Telecommunications: Data Gathering Weaknesses In FCC's Survey Of Information on Factors Underlying Cable Rate Changes
Published: 2003-05-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Over 65 percent of American households currently subscribe to cable television service. There has been increasing concern that cable television rates have been rising aster than the rate of inflation for the last few years. As required, on a yearly basis, FCC prepares a report on cable rates in areas that face and those that do not face effective competition--a term defined by statute. For information used in this report, FCC maintains information on the competitive status of cable franchises and annually surveys a sample of cable franchises. GAO examined (1) the reliability of information that cable companies provided to FCC in its annual survey regarding cost factors underlying cable rate increases and (2) FCC's process for updating and revising cable franchise classifications as to whether they face effective competition.
section_title: What GAO Found
paragraphs: Based on interviews with 100 randomly sampled cable franchises that completed FCC's 2002 survey, GAO's preliminary analysis indicates that FCC's survey may not be a reliable source of information on the cost factors underlying cable rate increases. Because of the following problems, GAO found that there are inconsistencies in how companies completed the survey. FCC provided minimal instructions or examples on how the portion of the survey covering the cost factors underlying rate increases should be completed. It appears that cable companies made varying assumptions on how to complete the survey. FCC's survey required that cable companies fully allocate their reported annual rate increase to various cost and non-cost factors. Our preliminary findings indicate that there was inadequate guidance on how to achieve this requisite balance, and cable companies approached the question in varying ways. Based on preliminary work, GAO found that FCC's classification of cable franchises as to whether they face effective competition might not accurately reflect current conditions. GAO found instances where information in the survey responses of some franchises would suggest that the criteria for an effective competition finding that was made in the past might no longer be present. However, a finding of effective competition is only changed if a formal process is instituted. GAO found only two instances where a petition was filed that resulted in a reversal of an effective competition finding.

section_title: Letter
paragraphs: I am pleased to be here today to provide preliminary observations from  our ongoing work on cable television rates. Over 65 percent of American  households are currently cable television subscribers. As you have noted,  Mr. Chairman, cable television rates have been rising faster than the rate  of general inflation for many years. At the request of this Committee, we  are providing preliminary observations today on two issues: (1) the  reliability of the information that cable companies have provided to the  Federal Communications Commission (FCC) in 2002 regarding the costs  factors underlying their recent cable rate increases, and (2) FCC’s process  for updating and revising the classification of cable franchises as to  whether they are facing effective competition—a statutorily-defined term.  We plan to issue a report with our final analysis of these and other issues  in October 2003.
To address the reliability of information that FCC collected, we randomly  sampled 100 of approximately 700 cable franchises that responded to  FCC’s 2002 cable rate survey. We selected a random sample of 100 cable  franchises so that we could make estimates about the entire population of  about 700 cable franchises that responded to the FCC.  We asked these  franchises a series of questions about how they completed a portion of  FCC’s survey that asks about the cost factors underlying annual cable rate  changes. To examine FCC’s process for classifying cable franchises as to  whether they face effective competition, we reviewed how various  franchises were classified according to FCC’s information and whether  these classifications continue to accurately reflect current circumstances.
Our work has focused on examining whether FCC’s annual report on cable  rates is providing reliable information on the causes of rate increases and  the competitive status in video markets.  In summary, our preliminary  analysis suggests that some of FCC’s information on cable companies is  inconsistent and potentially misleading. In particular:    Our preliminary analysis of the responses provided by 100 cable franchises  indicates that FCC’s 2002 survey does not provide a reliable source of  information on the cost factors underlying cable rate increases. We found  two key causes of variation in how companies completed the survey. First,  FCC provided minimal instructions or examples on how the portion of the  survey covering the cost factors underlying rate increases should be  completed. As a result, we found that cable companies made varying  assumptions about how to complete the survey. Second, the FCC survey  form requires that the reported dollar amounts reported for factors that  might underlie rate changes—5 cost factors and a non-cost factor are  included on the form—sum to the reported rate increase for the year. In  the absence of guidance on how to achieve this requisite balance, cable  companies approached the question in varying ways. In particular, most of  the companies told us that they adjusted one of the 5 cost factors for the  purpose of the required balancing, thereby misreporting actual cost  changes that had occurred.
Our preliminary findings show possible inaccuracies in FCC’s current  classification of cable franchises regarding their effective competition  status. We found indications that there are cases in which a finding of  effective competition in a particular franchise area that might have existed  in the past no longer seemed accurate. Nevertheless, the determination of  effective competition remained in effect because the franchising authority  had not filed a petition that would challenge that finding. In fact, we found  that such petitions are rare.
