for both assignments in accordance with generally  accepted government auditing standards.
My statement will make the following points:    Wire-based competition is limited to very few markets; according to FCC,  cable subscribers in about 2 percent of all markets have the opportunity to  choose between two or more wire-based operators. However, in those  markets where this competition is present, cable rates are about 15  percent lower than cable rates in similar markets without wire-based  competition in 2001. In our February 2004 report, we examined 6 markets  with wire-based competition in depth and found that cable rates in 5 of  these 6 markets were 15 to 41 percent lower than similar markets without  wire-based competition in 2003. DBS operators have emerged as a  nationwide competitor to cable operators, which has been facilitated by  the opportunity to provide local broadcast stations. Competition from DBS  operators has induced cable operators to lower cable rates slightly, and  DBS provision of local broadcast stations has induced cable operators to  improve the quality of their service.
As we mentioned in our May 6, 2003, testimony before this Committee,  certain issues undermine the reliability of information in FCC’s cable rate  report, which provides information on cable rates and competition in the  subscription video industry. Because the Congress and FCC use this  information in their monitoring and oversight of the cable industry, the  lack of reliable information in FCC’s cable rate report may compromise  the ability of the Congress and FCC to fulfill these roles. To improve the  quality and usefulness of the data FCC collects annually, we recommend  that the Chairman of FCC take steps to improve the reliability,  consistency, and relevance of information on rates and competition in the  subscription video industry   We found that a number of factors contributed to the increase in cable  rates. On the basis of data from 9 cable operators, programming expenses  and infrastructure investment appear to be the primary cost factors that  have been increasing in recent years. During the past 3 years, the cost of  programming has increased at least 34 percent. Also, since 1996, the cable  industry has spent over $75 billion to upgrade its infrastructure.
Some industry representatives believe that certain factors related to the  nature of ownership affiliations may also indirectly influence cable rates.  We did not find that ownership affiliations between cable networks (such  as CNN and ESPN) and broadcasters (such as NBC and CBS) or between  cable networks and cable operators (such as Time Warner and  Cablevision) are associated with higher license fees—that is, the fees  cable operators pay to carry cable networks. However, we did find that  both forms of ownership affiliations are associated with a greater  likelihood that a cable operator would carry a cable network.
Today, subscribers have little choice regarding the specific networks they  receive with cable television service. Adopting an à la carte approach,  where subscribers could choose to pay for only those networks they  desire, would provide consumers with more individual choice, but could  require additional technology and could alter the current business model  of the cable network industry wherein cable networks obtain roughly half  of their overall revenues from advertising. A move to an à la carte  approach could result in reduced advertising revenues and might result in  higher per-channel rates and less diversity in program choice. A variety of  factors—such as the pricing of à la carte service, consumers’ purchasing  patterns, and whether certain niche networks would cease to exist with à  la carte service—make it difficult to ascertain how many consumers would  be better off and how many would be worse off under an à la carte  approach.
Certain options for addressing factors that may be contributing to cable  rate increases have been put forth. Some consumer groups have suggested  that reregulation of cable rates needs to be considered, although others  have noted problems with past efforts at regulation. Other options put  forth include reviewing whether modifications to the program access rules  would be beneficial, promoting wireless competition, and reviewing  whether changes to the retransmission consent process should be  considered. Any options designed to help bring down cable rates could  have other unintended effects that would need to be considered in  conjunction with the benefits of lower rates. We are not making any  specific recommendations regarding the adoption of these options.
subsections: section_title: Background
paragraphs: Cable television emerged in the late 1940s to fill a need for television  service in areas with poor over-the-air reception, such as mountainous or  remote areas. By the late 1970s, cable operators began to compete more  directly with free over-the-air television by providing new cable networks,  such as HBO, Showtime, and ESPN. According to FCC, cable’s penetration  rate—as a percentage of television households—increased from 14  percent in 1975 to 24 percent in 1980 and to 67 percent today. Cable  television is by far the largest segment of the subscription video market, a  market that includes cable television, satellite service (including DBS  operators such as DIRECTV and EchoStar), and other technologies that  deliver video services to customers’ homes.
To provide programming to their subscribers, cable operators (1) acquire  the rights to carry cable networks from a variety of sources and (2) pay  license fees—usually on a per-subscriber basis—for these rights. The three  primary types of owners of cable networks are large media companies that  also own major broadcast networks (such as Disney and Viacom), large  cable operators (such as Time Warner and Cablevision), and independent  programmers (such as Landmark Communications).
