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. 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. 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. 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. 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. 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. 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. 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) 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. The General Accounting Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability. 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Summary: 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. 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.