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 in mountainous  or remote areas. By the late 1970s, cable began to compete more directly  with free over-the-air television by providing new networks—available  only on cable systems—such as HBO (introduced in 1972), Showtime  (introduced in 1976), and ESPN (introduced in 1979). According to FCC,  cable’s penetration rate—as a percent of television households—increased  from 14 percent in 1975 to 24 percent in 1980 and to 65 percent by 2002.  Cable television is by far the largest segment of the subscription video  market, a market that includes cable television, satellite service (direct  broadcast satellite (DBS) providers such as DirecTV), and other  technologies that deliver video services to customers’ homes.
Cable companies deliver video programming to customers through cable  systems. These systems consist of headends—facilities where  programming from broadcast and cable networks is aggregated—and  distribution facilities—the wires that carry the programming from the  headend to customers’ homes. Depending on the size of the community, a  single headend can serve multiple communities or several headends may  be required to serve a single large community. At the community level,  cable companies obtain a franchise license under agreed-upon terms and  conditions from a franchising authority, such as a township or county. In  some cases, state public service commissions are also involved in cable  regulation.
During cable’s early years, franchising authorities regulated many aspects  of cable television service, including franchise terms and conditions and  subscriber rates. In 1984, the Congress passed The Cable Communications  Policy Act, which imposed some limitations on franchising authorities’  regulation of rates. 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 that includes the broadcast networks—unless a cable  system has been found to be subject to effective competition, which the  act defined. The act also gave FCC authority to regulate any unreasonable  rates for upper tiers (often referred to as expanded-basic service), which  includes 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, CNN, and so forth. In anticipation of  growing competition from satellite and wire-based providers, the  Telecommunications Act of 1996 phased out all regulation of expanded- basic service rates by March 31, 1999. However, franchising authorities  retain the right to regulate basic cable rates in cases where no effective  competition has been found to exist.
As required by the 1992 act, FCC annually reports on cable rates for  systems found to have effective competition compared to systems without  effective competition. To fulfill this mandate, FCC annually surveys cable  franchises regarding their cable rates. In 2002, the survey included  questions about a range of cable issues including the percentage of  subscribers purchasing non-video services and the specifics of the  programming channels offered on each tier to better understand the cable  industry.
Until recently, cable companies usually encountered limited competition  in their franchise areas. Some franchise agreements were initially  established on an exclusive basis, thereby preventing wire-based  competition to the incumbent cable provider. 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. Still, only limited wire-based competition has emerged,  in part because it takes large capital expenditures to construct a cable  system. However, competition from DBS has grown rapidly in recent  years. Initially unveiled in 1994, DBS served over 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  companies.
In a recently released report, we found that competition in the  subscription video market can have a significant impact on cable rates.  Using an econometric model, we found that franchise areas with a second  wire-based video provider had rates approximately 17 percent lower than  similar franchise areas without such a competitor. We did not, however,  find that competition from DBS providers is associated with lower cable  prices, although we did find that where DBS companies provide local  broadcast networks to their customers, cable companies provide more  channels than in areas where DBS companies do not provide local  broadcast channels. Moreover, we also found that DBS providers obtain a  substantially higher level of subscribers in areas where they are providing  local broadcast channels.
section_title: FCC’s Cable Rate Survey Does Not Appear to Provide a Reliable Source of Information on the Cost Factors Underlying Cable Rate Increases
paragraphs: FCC’s annual cable rate survey seeks information on cable franchises’ cost  changes that may underlie changes in cable rates during the preceding  year. To evaluate the reliability of these statistics, we asked 100 of the  approximately 700 franchises that FCC surveyed in 2002 to describe how  cost change information that they provided to FCC was calculated. Figure  1 shows the actual portion of the FCC survey which franchises completed  to provide their cost change information.
E.  Programming Service Charges in Community In the following, the "basic cable service tier" or BST is the service tier that includes the retransmission of  over-the-air broadcast signals and may include a few satellite or regional channels.  A "cable programming service tier" or  CPST  is any other tier containing programming other than that on the BST, pay-per-channel, or pay-per-view.   CPST1  refers to the major CPST and typically meets two criteria: It has the most channels  and most subscribers among the CPST tiers (if more than one CPST is offered).  Sometimes a "mini-tier"  with considerably fewer channels has the most subscribers among the CPSTs.  This mini-tier is considered  CPST2 , whether or not it has the most subscribers.