At the community level, cable operators obtain a franchise license under  agreed-upon terms and conditions from a franchising authority, such as a  local or state government. During cable’s early years, franchising  authorities regulated many aspects of cable television service, including  subscriber rates. In 1984, the Congress passed the Cable Communications  Policy Act, which imposed some limitations on franchising authorities’  regulation of rates. However, 8 years later in response to increasing rates,  the Congress passed the Cable Television Consumer Protection and  Competition Act of 1992. The 1992 Act required FCC to establish  regulations ensuring reasonable rates for basic service—the lowest level  of cable service, which includes the local broadcast stations—unless a  cable system has been found to be subject to effective competition, which  the act defined. The act also gave FCC the authority to regulate any  unreasonable rates for upper tiers (often referred to as expanded-basic  service), which include cable programming provided over and above that  provided on the basic tier. Expanded-basic service typically includes such  popular cable networks as USA Network, ESPN, and CNN. In anticipation  of growing competition from satellite and wire-based operators, the  Telecommunications Act of 1996 phased out all regulation of expanded- basic service rates by March 31, 1999. However, franchising authorities  can regulate the basic tier of cable service where there is no effective  competition.
As required by the 1992 Act, FCC annually reports on average cable rates  for operators found to be subject to effective competition compared with  operators not subject to effective competition. To fulfill this mandate, FCC  annually surveys a sample of cable franchises regarding their cable rates.  In addition to asking questions that are necessary to gather information to  provide its mandated reports, FCC also typically asks questions to help the  agency better understand the cable industry. For example, the 2002 survey  included questions about a range of cable issues, including the cost factors  underlying changes in cable rates, the percentage of subscribers  purchasing other services (such as broadband Internet access and  telephone service), and the specifics of the programming channels offered  on each tier.
Some franchise agreements were initially established on an exclusive  basis, thereby preventing wire-based competition to the initial cable  operator. In 1992, the Congress prohibited the awarding of exclusive  franchises, and, in 1996, the Congress took steps to allow telephone  companies and electric companies to enter the video market. Initially  unveiled in 1994, DBS served about 18 million American households by  June 2002. Today, two of the five largest subscription video service  providers are DIRECTV and EchoStar—the two primary DBS operators.
section_title: Competition Leads to Lower Cable Rates and Improved Quality and Service among Cable Operators
paragraphs: Competition from a wire-based provider—that is, a competitor using a  wire technology—is limited to very few markets, but where available, has  a downward impact on cable rates. In a recent report, FCC noted that very  few markets—about 2 percent—have been found to have effective  competition based on the presence of a wire-based competitor. Our  interviews with cable operators and financial analysis firms yielded a  similar finding—wire-based competition is limited. However, according to  our cable-satellite model that included over 700 cable franchises  throughout the United States in 2001, cable rates were approximately 15  percent lower in areas where a wire-based competitor was present. With  an average monthly cable rate of approximately $34 that year, this implies  that subscribers in areas with a wire-based competitor had monthly cable  rates about $5 lower, on average, than subscribers in similar areas without  a wire-based competitor. Our interviews with cable operators also  revealed that these companies generally lower rates and/or improve  customer service where a wire-based competitor is present.
For our February 2004 report to the Senate Judiciary Subcommittee on  Antitrust, Competition Policy and Consumer Rights, we developed an  alterative methodology to examine the relationship between cable rates  and wire-based competition. In particular, we developed a case-study  approach that compared 6 cities where a broadband service provider  (BSP)—new wire-based competitors that generally offer local telephone,  subscription television, and high-speed Internet services to consumers— has been operating for at least 1 year with 6 similar cities that do not have  such a competitor. We compared the lowest price available for cable  service in the market with a BSP to the price for cable service offered in  markets without a BSP.
We found that cable rates were generally lower in the 6 markets we  examined with a BSP present than in the 6 markets that did not have BSP  competition. However, the extent to which rates were lower in a BSP  market compared to its “matched market” varied considerably across  markets. For example, in 1 BSP market, the monthly rate for cable  television service was 41 percent lower compared with the matched  market, and in 2 other BSP locations, cable rates were more than 30  percent lower when compared with their matched markets. In two other  BSP markets, rates were lower by 15 and 17 percent, respectively, in the  BSP market compared to its matched market. On the other hand, in 1 of  the BSP markets, the price for cable television service was 3 percent  higher in the BSP market than it was in the matched market.
