Telecommunications: Subscriber Rates and Competition in the Cable
Television Industry (25-MAR-04, GAO-04-262T).			 
                                                                 
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.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-262T					        
    ACCNO:   A09591						        
  TITLE:     Telecommunications: Subscriber Rates and Competition in  
the Cable Television Industry					 
     DATE:   03/25/2004 
  SUBJECT:   Cable television					 
	     Commercial television broadcasting 		 
	     Communication satellites				 
	     Competition					 
	     Cost analysis					 
	     Data collection					 
	     Data integrity					 
	     Rates						 
	     Reporting requirements				 
	     Telecommunication industry 			 
	     Price increases					 

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GAO-04-262T

United States General Accounting Office

GAO Testimony

Before the Committee on Commerce, Science, and Transportation, U.S. Senate

For Release on Delivery

Expected at 9:30 a.m. EST TELECOMMUNICATIONS

Thursday, March 25, 2004

       Subscriber Rates and Competition in the Cable Television Industry

Statement of Mark L. Goldstein, Director Physical Infrastructure Issues

GAO-04-262T

Highlights of GAO-04-262T, a testimony before the Committee on Commerce,
Science, and Transportation, U.S. Senate

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.

www.gao.gov/cgi-bin/getrpt?GAO-04-262T.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Mark Goldstein at (202)
512-2834 or [email protected].

March 25, 2004

TELECOMMUNICATIONS

Subscriber Rates and Competition in the Cable Television Industry

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
`a 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.

Mr. Chairman and Members of the Committee:

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.1 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.

1See U.S. General Accounting Office, Telecommunications: Issues Related to
Competition and Subscriber Rates in the Cable Television Industry,
GAO-04-8 (Washington, D.C.: Oct. 24, 2003) and U.S. General Accounting
Office, Telecommunications: Wire-Based Competition Benefited Consumers in
Selected Markets, GAO-04-241 (Washington, D.C.: Feb. 2, 2004).

To address these issues, we developed an empirical model (our
cablesatellite model) that examined the effect of competition on cable
rates and service using data from 2001;2 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:

o  	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.

2Our model was based on data from 2001 since this was the most recent year
for which we were able to acquire the required data on cable rates and
services and DBS penetration rates when we began our analysis.

o  	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.3 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

o  	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.

o  	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.

o  	Today, subscribers have little choice regarding the specific networks
they receive with cable television service. Adopting an `a 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 `a 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 `a la carte service, consumers'
purchasing

3See U.S. General Accounting Office, Telecommunications: Data Gathering
Weaknesses In FCC's Survey Of Information on Factors Underlying Cable Rate
Changes, GAO-03-742T (Washington, D.C.: May 6, 2003).

patterns, and whether certain niche networks would cease to exist with `a
la carte service-make it difficult to ascertain how many consumers would
be better off and how many would be worse off under an `a la carte
approach.

o  	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.

Background 	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.4 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.5 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.6 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 expandedbasic
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.

4Under the 1984 Act and FCC's subsequent rulemaking, over 90 percent of
all cable systems were not subject to rate regulation.

5Under statutory definitions in the 1992 Act, substantially more cable
operators were subject to rate regulations than had previously been the
case.

6Basic and expanded-basic are the most commonly subscribed to service
tiers-bundles of networks grouped into a package-offered by cable
operators. In addition, customers in many areas can purchase digital tiers
and also premium pay channels, such as HBO and Showtime.

  Competition Leads to Lower Cable Rates and Improved Quality and Service among
  Cable Operators

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.

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.7 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

7See Federal Communications Commission, Annual Assessment of the Status of
Competition in the Market for the Delivery of Video Programming, Ninth
Annual Report, FCC 02-338 (Washington, D.C.: Dec. 31, 2002).

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.8 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.

8In 1999, the Congress passed the Satellite Home Viewer Improvement Act,
which allows satellite operators to provide local broadcast stations to
their customers. Prior to this act, satellite operators were limited to
providing local broadcast stations to unserved areas where customers could
not receive sufficiently high-quality, over-the-air signals. This practice
had the general effect of preventing satellite operators from providing
local broadcast stations directly to customers in most circumstances.