Monthly Charges for Programming Services 48  49  50  51  Year-to-date change in monthly charge on row 50  Monthly charge for  BST  Monthly charge for  CPST1  Monthly charge for  BST plus CPST1  (rows 48 + 49)
For July 1, 2001 and July 1, 2002, allocate the change shown on row 51 by estimating the dollars and cents  that each factor, below, contributed.  The total of these factors (row 58) should equal the change on row 51. 52  License or copyright fees,  existing  programs  53  License or copyright fees,  new  programs  54  Headend or distribution facility investment  55  General inflation, not included elsewhere 56  Other cost changes (positive or negative)  57  Non-cost-related factors (positive or negative)  58  Total of rows 52-57 (must equal row 51) -----  -----  -----  -----  -----  -----  -----  Our discussions with cable franchises indicated considerable variation in  how franchises completed this section of the 2002 FCC cable rates survey.  Our preliminary observations indicate that there are two causes for the  resulting variation: (1) there were insufficient instructions or examples on  how the form was supposed to be completed, leading to confusion among  cable operators regarding what to include for the different cost factors and  how to calculate each of them; and (2) the requirement that the cost and  non-cost factors sum to the reported annual rate increase caused many  cable operators to adjust one or more of the cost factors, thereby resulting  in data that might not provide an accurate assessment of the cost factors  underlying cable rate increases.
Lack of adequate instructions. Our interviews with 100 cable franchises  indicate that the lack of specific guidance regarding the cost change  section of the survey caused considerable confusion about how to fill out  the form. Every franchise that we spoke with said it was unclear what FCC  expected for at least one of the six factors (5 cost factors as well as a non- cost factor); 73 of the 100 franchises said that the instructions were  insufficient. In particular, several cable representatives we interviewed  noted that there were no instructions or examples to show how to  calculate investment, what types of cost elements should go into the other  costs category, and what FCC meant by non-cost factors. This lack of  guidance created considerable variation in the approaches taken to  develop the cost factors. Table 1 provides information on the approaches  cable franchises used to complete the portion of the survey pertaining to  cost and non-cost factors underlying rate changes.
Requirement that factors sum to the reported annual rate change. Our  survey of 100 cable franchises that responded to FCC’s 2002 cable rates  survey indicated that a second source of confusion relates to the  requirement that the sum of the underlying cost and non-cost factors (see  fig. 1 lines 52-57) equal the change in the franchise’s cable rates (see fig. 1  line 51). This portion of FCC’s survey was originally designed during the  1990s when both basic and expanded-basic services were regulated. At  that time, cable companies were required to justify any rate increases the  cable company implemented based on cost increases that it had incurred  during the year. An FCC official told us that the rate/cost factor portion of  the form was designed to mirror a regulatory form that was used at that  time to justify rate changes. When expanded-basic services were  deregulated in March 31, 1999, FCC realized that cost factors would no  longer necessarily equal the yearly rate change because companies were  no longer required to tie rate changes to explicit cost factors for regulatory  purposes. In the 1999 cable rates survey, FCC added the non-cost line in  this section of the survey and continued to require that the cost factors  and the non-cost factor sum to the reported annual rate change.
FCC officials told us that cable operators could use the non-cost factor  element to make up any difference (positive or negative) between their  changes in costs and rates. However, based on our findings, it appears that  this may not have been clearly communicated to cable franchises. We  found that only 10 franchises took this approach and instead, most  franchises told us that they chose to change their estimate of one or more  of the cost factors. In most cases, cable representatives told us that this  meant reducing other cost factors because most franchises told us that  their actual annual cost increases for the year covered by the 2002 survey  exceeded their rate change for expanded-basic service. In other words,  most franchises—84 of the 100 franchises we spoke with—did not provide  a complete or accurate accounting of their costs changes for the year. The  following are some examples of how the franchises we surveyed chose to  equalize the cost factors with the rate change.
Fifteen franchises said they entered dollar values in the factors until the  entire rate increase was justified and did not consider the remaining cost  factors;   Twenty franchises said they chose to adjust the dollar estimates in existing  and/or new programming in order to balance costs and rates;   Seven franchises said they chose to adjust the costs included for  investment in order to balance costs and rates;    Twenty-seven franchises said they chose to adjust the amount of their  inflation estimate to ensure that costs and rates were in balance;   Twenty-six franchises said they chose to adjust the other costs factor to  ensure that costs and rate changes were in balance; and   Four franchises said they adjusted more than one of the cost factors in  order to balance costs and rates. For example, one franchise chose to  adjust all of the factors by a uniform percentage in order to retain a  constant ratio of cost increases.
section_title: FCC’s Process for Updating and Revising its Classification of the Competitive Status of Cable Franchises May Lead to Classifications that are No Longer Accurate
paragraphs: The 1992 Cable Act established three conditions for a finding of effective  competition, and a fourth was added in the 1996 Act. Specifically, a finding  of effective competition in a franchise area requires that FCC has found  one of the following conditions to exist:    Fewer than 30 percent of the households in the franchise area subscribe to  cable service (low-penetration test).