In recent years, DBS has become the primary competitor to cable  operators. The ability of DBS operators to compete against cable  operators was bolstered in 1999 when they acquired the legal right to  provide local broadcast stations—such as over-the-air affiliates of ABC,  CBS, Fox, and NBC—via satellite to their customers. On the basis of our  cable-satellite model, we found that in areas where subscribers can  receive local broadcast stations from both primary DBS operators, the  DBS penetration rate is approximately 40 percent higher than in areas  where subscribers cannot receive these stations from the DBS operators.  In terms of rates, we found that a 10 percent higher DBS penetration rate  in a franchise area is associated with a slight rate reduction—about 15  cents per month. Also, in areas where both primary DBS operators provide  local broadcast stations, we found that the cable operators offer  subscribers approximately 5 percent more cable networks than cable  operators in areas where this is not the case. During our interviews with  cable operators, most operators told us that they responded to DBS  competition through one or more of the following strategies: focusing on  customer service, providing bundles of services to subscribers, and  lowering prices and providing discounts.
section_title: Concerns Exist about the Reliability of FCC’s Data for Cable Operator Cost Factors and Effective Competition
paragraphs: As we mentioned in our May 6, 2003, testimony before this Committee,  weaknesses in FCC’s survey of cable franchises may lead to inaccuracies  in the relative importance of cost factors reported by FCC. Cable  franchises responding to FCC’s 2002 survey did not complete in a  consistent manner the section pertaining to the factors underlying cable  rate increases primarily because of a lack of clear guidance. These  inconsistencies may have led to unreliable information in FCC’s report on  the relative importance of factors underlying recent cable rate increases.  Overall, we found that 84 of the 100 franchises we surveyed did not  provide a complete or accurate accounting of their cost changes for the  year. As such, an overall accurate picture of the relative importance of  various cost factors, which may be important for FCC and congressional  oversight, may not be reflected in FCC’s data.
FCC’s cable rate report also does not appear to provide a reliable source  of information on the effect of competition. FCC is required by statute to  produce an annual report on the differences between average cable rates  in areas that FCC has found to have effective competition compared with  those that have not had such a finding. However, FCC’s process for  implementing this mandate may lead to situations in which the effective  competition designation may not reflect the actual state of competition in  the current time frame. In particular, FCC relies exclusively on external  parties to file for changes in the designation. Using data from FCC’s 2002  survey, we conducted several tests to determine whether information  contained in franchises’ survey information—which was filed with FCC in  mid-2002—was consistent with the designation of effective competition  for the franchise in FCC’s records. We found some discrepancies. These  discrepancies may explain, in part, the differential findings regarding the  impact of wire-based competition reported by FCC, which found a nearly 7  percent reduction in cable rates, and our finding of a 15 percent reduction  in cable rates.
Because the Congress and FCC use this information in their monitoring  and oversight of the cable industry, the lack of reliable information in  FCC’s report on these two issues—factors underlying cable rate increases  and the effect of competition—may compromise the ability of the  Congress and FCC to fulfill these roles. Additionally, the potential for this  information to be used in debate regarding important policy decisions,  such as media consolidation, also necessitates reliable information in  FCC’s report. As a result, we recommended that the Chairman of FCC  improve the reliability, consistency, and relevance of information on cable  rates and competition in the subscription video industry by (1) taking  immediate steps to improve its cable rate survey and (2) reviewing the  commission’s process for maintaining the classification of effective  competition. In commenting on our report, FCC agreed to make changes  to its annual cable rate survey in an attempt to obtain more accurate  information, but questioned, on a cost/benefit basis, the utility of revising  its process to keep the classification of effective competition in franchises  up to date. We recognize that there are costs associated with FCC’s cable  rate survey, and we recommend that FCC examine whether cost-effective  alternative processes exist that would enhance the accuracy of its  effective competition designations.
section_title: A Variety of Factors Contribute to Cable Rate Increases
paragraphs: Increases in expenditures on cable programming contribute to higher  cable rates. A majority of cable operators and cable networks, and all  financial analysts that we interviewed told us that high programming costs  contributed to rising cable rates. On the basis of financial data supplied to  us by 9 cable operators, we found that these operators’ yearly  programming expenses, on a per-subscriber basis, increased from $122 in  1999 to $180 in 2002—a 48 percent increase. Almost all of the cable  operators we interviewed cited sports programming as a major contributor  to higher programming costs. On the basis of our analysis of Kagan World  Media data, the average license fees for a cable network that shows almost  exclusively sports-related programming increased by 59 percent,  compared to approximately 26 percent for 72 nonsports networks, in the 3  years between 1999 and 2002. Further, the average license fees for the  sports networks were substantially higher than the average for the  nonsports networks (see fig. 1).
