Telecommunications: Issues Related to Competition and Subscriber 
Rates in the Cable Television Industry (24-OCT-03, GAO-04-8).	 
                                                                 
Over 70 million American households receive television service	 
from a cable television operator. 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.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-8						        
    ACCNO:   A08767						        
  TITLE:     Telecommunications: Issues Related to Competition and    
Subscriber Rates in the Cable Television Industry		 
     DATE:   10/24/2003 
  SUBJECT:   Cable television					 
	     Commercial television broadcasting 		 
	     Competition					 
	     Rates						 
	     Television broadcasting				 
	     Data integrity					 

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GAO-04-8

United States General Accounting Office

GAO Report to the Chairman, Committee on Commerce, Science, and Transportation,
                                  U.S. Senate

October 2003

TELECOMMUNICATIONS

Issues Related to Competition and Subscriber Rates in the Cable Television
                                    Industry

GAO-04-8

Highlights of GAO-04-8, a report to Senator John McCain, Chairman,
Committee on Commerce, Science, and Transportation, U.S. Senate

Over 70 million American households receive television service from a
cable television operator. 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 recommends that the Chairman of the FCC

o  	take immediate steps to improve the cable rate survey and

o  	review the commission's process for maintaining the status of
effective competition.

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 status of effective
competition up to date. GAO believes that FCC should examine whether
cost-effective alternative processes could help provide the Congress with
more accurate information.

www.gao.gov/cgi-bin/getrpt?GAO-04-8.

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].

October 2003

TELECOMMUNICATIONS

Issues Related to Competition and Subscriber Rates 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. In particular, GAO found that 84 of the 100 franchises it
surveyed did not provide a complete or accurate accounting of their cost
changes for the year. 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. Policies to bring about
lower cable rates could have other effects that would need to be
considered.

Contents

  Letter

Results in Brief
Background
Competition Leads to Lower Cable Rates and Improved Quality

and Service among Cable Operators
Concerns Exist about the Reliability of FCC's Data for Cable

Operator Cost Factors and Effective Competition
A Variety of Factors Contribute to Cable Rate Increases
Some View Ownership Affiliations as an Important Indirect

Influence on Cable Rates

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

Industry Participants Have Cited Certain Options That May

Address Factors Contributing to Rising Cable Rates
Conclusions
Recommendations for Executive Action
Agency Comments and Our Evaluation

                                       1

                                      3 7

                                       9

                                     12 20

27

30

39 44 45 46

Appendix I Scope and Methodology

Appendix II GAO Survey of Cable Franchises

Appendix III 	GAO's Modifications to FCC's Competition Classification

Appendix IV Cable-Satellite Model 56

Definitions and Sources for Variables 56
Estimation Methodology and Results 57

  Appendix V Cable Network Carriage Model 63

Set-up of Our Cable Network Carriage Model 63
Data Sources and Descriptive Statistics 64
Estimation Methodology and Results 66
Alternative Specification 68

Appendix VI 	Comments from the Federal Communications Commission 70

GAO Comments 76

Appendix VII Comments from Industry Participants

American Cable Association
Consumer Federation of America
Consumers Union
National Association of Broadcasters
National Association of Telecommunications Officers and Advisors
National Broadcasting Company
National Cable and Telecommunications Association
News Corporation
Satellite Broadcasting and Communications Association
Viacom
Walt Disney Company

80

80 80 81 82 82 83 84 85 86 86 86

Appendix VIII GAO Contacts and Staff Acknowledgments 88

GAO Contacts 88 Staff Acknowledgments 88

      Tables                                                          
                    Table 1: Definition and Source for Variables           56 
                           Table 2: Descriptive Statistics                 58 
                  Table 3: Three-Stage Least Squares Model Results         59 
                    Table 4: Definitions and Sources of Variables          65 
                           Table 5: Descriptive Statistics                 66 
                           Table 6: Logistic Model Results                 67 
                           Table 7: Logistic Model Results                 69 

Figures

Figure 1: Section of FCC's 2002 Cable Rate Survey Covering Cable
Franchises' Rate and Cost Changes 13 Figure 2: Change in the General and
Cable Television Consumer Price Indexes, 1997 - 2002 21

Figure 3: Average Monthly License Fees per Subscriber-Sports Programming
Networks v. Nonsports Networks, 1999 - 2002 23

Figure 4: Expenditures by 79 Cable Networks to Produce

Programming, 1999 - 2002 24 Figure 5: Cable Industry Infrastructure
Expenditures, 1996 - 2002 26 Figure 6: Ownership Affiliation of the 90
Most Carried Cable

Networks 28

Figure 7: Percentage of Cable Network Advertising Revenue Compared with
License Fee Revenues for 79 Cable Networks, 1999 - 2002 35

Abbreviations

ACA American Cable Association
BLS Bureau of Labor Statistics
CPI consumer price index
DBS direct broadcast satellite
FCC Federal Communications Commission
LEC local exchange carrier
MMDS multichannel multipoint distribution service
MSA metropolitan statistical area
MSO multiple system operator
NATOA National Association of Telecommunications Officers and

Advisors NBC National Broadcasting Company NCTA National Cable and
Telecommunications Association YES Yankees Entertainment and Sports
Network

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

United States General Accounting Office Washington, DC 20548

October 24, 2003

The Honorable John McCain Chairman, Committee on Commerce, Science, and
Transportation United States Senate

Dear Mr. Chairman:

In recent years, cable television has become a major component of the
American entertainment industry-today more than 70 million households
receive their television service through a subscription to 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 (such as DIRECTV and EchoStar)-which
did not exist a decade ago-has emerged and grown rapidly in recent years.
Nevertheless, cable rates continue to increase at a faster pace than the
general rate of inflation.

You asked us to review several issues related to recent increases in cable
rates and the competitiveness of the subscription video industry-an
industry that includes cable television, satellite service (including DBS
operators), and other technologies that deliver video services to
customers' homes. We agreed to (1) examine the impact of competition in
the subscription video industry on cable rates and service; (2) assess 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) examine the causes of recent
cable rate increases; (4) assess 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) discuss 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) discuss options to address factors
that could be contributing to cable rate increases.

To respond to the first objective on the impact of competition on cable
rates and service, we used an empirical model (our cable-satellite model)
that we previously developed that examines the effect of competition on
cable rates and service.1 Using data from 2001, 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
DBS penetration rates for areas throughout the United States. We further
developed the model to more explicitly examine whether varied forms of
competition have differential effects on cable rates. We also discussed
the degree and impact of competition in the subscription video industry
with an array of industry stakeholders and experts (see below).

For the second objective on the reliability of data in FCC's annual cable
rate report, we randomly sampled 100 of approximately 750 cable franchises
that responded to FCC's 2002 cable rate survey.2 We designed this sample
to be representative of the universe of franchises that responded to FCC's
survey. Using a telephone survey (our cable franchise survey), we 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 (see app. II). We also examined FCC's process for classifying
cable franchises regarding whether they face effective competition, a term
defined by statute (see app. III).