At least two companies unaffiliated with each other offer comparable  video programming service (through a wire or wireless—e.g., DBS— service) to 50 percent or more of the households in the franchise area and  at least 15 percent of the households take service other than from the  largest company (competitive provider test).
The franchising authority offers video programming service to at least 50  percent of the households in the franchise area (municipal test).
A local telephone company or its affiliate (or any other company using the  facilities of such carrier or its affiliate) offers video programming, by  means other than direct broadcast satellite, that is comparable to that  offered by the cable provider in the franchise area (LEC test).
Franchising authorities have primary authority to regulate basic cable  rates. However, these rates may only be regulated if the cable system is  not facing effective competition. Under FCC rules, in the absence of a  demonstration to the contrary, cable systems are presumed not to face  effective competition. The cable operator bears the burden of  demonstrating that it is facing effective competition. Once the presence of  effective competition has been established, the franchising authority is no  longer authorized to regulate basic cable rates. FCC does not  independently update or revise an effective competition finding once it is  made. An effective competition finding may be reversed if a franchising  authority petitions to be recertified to regulate basic rates by  demonstrating that effective competition no longer exists. However, such  petitions are rare.
Our preliminary review of the approximately 700 cable franchises that  responded to FCC’s 2002 cable rates survey suggests that the agency’s lack  of any updates or reexamination of the status of competition in franchise  areas may lead to some classifications of the competitive status of  franchises that do not reflect current conditions. For example:    Forty-eight of the 86 franchises in the sample that FCC had classified as  satisfying the low-penetration test for effective competition actually  reported current information to FCC on their operations that appeared,  based on our preliminary calculations, to indicate that current penetration  rates are greater than the 30 percent threshold. Ten cable franchises  appeared to have a penetration rate exceeding 70 percent—a full 40  percentage points above the legislated low-penetration threshold.
Forty of the 262 franchises in the FCC survey that had been classified as  having effective competition by FCC also reported that the franchising  authority was currently regulating basic service rates. This would not be in  accord with the statutory requirement. It is possible that such an  inconsistency could occur because cable companies incorrectly completed  FCC’s survey in some fashion.
Although the survey form asks the cable franchise whether they face  effective competition in the franchise area, those responses are not always  consistent with information maintained by FCC regarding whether there  has been an official finding of effective competition. When FCC’s  information conflicts with the survey response, FCC overrides the answer  provided by the cable franchise. We found that FCC staff overrode the  survey responses on effective competition for 24 percent of all franchises  in its 2002 survey.
Also, we have searched for instances in which franchising authorities  sought to have a finding of effective competition reversed. We found two  instances in which FCC reversed a finding of effective competition.  However, in one of these instances involving ten franchises in Delaware,  some of the franchises appear to remain classified as having effective  competition even though FCC reversed the position in 1999.
In its 2002 Report on Cable Industry Prices, FCC acknowledges that the  classification of the competitive status of some franchises may not reflect  current conditions. Some franchises that face competition may not have  filed a petition, and therefore are not classified as facing effective  competition. Also, some franchises may have previously met the criteria  for a finding of effective competition, but because of changing  circumstances may not currently meet the criteria and remain classified as  facing effective competition.
section_title: Additional GAO Work on Cable Rate and Competition Issues
paragraphs: We are conducting additional work on the issues discussed today and a  more complete analysis will be included in our final report, which we plan  to issue in October 2003. In addition to the topics discussed today, we will  be providing a more comprehensive analysis of the factors underlying  recent cable rate increases, the impact of competition on cable rates and  service, and cable tiering issues.
Mr. Chairman, this concludes my prepared remarks. We would be pleased  to answer any questions you or other members of the Committee may  have.
section_title: Contact and Acknowledgments
paragraphs: For questions regarding this testimony, please contact William B. Shear on  (202) 512-4325 or at shearw@gao.gov. Individuals making key  contributions to this testimony included Amy Abramowitz, Mike Clements,  Keith Cunningham, Michele Fejfar, Wendy Turenne, Mindi Weisenbloom,  and Carrie Wilks.