The cable network executives we interviewed cited several reasons for  increasing programming costs. We were told that competition among  networks to produce and show content that will attract viewers has  become more intense. This competition, we were told, has bid up the cost  of key inputs (such as talented writers and producers) and has sparked  more investment in programming. Most notably, these executives told us  that networks today are increasing the amount of original content and  improving the quality of programming generally.
Although programming is a major expense for cable operators, several  cable network executives we interviewed also pointed out that cable  operators offset some of the cost of programming through advertising  revenues. Local advertising dollars account for about 7 percent of the total  revenues in the 1999 to 2002 time frame for the 9 cable operators that  supplied us with financial data. For these 9 cable operators, gross local  advertising revenues—before adjusting for the cost of inserting and selling  advertising—amounted to about $55 per subscriber in 2002 and offset  approximately 31 percent of their total programming expenses.
In addition to higher programming costs, the cable industry has spent over  $75 billion between 1996 and 2002 to upgrade its infrastructure by  replacing degraded coaxial cable with fiber optics and adding digital  capabilities. As a result of these expenditures, FCC reported that there  have been increases in channel capacity; the deployment of digital  transmissions; and nonvideo services, such as Internet access and  telephone service. Many cable operators, cable networks, and financial  analysts we interviewed said investments in system upgrades contributed  to increases in consumer cable rates.
Programming expenses and infrastructure investment appear to be the  primary cost factors that have been increasing in recent years. On the  basis of financial data from 9 cable operators, we found that annual  subscriber video-based revenues increased approximately $79 per  subscriber from 1999 to 2002. During this same period, programming  expenses increased approximately $57 per subscriber. Depreciation  expenses on cable-based property, plant, and equipment—an indicator of  expenses related to infrastructure investment—increased approximately  $80 per subscriber during the same period. However, because these  infrastructure-related expenses are associated with more than one service,  it is unclear how much of this cost should be attributed to video-based  services. Moreover, cable operators are enjoying increased revenues from  nonvideo sources. For example, revenues from Internet-based services  increased approximately $74 per subscriber during the same period.
section_title: Some View Ownership Affiliations as an Important Indirect Influence on Cable Rates
paragraphs: Several industry representatives and experts we interviewed told us that  they believe ownership affiliation may also influence the cost of  programming and thus, indirectly, the rates for cable service. Of the 90  cable networks that are carried most frequently on cable operators’ basic  or expanded-basic tiers, we found that approximately 19 percent were  majority-owned (i.e., at least 50 percent owned) by a cable operator,  approximately 43 percent were majority-owned by a broadcaster, and the  remaining 38 percent of the networks are not majority-owned by  broadcasters or cable operators (see fig. 2).
Despite the view held by some industry representatives with whom we  spoke that license fees for cable networks owned by either cable  operators or broadcasters tend to be higher than fees for other cable  networks, we did not find this to be the case. We found that cable  networks that have an ownership affiliation with a broadcaster did not  have, on average, higher license fees (i.e., the fee the cable operator pays  to the cable network) than cable networks that were not majority-owned  by broadcasters or cable operators. We did find that license fees were  statistically higher for cable networks owned by cable operators than was  the case for cable networks that were not majority-owned by broadcasters  or cable operators. However, when using a regression analysis (our cable  license fee model) to hold constant other factors that could influence the  level of the license fee, we found that ownership affiliations—with  broadcasters or with cable operators—had no influence on cable  networks’ license fees. We did find that networks with higher advertising  revenues per subscriber (a proxy for popularity) and sports networks  received higher license fees.