For the third, fourth, fifth, and sixth objectives addressing the causes
of recent cable rate increases, the impact of ownership affiliations, why
cable operators group networks into tiers, and possible options for
addressing factors that may be contributing to rate increases, we
interviewed officials and obtained documents and data from FCC and the
Bureau of Labor Statistics. We also interviewed officials from several
trade associations and other organizations: the National Cable and
Telecommunications Association (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, three major sports leagues, and
the Cable Television Advertising Bureau. We also conducted semistructured

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

2Each year, FCC samples between 700 and 800 of the universe of roughly
10,000 cable systems using a stratified sampling approach that is based on
the status of effective competition and the size of the cable system.

interviews with a variety of companies: 11 cable operators, one DBS
operator, four broadcast networks (such as ABC and NBC), 15 cable networks
(such as CNN and ESPN), and representatives of five financial analysis
firms. Furthermore, we used data on cable network revenues and programming
expenses that we acquired from Kagan World Media, which is a private
communications research firm that specializes in cable industry data. We
used these data to develop models that examine whether ownership of cable
networks by broadcasters or by cable operators influences (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).

We conducted our review from December 2002 through September 2003 in
accordance with generally accepted government auditing standards. For
additional information on our scope and methodology, see appendix I.

                                Results in Brief

Competition from wire-based and DBS operators leads to lower cable rates
and improved quality and service among cable operators. Competition from a
wire-based provider-that is, a competitor using a wire technology, such as
a second cable operator, a local telephone company, or an electric
utility-is limited to very few markets. However, in those markets where
this competition is present, cable rates are significantly lower-by about
15 percent-than cable rates in similar markets without wire-based
competition. Since 1999, when DBS operators acquired the legal right to
provide local broadcast stations (such as affiliates of ABC, CBS, Fox, and
NBC), these companies have emerged as important competitors to cable
operators. In particular, in areas where subscribers can receive local
broadcast stations from both primary DBS operators, the DBS penetration
rate-that is, the percentage of households that subscribe to satellite
service-is approximately 40 percent higher than in areas where subscribers
cannot receive local broadcast stations from both primary DBS operators.
In addition, the DBS provision of local broadcast stations has induced
cable operators to improve the quality of their service by providing their
subscribers with approximately 5 percent additional cable networks.

FCC's cable rate report may not provide reliable information on the
factors underlying recent cable rate increases or on the effect of
competition. In particular, 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; 73 of 100 cable franchises whom we spoke with said that

the instructions included with FCC's survey were insufficient. These
inconsistencies may have led to unreliable information in FCC's report on
the relative importance of factors underlying recent cable rate increases.
For example, we spoke with 83 franchises that reported zero for
infrastructure investment to FCC, 33 of these franchises told us that they
had incurred costs for such investments, thereby implying that they
understated the contribution of infrastructure investment to their 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. Regarding the effect of competition, because FCC's
process does not provide for updates or revisions to the competitive
classification of cable franchises unless specifically requested to do so,
FCC's classifications of cable franchises as having (or not having)
effective competition on the basis of the statutory definition do not
always accurately reflect current competitive conditions. In our analysis
of the impact of wire-based competition, we checked the current status of
competition in each franchise. The changes we made as a result of this
process 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 issues, such as media consolidation, also
necessitates reliable information in FCC's report. To improve the quality
and usefulness of the data FCC collects annually on cable television rates
and competition in the subscription video industry, 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.

Several key factors-including programming costs and infrastructure
investments-are putting upward pressure on cable rates. Programming costs
incurred by cable operators have risen considerably-on average by as much
as 34 percent-in the last 3 years, and, in particular, programming costs
associated with cable networks showing sporting events have risen even
more-on average by 59 percent-during the same time frame. The cable
industry has also spent billions of dollars in upgrading its
infrastructure to enable new services, such as digital channels and
broadband Internet access. While these upgrades benefit cable subscribers
by expanding the number of cable networks available and improving

picture quality, some of this benefit accrues to subscribers who purchase
new, advanced services, such as broadband Internet access. Additionally,
cable operators have increased spending on customer service, which
typically is now available 24 hours a day, 7 days a week. For the 9 cable
operators3 that provided financial information to us, we found that
programming expenses and infrastructure investment appear to be the
primary cost factors that have been increasing in recent years.4

Several industry representatives whom we spoke with believe that certain
factors related to the nature of ownership affiliations may also
indirectly influence cable rates through their influence on cable
operators' choice of which cable networks to carry and the cost to the
cable operator for the right to carry the networks. 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 the
level of 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 the likelihood that a cable operator would carry a
cable network. Holding constant certain other factors that might influence
the likelihood of a cable network being carried by a cable operator-such
as the popularity of the network or the type of programming the network
carries-we found that operators were more likely to carry cable networks
that were majority-owned by either cable operators or by broadcasters than
to carry other cable networks. Moreover, cable operators were
substantially more likely to carry cable networks that they directly own
than to carry cable networks owned by other cable operators, broadcasters,
or others.

Currently, technological, contractual, and economic factors lead cable
operators to sell large numbers of networks on tiers. On average, a basic
tier of service includes about 25 channels, including local broadcast
stations, and the next tier provides, on average, 36 additional channels,
including such popular cable networks as CNN and ESPN. Because

3These 9 cable operators that provided data to us serve approximately 62
percent of all cable subscribers in the United States as of 2002.

4While programming expenses are directly related to the cable rates, it is
less clear how much of the infrastructure investment underlies cable rate
increases since some of these costs are more directly related to the
provision of digital cable tiers and cable modem service.

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. Greater subscriber choice might be provided if
cable operators used an `a la carte system, wherein subscribers would
receive and pay for only the networks they want to watch. But, an `a la
carte system could impose additional costs on subscribers in the near term
because additional equipment-which many subscribers do not currently
have-will be required on every television attached to the cable system to
unscramble networks the subscriber is authorized to receive. Moreover, an
`a la carte system could alter the current economics of the cable network
industry, wherein cable networks derive significant revenues from
advertising. In particular, cable networks experiencing a falloff in
subscribers could also see an associated decline in advertising revenues,
since the amount that companies are willing to pay for advertising spots
is based on the number of potential viewers. Although cable networks may
take steps to reduce their production costs to compensate for the decline
in advertising revenue, cable networks may also raise the license fees
charged to cable operators for the right to carry the networks. If license
fees rise, some of the increase is likely to be passed on to subscribers.
Because of the reliance on advertising revenues by the cable network
industry, most cable networks require that cable operators place their
networks on widely distributed tiers. A variety of factors-such as the
pricing of `a la carte service, consumers' purchasing 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 made worse off under an `a la carte approach.
Creating a separate tier for sports channels may be viable because this
genre of programming has a loyal base of customers. However, sports
leagues may be reluctant to have sporting events appear on cable networks
that are placed on a separate sports tier because the programming would
not be widely available.