  Concerns Exist about the Reliability of FCC's Data for Cable Operator Cost
  Factors and Effective Competition

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.9 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.

  A Variety of Factors Contribute to Cable Rate Increases

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.10 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 2002.11 Further, the average license fees for the sports
networks were substantially higher than the average for the nonsports
networks (see fig. 1).

9See U.S. General Accounting Office, Telecommunications: Issues Related to
Competition and Subscriber Rates in the Cable Television Industry,
GAO-04-8 (Washington, D.C.: Oct. 24, 2003), page 45 for a full discussion
of our recommendations.

10Using data from Kagan World Media, we found that the average fees cable
operators must pay to purchase programming (referred to as license fees)
increased by 34 percent from 1999 to 2002.

11The seven national sports networks that we included in our analysis were
ESPN, ESPN Classic, ESPN2, FOX Sports Net, The Golf Channel, The Outdoor
Channel, and the Speed Channel.

Figure 1: Average Monthly License Fees per Subscriber-Sports Networks v.
Nonsports Networks, 1999-2002

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.12

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.13 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.

12Advertising sales revenues net of expenses incurred to insert and sell
local advertising would offset a lower percentage of cable operators'
programming expenses.

13For example, FCC reported that approximately 74 percent of cable systems
had system capacity of at least 750 MHz, and that approximately 70 percent
of cable subscribers were offered high-speed Internet access by their
cable operator in 2002.

  Some View Ownership Affiliations as an Important Indirect Influence on Cable
  Rates

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).

Figure 2: Ownership Affiliation of the 90 Most Carried Cable Networks

Note: Cable networks were assumed affiliated if the ownership interest was
50 percent or greater.

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

  Several Factors Generally Lead Cable Operators to Offer Large Tiers of
  Networks Instead of Providing A La Carte or Minitier Service

broadcasters or with cable operators-had no influence on cable networks'
license fees.14 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.

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 `a 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.

14In the cable license fee model, we regressed the average monthly license
fee for 90 cable networks on a series of variables that might influence
the license fee. See GAO-04-8 for a list of variables included in that
model.

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 `a la
carte approach would be mitigated.

If cable subscribers were allowed to choose networks on an `a 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).

Figure 3: Percentage of Cable Network Advertising Revenue Compared with
License Fee Revenues for 79 Cable Networks, 1999 - 2002

Note: Although cable networks have other sources of revenues, advertising
and license fee revenues comprise the vast majority of cable network
revenues.

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.15 According to cable network representatives we interviewed, any
movement of networks from the most widely distributed tiers to an `a 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

15Most contracts negotiated between cable networks and cable operators
specify the tier that the network must appear on. We were told that cable
networks include these provisions in their contracts because their
business models are developed on the basis of a wide distribution of their
network.

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 `a la carte
system. Moreover, most cable networks we interviewed also believe that
programming diversity would suffer under an `a 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 `a 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 `a 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
`a 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 `a la carte approach. These factors
include how cable operators would price their services under an `a 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.

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

  Industry Participants Have Cited Certain Options That May Address Factors  o

Contributing to Rising 	evidence that reregulation needs to be considered
because it might be the only alternative to mitigate increasing cable
rates and cable operators'

Cable Rates 	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.

o  	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.

o  	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.

o  	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.

Contact and	For questions regarding this testimony, please contact Mark L.
Goldstein on (202) 512-2834 or [email protected]. Individuals making key

Acknowledgments 	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.

                       Appendix I: Scope and Methodology

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.1 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.

1See U.S. General Accounting Office, Telecommunications: Issues in
Providing Cable and Satellite Television Services, GAO-03-130 (Washington,
D.C.: Oct. 15, 2002).

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:

o  	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.

o  	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.

o  	We compared the average license fees among three groups of networks:
those that are majority-owned by a broadcaster, those that are
majorityowned 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.

o  	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.

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