Industry representatives we interviewed also told us that cable networks  owned by cable operators or broadcasters are more likely to be carried by  cable operators than other cable networks. On the basis of our cable  network carriage model—a model designed to examine the likelihood of a  cable network being carried—we found that cable networks affiliated with  broadcasters or with cable operators are more likely to be carried than  other cable networks. In particular, we found that networks owned by a  broadcaster or by a cable operator were 46 percent and 31 percent,  respectively, more likely to be carried than a network without majority  ownership by either of these types of companies. Additionally, we found  that cable operators were much more likely to carry networks that they  themselves own. A cable operator is 64 percent more likely to carry a  cable network it owns than to carry a network with any other ownership  affiliation.
section_title: Several Factors Generally Lead Cable Operators to Offer Large Tiers of Networks Instead of Providing À La Carte or Minitier Service
paragraphs: Using data from FCC’s 2002 cable rate survey, we found that with basic  tier service, subscribers receive, on average, approximately 25 channels,  which include the local broadcast stations. The expanded-basic tier  provides, on average, an additional 36 channels. In general, to have access  to the most widely distributed cable networks—such as ESPN, TNT, and  CNN—most subscribers must purchase the expanded-basic tier of service.  Because subscribers must buy all of the networks offered on a tier that  they choose to purchase, they have little choice regarding the individual  networks they receive.
If cable operators were to offer all networks on an à la carte basis—that is,  if consumers could select the individual networks they wish to purchase— additional technology upgrades would be necessary in the near term. In  particular, subscribers would need to have an addressable converter box  on every television set attached to the cable system to unscramble the  signals of the networks that the subscriber has agreed to purchase.
According to FCC’s 2002 survey data, the average monthly rental price for  an addressable converter box is approximately $4.39. Although cable  operators have been placing addressable converter boxes in the homes of  customers who subscribe to scrambled networks, many homes do not  currently have addressable converter boxes or do not have them on all of  the television sets attached to the cable system. Since cable operators may  move toward having a greater portion of their networks provided on a  digital tier in the future, these boxes will need to be deployed in greater  numbers, although it is unclear of the time frame over which this will  occur. Also, consumer electronic manufactures have recently submitted  plans to FCC regarding specifications for new television sets that will  effectively have the functionality of an addressable converter box within  the television set. Once most customers have addressable converter boxes  or these new televisions in place, the technical difficulties of an à la carte  approach would be mitigated.
If cable subscribers were allowed to choose networks on an à la carte  basis, the economics of the cable network industry could be altered. If this  were to occur, it is possible that cable rates could actually increase for  some consumers. In particular, we found that cable networks earn much  of their revenue from the sale of advertising that airs during their  programming. Our analysis of information on 79 networks from Kagan  World Media indicates that these cable networks received nearly half of  their revenue from advertising in 2002; the majority of the remaining  revenue is derived from the license fees that cable operators pay networks  for the right to carry their signal (see fig. 3).
To receive the maximum revenue possible from advertisers, cable  networks strive to be on cable operators’ most widely distributed tiers  because advertisers will pay more to place an advertisement on a network  that will be viewed, or have the potential to be viewed, by the greatest  number of people. According to cable network representatives we  interviewed, any movement of networks from the most widely distributed  tiers to an à la carte format could result in a reduced amount that  advertisers are willing to pay for advertising time. To compensate for any  decline in advertising revenue, network representatives contend that cable  networks would likely increase the license fees they charge to cable  operators. Because increased license fees, to the extent that they occur,  are likely to be passed on to subscribers, it appears that subscribers’  monthly cable bills would not necessarily decline under an à la carte  system. Moreover, most cable networks we interviewed also believe that  programming diversity would suffer under an à la carte system because  some cable networks, especially small and independent networks, would  not be able to gain enough subscribers to support the network.
The manner in which an à la carte approach might impact advertising  revenues, and ultimately the cost of cable service, rests on assumptions  regarding customer choice and pricing mechanisms. In particular, the  cable operators and cable networks that discussed these issues with us  appeared to assume that many customers, if faced with an à la carte  selection of networks, would choose to receive only a limited number of  networks, which is consistent with the data on viewing habits. In fact,  some industry representatives had different views on the degree to which  consumers place value on networks they do not typically watch. While two  experts suggested that it is not clear whether more networks are a benefit  to subscribers, others noted that subscribers place value in having the  opportunity to occasionally watch networks they typically do not watch.  Additionally, the number of cable networks that customers choose to  purchase will also be influenced by the manner in which cable operators  price services under an à la carte scenario. Thus, there are a variety of  factors that make it difficult to ascertain how many consumers would be  made better off and how many would be made worse off under an à la  carte approach. These factors include how cable operators would price  their services under an à la carte system; the distribution of consumers’  purchasing patterns; whether niche networks would cease to exist, and, if  so, how many would exit the industry; and consumers’ true valuation of  networks they typically do not watch.
section_title: Industry Participants Have Cited Certain Options That May Address Factors Contributing to Rising Cable Rates
paragraphs: Industry participants have suggested the following options for addressing  the cable rate issue. This discussion is an overview, and we are not making  any specific recommendations regarding the adoption of any of these  options.