Certain options for addressing factors that may be contributing to cable
rate increases have been put forth. Although reregulation of cable rates
stands as a possible option, taking steps to promote competition would
help to reduce cable rates by leveraging the normal workings of the
marketplace. Specific options 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 the lower rates. We are

Background

not making any specific recommendations regarding the adoption of any of
these options.

FCC provided comments on a draft of this report in which they stated that
the agency is taking steps to redesign their survey questionnaire in an
attempt to obtain more accurate information. However, FCC questioned, on a
cost/benefit basis, the utility of adopting a revised process to keep the
status of effective competition in franchises up to date. We believe that
providing the Congress with reliable information on cable rates and
competition is important, and that more accurate effective competition
designations would help to accomplish this. Therefore, we believe that FCC
should examine whether cost-effective alternative processes exist to
enhance the accuracy of its effective competition designations. FCC's
comments are contained in appendix VI, along with our responses to those
comments. We also provided a draft of this report to several industry
participants and other experts for their review and comment. The comments
we received covered a broad range of issues and each groups' comments are
summarized in appendix VII.

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 (introduced in 1972), Showtime (introduced in 1976),
and ESPN (introduced in 1979). 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

township or county.5 During cable's early years, franchising authorities
regulated many aspects of cable television service, including franchise
terms and conditions and subscriber rates. In 1984, the Congress passed
the Cable Communications Policy Act, which imposed some limitations on
franchising authorities' regulation of rates.6 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.7 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.8 Expanded-basic service typically
includes such popular cable networks as USA Network, ESPN, and CNN. In
anticipation of growing competition from satellite and wire-based
operators, the Telecommunications Act of 1996 phased out all regulation of
expanded-basic service rates by March 31, 1999. However, franchising
authorities can regulate the basic tier of cable service where there is no
effective competition.

As required by the 1992 Act, FCC annually reports on average cable rates
for operators found to be subject to effective competition compared with
operators not subject to effective competition. To fulfill this mandate,
FCC annually surveys a sample of cable franchises regarding their cable
rates. In addition to asking questions that are necessary to gather
information to provide its mandated reports, FCC also typically asks
questions to help the agency better understand the cable industry. For
example, the 2002 survey included questions about a range of cable issues,
including the cost factors

5In some cases, state public service commissions are also involved in
cable regulation.

6The 1984 Act restricted regulation to only basic services for cable
systems that were not subject to effective competition. In its rulemaking,
FCC initially said that effective competition existed if three or more
over-the-air broadcast signals existed in a given market. Under this
definition, over 90 percent of all cable systems would be subject to
effective competition and therefore not subject to rate regulation.

7Under statutory definitions in the 1992 Act, substantially more cable
operators would be subject to rate regulations than had previously been
the case.

8Basic 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.

underlying changes in cable rates, the percentage of subscribers
purchasing other services (such as broadband Internet access and telephone
service), and the specifics of the programming channels offered on each
tier.

Some franchise agreements were initially established on an exclusive
basis, thereby preventing wire-based competition to the initial cable
operator. In 1992, the Congress prohibited the awarding of exclusive
franchises, and, in 1996, the Congress took steps to allow telephone
companies and electric companies to enter the video market. Initially
unveiled in 1994, DBS served about 18 million American households by June
2002. Today, two of the five largest subscription video service providers
are DIRECTV and EchoStar-the two primary DBS operators.

Today, wire-based competition-that is, competition from a provider using a
wire technology, such as a local telephone company or an electric
utility-is limited to very few markets, with cable subscribers in about 2
percent of markets having the opportunity to choose between two or more
wire-based video operators. However, in those markets where this
competition is present, cable rates are significantly lower-by about 15
percent-than cable rates in similar markets without wire-based
competition, according to our analysis of rates in 2001. DBS operators
have emerged as a nationwide competitor to cable operators. This
competition 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 channels has induced cable operators to improve the quality of
their service.

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

Wire-Based Competition Is Although the Telecommunications Act of 1996
sought to increase wire-Limited but, Where based competition, few
customers have a choice among companies Available, Has a providing video
service via wire-based facilities. In a recent report, FCC

noted that very few markets-about 2 percent-have been found to
haveDownward Impact on effective competition based on the presence of a
wire-based competitor.9 Cable Rates Our interviews with 11 cable operators
and five financial analysis firms

9See 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).

yielded a similar finding-wire-based competition is limited. Local
telephone companies are not providing widespread competition to cable, and
FCC also reported in their 2002 video competition report that the four
largest local telephone companies have largely exited the cable market.
Also, electric and gas utilities-which can use their networks and rights
of way to provide video services-are only providing competition to cable
operators in scattered localities. Broadband service providers-a
relatively new kind of entrant, such as Knology and WideOpenWest-are
building new, advanced networks to provide a bundle of services (video,
voice, and high-speed Internet access) and compete with cable operators as
well as with telephone companies. However, the three largest broadband
service providers only serve approximately 940,000 subscribers.

Although wire-based competition is limited, in those markets where it
exists, this competition has a measurable impact. According to our
cable-satellite model (see app. IV), in 2001, cable rates were
approximately 15 percent lower in areas where a wire-based competitor was
present.10 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
example, 1 cable operator told us that it stopped raising rates 3 years
ago in one market where a wire-based competitor had entered.11

DBS Has Become an Important Competitor to Cable Operators Nationwide

In recent years, DBS has become the primary competitor to cable operators
in the subscription video industry. As of June 2002, about 18 million
households-roughly 20 percent of the total video subscribers- were served
by DBS. Most cable operators that we interviewed described competition
from DBS as substantial. 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-that is, to offer the

10Our 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 this analysis.

11This cable operator also noted that current rates in the market are not
sustainable given the increasing cost of programming.

signals of over-the-air broadcast stations, such as affiliates of ABC,
CBS, Fox, and NBC-via satellite to their customers.12 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-that is, the percentage of housing units that have
satellite service-is approximately 40 percent higher than in areas where
subscribers cannot receive these stations from the DBS operators. In a
recent report, FCC noted that in 62 of the 210 television markets in the
United States, at least one DBS operator offered local broadcast
stations.13 Both EchoStar and DIRECTV continue to roll out the provision
of local broadcast stations in more markets.

DBS competition is associated with a slight reduction in cable rates as
well as improved quality and service. 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.14 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. These results indicate that cable operators are responding to DBS
competition and the provision of local broadcast stations by lowering
rates slightly and improving their quality. 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.

12In 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 signals 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.

13See Ninth Annual Report, FCC 02-338.

14In our October 2002 report (GAO-03-130), we did not find that DBS
competition was associated with lower cable rates. Although the parameter
estimate was negative- indicating that DBS competition was associated with
lower cable rates-the estimate was not statistically significant. As part
of our analysis for this report, we further examined and refined our
competition measures to more accurately reflect the true nature of
competition in the franchise areas that were included in our analysis.
Although the parameter estimate remains negative and the estimate is now
statistically significant, the magnitude of estimate is very small.

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

Responses to our cable franchise survey suggest that 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. In particular, we found that respondents did not fill out
FCC's survey on factors underlying cable rate increases in a consistent
manner. Additionally, FCC's designations of franchise areas as having (or
not having) effective competition do not always accurately reflect current
competitive conditions. For determinations of effective competition that
are based on DBS service, local franchising authorities have raised
concerns about the industry data used to substantiate these filings.
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. Additionally, the potential for this information to
be used in debates on important policy decisions, such as media
consolidation, also necessitates reliable information in FCC's report.

Weaknesses in FCC's Survey May Lead to Inaccuracies in the Relative
Importance of Cost Factors

Results of our cable franchise survey indicated considerable variation in
how cable franchises completed the section of FCC's 2002 cable rate survey
on which they provide information about the factors underlying recent
cable rate increases. Figure 1 shows the actual section of FCC's survey
that franchises completed to provide their cost change information; see
also appendix II for our cable franchise survey. We identified two key
problems with FCC's survey, as follows: a lack of guidance on how the
survey was to be completed, and the requirement that the sum of the cost
and noncost factors equal the change in cable rates.

Figure 1: Section of FCC's 2002 Cable Rate Survey Covering Cable
Franchises' Rate and Cost Changes

Our telephone survey with 100 cable franchises indicated that a lack of
specific guidance regarding this cost change section of the survey caused
considerable confusion about how to complete the form.15 Every franchise
that we surveyed said it was unclear what FCC expected for at least one of
the six factors (five cost factors plus a noncost factor) listed in figure
1 above, and 73 of the 100 franchises said that the instructions were
insufficient. In particular, several cable representatives we surveyed
noted that there were no instructions or examples to show how to calculate
investment, what types of cost elements should go into the "other cost"
category, and what FCC meant by "non-cost-related factors." This lack of
guidance created considerable variation in the approaches taken to develop
the cost factors. For example, although 76 of the franchises left the
noncost factors answer blank, other franchises included a number to

15See 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), page 7, for a
summary of the approaches used by cable operators to complete the form.

reflect a change in profit margin or the need to establish uniform rates
across franchises.

Our cable franchise survey also indicated that another source of confusion
for respondents was the requirement that the sum of the underlying cost
and noncost factors (see fig. 1, lines 52-57) equal the change in the
franchise's cable rates (see fig. 1, line 51). Because the expanded-basic
service was deregulated in 1999, it is no longer necessary that the cost
factors equal the yearly change in cable rates.16 FCC officials told us
that, cable operators could use the noncost factor element to adjust the
sum of the factors to ensure that they equal the change in annual rates.
That is, FCC officials suggested that after accounting for all cost
factors, any difference between the sum of these costs and the rate
change-whether positive or negative-could be accounted for by the noncost
factor. However, it appears that this information may not have been
clearly communicated to the cable franchises. We found that only 10 of the
100 franchises that we surveyed took this approach and instead, most
franchises told us that they chose to change their estimate of one or more
of the cost factors in order to achieve the rate-cost balance. In most
cases, cable representatives told us that this meant reducing other cost
factors because most franchises told us that their actual annual cost
increases for the year covered by the 2002 survey exceeded their rate
change for expanded basic service.17 In fact, most franchises-84 of the
100 franchises we surveyed-did not provide a complete or accurate
accounting of their cost changes for the year.18

According to FCC's 2002 cable rate report, cable franchises attributed 65
percent of their rate increases last year to the changes in the cost of
new and existing programming. Comparatively, investment and other cost
changes had a lesser role in the rate increases. However, our findings
regarding how cable franchises responded to FCC's survey on these issues

16In unregulated markets, for example, costs are an important factor in
price setting by companies, but several other key factors, such as
consumer demand and the competitiveness of the market, also influence the
market price. Thus, costs and prices need not move in tandem.

17Many cable franchises we surveyed said that their profit margins for
basic and expanded-basic cable services decreased in 2002, but many also
said that those decreases were offset by increased profits from other
services, such as cable Internet and digital cable.

18For example, 15 cable franchises said that they entered dollar values in
the factors until the entire rate increase was justified and did not
consider the remaining cost factors; many others cited specific cost
factors that were adjusted to reach a balance.

indicated that the survey findings may not accurately reflect the relative
importance of these cost factors. In particular, we found that most
franchises used real cost data to calculate the change in new or existing
programming costs. However, franchises often understated their estimates
for investments and other costs. For example, 33 of the 83 respondents who
entered zero for infrastructure investment, noted in our survey
discussions with them that there had been costs for such investments that
year. Similarly, we found that 64 franchises entered a zero for the other
cost category, even though half of these respondents told us during our
survey that there were costs in that category during that year. Moreover,
the investment and other cost factors were often used to adjust overall
costs to equal the rate change for the year-these adjustments most often
required downward adjustments in these cost factors. 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 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. FCC
reported that on July 1, 2001, competitive operators were charging an
average monthly rate of $34.93, while noncompetitive operators were
charging $37.13-a 6.3 percent differential for the combined basic and
expanded-basic tiers of service and equipment.19 In another analysis, FCC
looked at a subset of those areas that had been found to have effective
competition-that is, areas in which effective competition had been granted
on the basis of the existence of a wire-based competitor. Using a
regression model, FCC found that cable rates were nearly 7 percent lower
when such a competitor existed. Conversely, as previously mentioned, we
found a greater impact of wire-based competition using a similar model,
that is, rates were lower by 15 percent in locations where a wire-based
competitor was operating, according to our cable-satellite model.

One possible explanation for the difference between FCC's results and
those of our cable-satellite model may be the differences in the criteria
used to classify the status of competition. When reporting on differences

19See Federal Communications Commission, Report on Cable Industry Prices
(Washington, D.C.: Apr. 1, 2002). This is the most recent FCC report that
is consistent with the data used in our analysis.

between average rates for locations with and without effective
competition, FCC is mandated to include in the group defined to have
effective competition only those franchise areas that have had a finding
by FCC that is based on the statutory definition of effective
competition.20 However, FCC's process for implementing this mandate may
lead to situations in which the effective competition designation does not
reflect the actual state of competition in the current time frame. In
particular, key aspects of FCC's process are as follows:

o  	As set forth in FCC's rules, cable franchises are presumed not to face
effective competition.

o  	Cable operators can petition FCC for a finding of effective
competition, which would prohibit the franchising authority from
regulating the rates for basic-tier service.21 If the cable franchise can
show that at least one of the statutory criteria for effective competition
is met, FCC classifies the cable franchise as facing effective
competition.

o  	A franchising authority can file a petition for recertification to
regulate rates for basic-tier service, if it believes that the conditions
under which effective competition was granted no longer exist. If
recertification is granted, the franchise will no longer be considered to
have effective competition.