Some consumer groups have pointed to the lack of competition as  evidence that reregulation needs to be considered because it might be the  only alternative to mitigate increasing cable rates and cable operators’  market power. However, some experts expressed concerns about cable  regulation after the 1992 Act, including lowering of the quality of  programming, discouragement of investment in new facilities, and  imposition of administrative burdens on the industry and regulators.
The 1992 Act included provisions to ensure that cable networks that have  ownership relationships with cable operators (i.e., vertically integrated  cable operators) generally make their satellite-delivered programming  available to competitors. Some have expressed concern that the law is too  narrow because it applies only to the satellite-delivered programming of  vertically integrated cable operators and it does not prohibit exclusive  contracts between a cable operator and an independent cable network.  Given these concerns, some have suggested that changes in the statutory  program access provisions might enhance the ability of other providers to  compete with the incumbent cable operators while others have noted that  altering these provisions could reduce the incentive for companies to  develop innovative programming.
DBS operators have stated that they are currently not able to provide local  broadcast stations in all 210 television markets in the United States  because they do not have adequate spectrum to do so while still providing  a wide variety of national networks. As part of the so-called carry one,  carry all provisions, these companies are required to provide all local  broadcast stations in markets where they provide any of those stations.  Some suggest modifying the carry one, carry all provisions to promote  carriage of local stations in more markets. However, any modifications to  the DBS carry one, carry all rules would need to be examined in the  context of why those rules were put into place—that is, to ensure that all  broadcast stations are available in markets where DBS providers choose  to provide local stations.
In the 1992 Act, the Congress created a mechanism, known as  retransmission consent, through which local broadcast station owners  (such as local ABC, CBS, Fox, and NBC affiliates) could receive  compensation from cable operators in return for the right to carry their  broadcast stations. Today, few retransmission consent agreements include  cash payment for carriage of the local broadcast station. Rather,  agreements between some large broadcast groups and cable operators  generally include provisions for carriage of broadcaster-owned cable  networks. As a result, cable operators sometimes carry cable networks  they otherwise might not have carried. Alternatively, representatives of the  broadcast networks told us that they did not believe that cable networks  had been dropped and that they accept cash payment for carriage of the  broadcast signal, but that cable operators tend to prefer carriage options  in lieu of a cash payment. Certain industry participants with whom we met  advocated the removal of the retransmission consent provisions and told  us that this may have the effect of lowering cable rates, but others have  stated that such provisions serve to enable television stations to obtain a  fair return for the retransmitted content they provide and that  retransmission rules help to ensure the continued availability of free  television for all Americans.
Mr. Chairman, this concludes my prepared statement. I would be happy to  respond to any questions you or other Members of the Committee may  have at this time.
section_title: Contact and Acknowledgments
paragraphs: For questions regarding this testimony, please contact Mark L. Goldstein  on (202) 512-2834 or goldsteinm@gao.com. Individuals making key  contributions to this testimony included Amy Abramowitz, Stephen  Brown, Julie Chao, Michael Clements, Andy Clinton, Keith Cunningham,  Bert Japikse, Sally Moino, Mindi Weisenbloom, and Carrie Wilks.
section_title: Appendix I: Scope and Methodology
paragraphs: To respond to the first issue—examine the impact of competition on cable  rates—we used an empirical model (our cable-satellite model) that we  previously developed that examines the effect of competition on cable  rates and services. Using data from the Federal Communications  Commission’s (FCC) 2001 cable rate survey, the model considers the  effect of various factors on cable rates, the number of cable subscribers,  the number of channels that cable operators provide to subscribers, and  direct broadcast satellite (DBS) penetration rates for areas throughout the  United States. We further developed the model to more explicitly examine  whether varied forms of competition—such as wire-based, DBS,  multipoint multichannel distribution systems (MMDS) competition—have  differential effects on cable rates. In addition, we spoke with an array of  industry stakeholders and experts (see below) to gain further insights on  these issues.