Our analysis of FCC's classification of cable franchises regarding
effective competition revealed that FCC's process for maintaining this
classification-namely, their reliance on external parties to file for

20The 1992 Act established three conditions for a finding of effective
competition, and a fourth was added in the 1996 Act. Specifically, a
finding of effective competition in a franchise area requires that FCC has
found one of the following conditions to exist: fewer than 30 percent of
the households in the franchise area subscribe to cable service
(low-penetration test); at least two companies unaffiliated with each
other offer comparable video programming service (through a wire or
wireless (e.g., DBS service)) to 50 percent or more of the households in
the franchise area, and at least 15 percent of the households take service
other than from the largest company (competitive provider test); the
franchising authority offers video programming service to at least 50
percent of the households in the franchise area (municipal test); or a
local telephone company or its affiliate (or any other company using the
facilities of such a carrier or its affiliate) offers video programming,
by means other than DBS, that is comparable to that offered by the cable
provider in the franchise area (local exchange carrier (LEC) test). For
the LEC test to be applicable, the telephone company and the cable
provider must be unaffiliated.

21Without a finding of effective competition, the cable operator must also
charge a uniform rate for cable services throughout the cable franchise.

changes in the classification-may lead to some classifications of the
competitive status of franchises that do not reflect current conditions.
Using data from FCC's 2002 cable rate 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
classification of effective competition for the franchise in FCC's
records. We found some discrepancies. We subsequently interviewed
officials from local franchising authorities in a number of areas with
seemingly inconsistent information to further investigate the nature of
the discrepancies.

Of 86 franchises in FCC's 2002 survey classified as satisfying the
low-penetration test22 for effective competition, we found that 48
franchises reported current information to FCC that indicate, on the basis
of our calculations, the penetration rate exceeded the 30 percent
threshold.23 We spoke with officials from three local franchising
authorities in areas having a low-penetration classification and found the
following: a Maryland franchise with a current penetration rate of 75
percent, a Virginia franchise with a penetration rate of 76 percent, and a
California franchise with a penetration rate of 97 percent. In the
aforementioned franchise areas, the local officials told us that they did
not know why the franchise was classified as low penetration. However, our
review of FCC filings found that the cable operators in those franchise
areas had filed for and received an effective competition finding that was
based on the low-penetration test in the years between 1994 and 1997.
Because there had never been a petition by the franchise authority to be
recertified to regulate basic cable rates, the franchise area remained
designated as having low penetration.

Under the statute, local franchising authorities do not have the authority
to regulate cable rates in franchises found to have effective competition.
Therefore, a franchise should not simultaneously be listed as facing
effective competition and having regulation of basic rates. Of 262
franchises in FCC's survey classified as facing effective competition, 40
also reported that the franchising authority regulated their basic service
rates. For example, FCC survey data include one franchise each in three

22The low-penetration test of effective competition applies if fewer than
30 percent of the households in the franchise area subscribe to cable
service.

23We calculated the penetration rate by dividing the number of franchise
subscribers by the number of households in the franchise area, as reported
by the cable operator to FCC.

states-New Jersey, Kentucky, and California-that were identified as facing
effective competition and also as subject to rate regulation. Officials
from the franchising authorities in New Jersey and Kentucky told us that
they indeed regulate the basic service tier, and that no competitor was
present. The official in Kentucky said that the discrepancy could be the
result of a wire-based competitor that was granted a franchise but has yet
to enter the market due to a lawsuit filed by the incumbent cable operator
attempting to block the competitor's entry. The official in New Jersey
said there is no competition in the area and the discrepancy may be
attributed to the fact that two cable operators hold franchise agreements
in the community, but do not compete against each other because each
serves a different area of the community. According to an official in the
California franchise, the franchise is not regulated-implying that the
cable operator incorrectly answered FCC's question. However, the official
also told us that there is no competition in the area-that is, while two
cable operators hold franchise agreements, they do not compete against
each other. We also found one franchise each in two states-Texas and
Illinois-that were identified as facing effective competition and also
reporting that they are subject to rate regulation. The official in the
Texas franchise said that the discrepancy may be attributed to the fact
that the incumbent cable operator filed for a finding of effective
competition, but a finding has not yet been granted. According to a local
franchising authority official in the Illinois franchise, the discrepancy
could be a result of a wire-based competitor that expressed an interest in
entering the market, but never did.

When the information contained in FCC's database on effective competition
conflicts with a cable operator's response on the annual survey, FCC uses
the information in their database for the purpose of its analysis of the
differences in prices in areas with and without effective competition. We
found that the survey responses on effective competition were not in
accord with FCC's files for 24 percent of all franchises-or 165
franchises-in its 2002 survey.

DBS Subscriber Information Used in Effective Competition Filings Has Not
Been Independently Validated

In the last several years, there have been dozens of petitions for a
determination of effective competition based on DBS competition. However,
the data on subscriber counts by zip code, which are used to make these
petitions, are considered proprietary business information by DBS
companies. DBS providers EchoStar and DIRECTV, as well as big dish
satellite provider Motorola, have agreed to make their individual market
data available to SkyTRENDS-a market research and reporting firm for the
satellite industry-which aggregates the information across

the providers.24 SkyTRENDS subsequently makes the aggregated data
available to cable operators for the purpose of making filings for
effective competition to FCC. Although FCC has not verified the SkyTRENDS
data or the method used by SkyTRENDS (and by cable operators) to calculate
penetration levels at the franchise level, it nonetheless accepts
SkyTRENDS data for these petitions.

The SkyTRENDS data used to make effective competition petitions that are
based on DBS competition are generally not available to government
regulators. According to government regulators and a SkyTRENDS official,
SkyTRENDS will not provide local franchising authorities with the
underlying data used to support these filings, unless (in accordance with
agreements with the satellite providers) the cable operator authorizes
that dissemination. However, franchising authorities do have access to the
data provided by cable franchises in their submissions for effective
competition to FCC. According to FCC officials, the agency has not
obtained detailed SkyTRENDS data since 1999. Some local franchise
authorities have questioned the accuracy and validity of the DBS data and
methods used by SkyTRENDS and cable operators for developing DBS
penetration levels used to support effective competition determinations.
Nevertheless, FCC has reiterated that it finds the SkyTRENDS data reliable
for purposes of effective competition determinations, and that these data
are the only available source for determining DBS penetration.

The Lack of Reliable Information May Compromise Monitoring and Oversight
of the Cable Industry

FCC's annual cable rate report provides an important source of information
about the cable industry. This report provides an extensive analysis of
the cable industry, including such important factors as cable rates,
factors underlying changes in cable rates, and provision of advanced
services (such as cable modem Internet access). FCC's findings provide the
Congress with information relevant to important policy decisions,
including the regulation of cable rates and/or services and media
consolidation and the convergence of video, voice, and data services. The
lack of reliable information in FCC's cable rate report may compromise the
ability of the Congress to make these important policy decisions and of
FCC to monitor and provide oversight of the cable industry. As such, it is
important for FCC's report to provide accurate, current, and relevant
information about the cable industry.

24The provision of DBS data for effective competition has recently been
transferred to the Satellite Broadcasting and Communications Association.

A Variety of Factors Contribute to Cable Rate Increases

During the preceding 5 years, cable rates have increased approximately 40
percent-well in excess of the approximately 12 percent increase in the
general rate of inflation. We found that a number of factors contributed
to the increase in cable rates. These factors include increased
expenditures on programming, infrastructure investments, and costs
associated with customer service. 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.

Rates for Cable Service Have Increased Rapidly, Far Outpacing the General
Rate of Inflation

FCC data indicate that the average monthly rate subscribers are charged
for the combined basic and expanded-basic tiers of service rose from
$26.06 in 1997 to $36.47 in 2002-a 40 percent increase over the 5 years.
This rate of increase is much greater than the general rate of inflation,
as measured by the Consumer Price Index (CPI), which rose 12 percent over
the same period. The CPI cable television subcategory index also shows
cable rates increasing much faster than inflation, although the rise is
somewhat less than the rise in rates as reported by FCC, likely because
the Bureau of Labor Statistics (BLS) calculates this index in a way that
takes into account the increasing number of channels offered over time. As
figure 2 shows, the CPI cable television subcategory index rose just under
30 percent in the same 5-year time frame.

Several cable industry officials told us that the general rate of
inflation is not an appropriate gauge for evaluating cable rates. In
particular, these officials told us that a more appropriate comparison
against which to evaluate the price increases for cable television would
be other services that have the same kind of cost factors, such as other
forms of entertainment media and services, which have also experienced
significant price increases in recent years. Moreover, several cable
industry representatives told us that on a per-channel basis, the increase
in cable rates has not been as dramatic because cable operators are
providing additional cable networks.25 However, it is not clear how
meaningful cable rates reported on a per-channel basis are since
subscribers cannot purchase cable service on a per-channel basis.
Alternatively, in a recent analysis, a researcher found that because the
number of hours subscribers

25In addition to the BLS cable television subcategory index, FCC also
reports the price per channel over time. Contrary to the BLS index
indicating that cable prices increased just under 30 percent, FCC found
that the price per channel rose by about 5 percent during this 5-year
span.

view cable networks has increased, cable rates, adjusted for this
additional viewing, have actually declined.26

Figure 2: Change in the General and Cable Television Consumer Price
Indexes, 1997 - 2002

As discussed in the previous section, one important factor contributing to
higher cable rates is cable operators' increased costs to purchase
programming from cable networks. Ten of the 11 cable operators, 8 of the
15 cable networks, and all of the financial analysts we interviewed told
us that higher programming costs contribute 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. Using

26See Wildman, S.S. Assessing Quality-Adjusted Changes in the Real Price
of Basic Cable Service. Michigan State University: September 10, 2003.

Increases in Expenditures on Cable Programming Contribute to Higher Cable
Rates

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 2002.27 Although these estimated
increases are somewhat different-which probably occurs because the data
underlying these analyses are from different sources-both methods appear
to reflect a substantial rise in programming expenses over the past few
years.

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 in the 3 years between 1999 and 2002.28 Conversely, for the
72 nonsports networks, the average increase in license fees for the same
period was approximately 26 percent. Further, the average license fees for
the sports networks were substantially higher than the average for other
networks. See figure 3 for a comparison of the average license fees for
sports programming networks compared with nonsports networks from 1999 to
2002.

27Since the rates that cable networks negotiate with their
clients/affiliates are confidential, we do not know the actual fees cable
operators pay to carry the networks. We thus relied on license fee data
compiled by Kagan World Media.

28The 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 3: Average Monthly License Fees per Subscriber-Sports Programming
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. Also, some executives cited the increased cost of
sports rights29 and increased competition among networks for the broadcast
rights of existing programming (such as syndicated situation comedies). As
figure 4 shows, data from Kagan World

29Two of the three sports leagues with whom we spoke told us that the cost
of sports rights, paid by networks to the leagues, has not increased
faster than the cost of other network programming in the last couple of
years. However, representatives of the leagues did note that the cost to
sports networks of producing sports programming is increasing because
these are live events that require complex and costly production.

Media indicate that of 79 cable networks we analyzed, expenditures by
these networks to produce programming increased from $6.47 billion in 1999
to $8.90 billion in 2002, or by about 38 percent.30

Figure 4: Expenditures by 79 Cable Networks to Produce Programming, 1999 -
2002

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. In
fact, 3 cable networks with whom we spoke said that they believe at least
half of the license fees cable operators pay to carry their networks are
recouped through the sale of the local advertising time that cable
networks allow the cable operators to sell, which typically amounts to 2
minutes per hour. According to industry data, cable operators received
over $3 billion from the sale of local advertising time in recent

30For this analysis, we only used networks included in the Kagan
publication that had financial data for the years 1999 to 2002. Later in
this report, we have other analyses that use more of the networks included
in the Kagan publication. In those analyses, we did not need 4 historical
years of data.

years. 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.31
However, we were told that only the larger cable operators gain
significant revenues from the sale of advertising, and that smaller cable
operators generally do not sell as much local advertising because it is
not always cost-effective for them to do so. In fact, even the larger
cable operators do not sell all of the local advertising time that is
available to them because there are significant costs of selling
television ads.

Several Other Factors Appear to Contribute to Higher Rates for Cable
Service

In addition to higher programming costs, the cable industry has incurred
other increased costs. For example, according to industry sources, the
cable industry spent over $75 billion between 1996 and 2002 to upgrade its
infrastructure by replacing degraded coaxial cable with fiber optics and
adding digital capabilities (see fig. 5). 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.32 Five of the 11 cable
operators, 9 of the 15 cable networks, and three of the five financial
analysts we interviewed said investments in system upgrades contributed to
increases in consumer cable rates. For example, one network with whom we
spoke said that the major cause of recent cable rate increases is the
cable industry's capital improvements. Although these upgrades benefit
cable subscribers by expanding the number of cable networks available and
improving picture quality, much of the benefit of infrastructure
improvements accrue to subscribers who purchase new, advanced services,
such as broadband Internet access. One expert who commented on our report
noted that there is no need for cable operators to pass on costs
associated with infrastructure upgrades to subscribers purchasing basic
and expanded-basic service because, by his calculations, these costs

31Advertising sales revenues net of expenses incurred to insert and sell
local advertising would offset a lower percentage of cable operators'
programming expenses.

32For 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.

are almost fully offset by increases in revenues for digital tier and
advanced (e.g., cable modem) services.