The second issue consists of two parts. To respond to part one—assess  the reliability of the cost justifications for rate increases provided by cable  operators to FCC, we conducted a telephone survey (our cable franchise  survey), from January 2003 through March 2003, of cable franchises that  responded to FCC’s 2002 cable rate survey. We drew a random sample of  100 of these cable franchises; the sample design was intended to be  representative of the 755 cable franchises that responded to FCC’s survey.  We used data from FCC, and conversations with company officials, to  determine the most appropriate staff person at the franchise to complete  our survey. To ensure that our survey gathered information that addressed  this objective, we conducted telephone pretests with several cable  franchises and made the appropriate changes on the basis of the pretests.  We asked cable franchises a series of open-ended questions regarding how  the franchise staff calculated cost and noncost factors on FCC’s 2002 cable  rate survey, how well the franchise staff understood what FCC wanted for  those factors, and franchise staff’s suggestions for improving FCC’s cable  rate survey. All 100 franchises participated in our survey, for a 100 percent  response rate. In conducting this survey, we did not independently verify  the answers that the franchises provided to us.
Additionally, to address part two of the second issue—assess FCC’s  classifications of effective competition—we examined FCC’s classification  of cable franchises regarding whether they face effective competition.
Using responses to FCC’s 2002 cable rate survey, we tested whether the  responses provided by cable franchises were consistent with the various  legal definitions of effective competition, such as the low-penetration test.  Further, we reviewed documents from FCC proceedings addressing  effective competition filings and contacted franchises to determine  whether the conditions present at the time of the filing remain in effect  today.
To address the third, fourth, fifth, and sixth issues (examine reasons for  recent rate increases, examine whether ownership relationships between  cable networks and cable operators and/or broadcasters influence the  level of license fees for the cable networks or the likelihood that a cable  network will be carried, examine why cable operators group networks into  tiers rather than sell networks individually, and discuss options to address  factors that could be contributing to cable rate increases), we took several  steps, as follows:    We conducted semistructured interviews with a variety of industry  participants. We interviewed officials and obtained documents from FCC  and the Bureau of Labor Statistics. We interviewed 15 cable networks—12  national and 3 regional—from a listing published by the National Cable  and Telecommunications Association (NCTA), striving for a mixture of  networks that have a large and small number of subscribers and that  provide varying content, such as entertainment, sports, music, and news.  We interviewed 11 cable operators, which included the 10 largest publicly  traded cable operators and 1 medium-sized, privately held cable operator.  In addition, we interviewed the four largest broadcast networks, one DBS  operator, representatives from three major professional sports leagues,  and five financial analysts that cover the cable industry. Finally, we  interviewed officials from NCTA, Consumers Union, the National  Association of Broadcasters, the National Association of  Telecommunications Officers and Advisors, the American Cable  Association, the National Cable Television Cooperative, and the Cable  Television Advertising Bureau.
We solicited the 11 cable operators we interviewed to gather financial and  operating data and reviewed relevant Securities and Exchange  Commission filings for these operators. Nine of the 11 cable operators  provided the financial and operating data we sought for the period 1999 to  2002. We also acquired data from Kagan World Media, which is a private  communications research firm that specializes in the cable industry. These  data provided us with revenue and programming expenses for over 75  cable networks.
We compared the average license fees among three groups of networks:  those that are majority-owned by a broadcaster, those that are majority- owned by a cable operator, and all others. We preformed t-tests on the  significance of these differences. We also ran a regression (our cable  license fee model) in which we regressed the license fee across 90 cable  networks on the age of the network, the advertising revenues per  subscriber (a measure of network popularity), dummy variables for sports  and news programming, and a variety of factors about each franchise.
We conducted several empirical tests on the channel lineups of cable  operators as reported to FCC in its 2002 cable rate survey. We developed  an empirical model (our cable network carriage model) that examined the  factors that influence the probability of a cable network being carried on a  cable franchise, including factors such as ownership affiliations and the  popularity of the network. Further, we developed descriptive statistics on  the characteristics of various tiers of service and the channels included in  the various tiers.
This is a work of the U.S. government and is not subject to copyright protection in the  United States. It may be reproduced and distributed in its entirety without further  permission from GAO. However, because this work may contain copyrighted images or  other material, permission from the copyright holder may be necessary if you wish to  reproduce this material separately.