Figure 5: Cable Industry Infrastructure Expenditures, 1996 - 2002

Another factor contributing to higher cable rates is cable operators'
increased expenditures on customer service. NCTA said that the industry is
paying more in labor costs because it has sought better-educated and more
highly trained employees to provide customer support for the new services
that the cable operators are offering. Additionally, customer service is
now typically available to cable subscribers 24 hours a day, 7 days a
week. Three of the five financial analysts we interviewed agreed that
increased customer service costs contributed to increases in cable rates,
while 5 of the 11 cable operators we interviewed said increases in
customer service, labor costs, or both contributed to higher cable rates.

Programming Expenses and Infrastructure Investment Appear to Be Primary
Contributors to Cable Rate Increases

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

On the basis of financial data from 9 cable operators, we found that
annual subscriber video-based revenues-that is, revenues from basic,
expanded-basic, and digital tiers; pay-per-view; installation charges; and
other revenues such as equipment rental-increased approximately $79 per
subscriber from 1999 to 2002. By 2002, revenues per subscriber averaged
$561, or $47 per month. 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. Although this may indicate that the
marginal profits for the video business have been declining-which is
consistent with what we were told during our interviews with financial
analysts-there are two important caveats to this conclusion. First,
depreciation expenses (and therefore infrastructure investment) represent
a joint (or common) expense for both video-based and Internet-based
services. Because these expenses are associated with more than one
service, it is unclear how much of this cost should be attributed to
video-based services. Second, cable operators are enjoying increased
revenues from these nonvideo sources. For example, revenues from
Internet-based services increased approximately $74 per subscriber during
the same period. Thus, even if video profit margins have been in decline,
this does not imply that overall profitability of cable operators has
declined.

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. We found
that there are two primary ownership relationships that some believe
influence the cost of cable programming: relationships between cable
networks and cable operators, and relationships between cable networks and
broadcasters. To understand the nature of these ownership relationships,
we analyzed the ownership of 90 cable networks that are carried most
frequently on cable operators' basic or expanded-basic tier (see fig. 6).
Of these 90 cable networks, we found that approximately 19 percent were
majority-owned (i.e., at least 50 percent owned) by a cable operator.33
For example, cable operators have ownership interests of at

33We also performed the analysis reported in this section with a 20
percent ownership affiliation threshold-that is, we considered a network
as "owned" by a broadcast network or cable operator if the network was at
least 20 percent owned by either of these types of providers. With this
ownership threshold, our findings were nearly identical to those reported
here.

least 50 percent in such widely distributed cable networks as TBS, TNT,
CNN, AMC, and the Cartoon Network.34 We also found that approximately 43
percent of the 90 networks were majority-owned by a broadcaster. For
example, broadcasters have ownership interests of at least 50 percent in
such widely distributed cable networks as ESPN, FX, MSNBC, and MTV. The
remaining 38 percent of the networks are not majority-owned by
broadcasters or cable operators.

Figure 6: 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. In particular, 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-

34Only 3 of the large cable operators are majority owners of national
cable networks.

owned by broadcasters or cable operators.35 We did find that license fees
were statistically higher for cable networks owned by cable operators than
was the case for cable networks that were not majority-owned by
broadcasters or cable operators. However, when using a regression analysis
(our cable license fee model) to hold constant other factors that could
influence the level of the license fee, we found that ownership
affiliations-with broadcasters or with cable operators-had no influence on
cable networks' license fees.36 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. There was a particular concern
expressed to us regarding retransmission consent agreements. These
agreements often include, as part of the agreement between cable operators
and broadcasters for the right of the cable operator to carry the
broadcast station, a simultaneous agreement to carry one or more
broadcast-owned cable networks. Many representatives from cable operators
and several independent (nonbroadcast) cable networks told us that because
the terms of retransmission consent agreements often include carriage of
broadcast-owned cable networks, cable operators sometimes carry networks
they might otherwise not have carried, and this practice can make it
difficult for independent cable networks to be carried by cable operators.
Alternatively, representatives of the broadcast networks told us that, to
their knowledge, cable networks had not been dropped nor were independent
cable networks unable to be carried by cable operators because of
retransmission consent agreements. Further, these representatives told us
that they accept cash payment for carriage of the broadcast station, but
that cable operators prefer to carry broadcast-owned cable networks in
lieu of a cash payment.

35License fees received by broadcaster-affiliated networks were higher
than those received by cable networks that were not majority-owned by
broadcasters or cable operators, but the difference was not statistically
significant. Moreover, when sports networks were eliminated from the
analysis, the average level of license fee was almost identical across
these two groups.

36In 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 appendix I for a list of variables included in that
model.

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. Appendix V provides a detailed discussion of
this model.

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

Most cable operators with whom we spoke provide subscribers with similar
tiers of networks, typically the basic and expanded-basic tiers, which
provide subscribers with little choice regarding the specific networks
they purchase. 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
impose additional costs on both cable operators and subscribers.
Additionally, this approach 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. Because of this
reliance on advertising revenues by cable networks, most cable networks
require cable operators to place their network on widely distributed
tiers. A variety of factors-such as the pricing of `a la carte service,
consumers' purchasing 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 made worse off
under an `a la carte approach. Creating a greater number of smaller tiers
could cause many of the same technological and economic concerns as an `a
la carte approach.

Most Cable Operators The 11 cable operators that we interviewed adopt very
similar strategies Offer Similar Bundles of for bundling networks into
tiers of service. These cable operators offer Networks their subscribers
the following tiers of service: basic tier (11 operators),

expanded-basic tier (11 operators), digital tier (11 operators), and
premium services (7 operators). Five of the 11 cable operators offer the
same or similar tiers of service to subscribers in all their franchise
areas. The remaining 6 cable operators offer different tiers of service
among their

franchise areas; we were told that these differences are generally the
result of the cable operators acquiring franchises with different tiering
strategies.

Using data from FCC's 2002 cable rate survey, we also examined the
networks included in the basic, expanded-basic, and digital tiers of
service. With basic tier service, subscribers receive, on average,
approximately 25 channels, which include the local broadcast stations.37
The expanded-basic tier provides, on average, an additional 36 channels.
With a digital tier, subscribers receive, on average, 104 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.

Concerns Exist about a Lack of Subscriber Choice

The manner in which cable networks are currently packaged has raised
concern among policy makers and consumer advocates about the lack of
consumer choice in selecting the programming they receive. Under the
current approach, it is likely that many subscribers are receiving cable
networks that they do not watch. In fact, a 2000 Nielsen Media Research
Report indicated that households receiving more than 70 networks only
watch, on average, about 17 of these networks. The current approach has
sparked calls for more flexibility in the manner that subscribers receive
cable service, including the option of `a la carte service, in which
subscribers receive only the networks that they choose and for which they
are willing to pay. Additionally, an organization representing small cable
operators recently released a report advocating an `a la carte approach
because they believe it will mitigate the ability of broadcast networks to
gain carriage agreements for their cable networks through the
retransmission consent process.38

37Representatives of a broadcast organization told us that the digital
local broadcast signals are sometimes carried on a digital tier.

38See The Carmel Group, The Telecom Future of Independent Cable: ACA
Member Concerns and Issues (Carmel-by-the-Sea, CA: May 2003), a report
prepared for the American Cable Association.

An A La Carte Network Offering Could Impose Costs on Cable Subscribers and
Operators

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. Today,
the networks included on the basic and expanded-basic tiers are usually
transmitted throughout the cable system in an unscrambled fashion. Because
most televisions in operation today are cable ready, a cable wire can
usually be connected directly into the television and the subscriber can
view all of the networks on those tiers. An addressable converter
box-which serves to unscramble any scrambled networks-is only needed if
the subscriber chooses to purchase networks that the cable operator
transmits in a scrambled fashion, as is usually the case for networks
placed on digital tiers, certain premium movie channels, and pay-per-view
channels.39

If all networks were offered on an `a la carte basis, cable operators
would need to scramble all of the networks they transmit to ensure that
subscribers are unable to view networks they are not paying to receive.
Under such a scenario, addressable converter boxes, which enable the
operator to send messages from the cable facility to the box to indicate
which networks the subscriber is purchasing and thus allowed to watch,
would need to be connected to all television sets attached to the cable
system. The addressable converter box would unscramble the signals of the
networks that the subscriber has agreed to purchase. The need for an
addressable converter box deployment could be costly. According to FCC's
2002 survey data, of the franchises that responded to the survey and
provided cost data on addressable converter boxes, the average monthly
rental price for a box is approximately $4.39. For homes that have
multiple television sets, the expense for these boxes could add up-the
extra cost for a home that needs to add three addressable converter boxes
would be about $13.17 a month at current prices.

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. For example, a
representative of 1 cable operator we interviewed indicated

39Sometimes certain cable networks are transmitted unscrambled and
trapping devices are used outside of the customer's home to keep networks
that the home has not purchased from transmitting to the customer's
televisions. This trapping technology would not be economically viable in
an `a la carte regime.

that most of its subscribers do not have addressable converter boxes. A
representative of another cable operator stated that only 40 percent of
its subscribers have addressable converter boxes. Conversely, 1 operator
told us that nearly three out of four of its subscribers do have at least
one addressable converter box in place, and that the number of homes with
a box will only continue to increase. Addressable converter boxes are
becoming more commonly deployed as more customers subscribe to digital
tiers. 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. Moreover, consumer electronic
manufacturers have recently submitted plans to FCC regarding
specifications for new television sets that will effectively have the
functionality of an addressable 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. Several experts that we spoke with offered a wide divergence of
views on how long it would be before addressable converter boxes and/or
new televisions with built-in boxes are fully deployed in all American
homes.

In addition to the subscriber costs of converter boxes, cable operators
also would incur costs to monitor and manage an `a la carte approach.
Cable operators likely would have to add additional customer service and
technical staff to deal with the increased number of transactions that
would occur under an `a la carte regime. One cable network representative
we interviewed indicated that an `a la carte regime would be a substantial
undertaking for the cable operators. For example, this network
representative told us that a cable operator offering 150 channels of `a
la carte programming could have its subscribers choosing all different
numbers of networks, which would mean that subscribers would be spending
much longer periods of times on the telephone with customer service staff.

Cable Networks Often Specify Placement on the Basic or Expanded-Basic Tier

Even if cable operators desired to offer customers a wider variety of
bundles of services or even `a la carte service, most contracts negotiated
between cable networks and cable operators prohibit these alternatives.
All 11 cable operators and four of five financial analysts that we
interviewed told us that program contracts generally specify the tier that
the network must appear on, or the contract establishes a threshold
percentage of subscribers that must be able to see a network-which
effectively requires the same tier placements. For example, one individual
responsible for negotiating program contracts for cable operators noted

that all of the top 40 to 50 networks specify that their networks appear
on either the basic or expanded-basic tier. We also reviewed sample
contracts for 2 cable networks, one contract specified that the network
appear on the basic or expanded-basic tier and the other contract
specified "the most widely subscribed level of service." 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.

Economic Characteristics of the Cable Network Market Are a Constraint to
an A La Carte Approach

If cable subscribers were allowed to choose networks on an `a la carte
basis, the economics of the cable network industry could be altered, and,
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. For example, 3 of the 15 cable network representatives
we interviewed indicated that they receive approximately 60 percent of
their revenue from advertising. 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 to networks for the right to carry their signals. Figure 7 provides a
breakdown of the relationship in recent years between advertising revenues
and license fee revenues on the basis of data from Kagan.

Figure 7: 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. In other
words, advertisers will pay more to place an advertisement on a network
that will be viewed, or have the potential to be viewed, by the greatest
number of people. According to cable network representatives we
interviewed, any movement of networks from the most widely distributed
tiers to an `a la carte format could result in a reduced amount that
advertisers are willing to pay for advertising time because there would be
a reduction in the number of viewers available to watch the networks. To
compensate for any decline in advertising revenue, network representatives
contend that cable networks would likely increase the license fees they
charge to cable operators. In particular, we were told by many cable
networks that under an `a la carte system, the cost burden of cable
television would become less reliant on advertising revenues and much more
reliant on license fees that would likely be passed on to

consumers. For example, one cable network representative estimated that to
compensate for the loss of advertising revenue in an `a la carte scenario,
the network would have to raise its monthly license fee from the current
monthly rate of $0.25 per subscriber to a level several fold higher-
possibly as much as a few dollars per subscriber per month. Additionally,
four of the five financial analysts we interviewed also stated that
license fees would increase under an `a la carte approach. At the same
time, if cable networks see advertising revenues decline, they will also
likely take steps to reduce production costs, because cable operators
might be unwilling to accept increases in license fees to fully offset the
decline in adverting revenues. As such, it is not clear whether license
fees would need to completely offset any declines in advertising revenues.

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. The cable
networks that we interviewed generally told us that they believe that an
`a la carte approach would not reduce cable rates for most subscribers. In
fact, representatives of 7 cable networks noted that costs to subscribers
could actually increase under an `a la carte system, while 6 networks said
that subscribers might pay about the same monthly bill but would likely
receive far fewer channels. Conversely, for subscribers who purchase only
a few cable networks, rates would likely decline under this approach
because they would only have to pay for the limited number of networks
that they choose to purchase. Thus, an `a la carte approach would provide
consumers with greater control over their cable choices, even if, on
average, consumer bills did not decline.

Most of the 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. For example, one network
told us that under an `a la carte system, fewer networks would remain
financially viable and new networks would be less likely to be developed.
Three of the cable operators and four of the five financial analysts we
interviewed also said that smaller networks or those providing specialty
programming would be hurt the most by an `a la carte system. A number of
the cable networks indicated that launching a new network under an `a la
carte system would be very difficult. Similarly, according to NCTA, an `a
la carte approach could result in the disappearance of many networks and
could undermine the prospects for any new basic cable networks. Further,
if an `a la carte system resulted in limited subscribers

and decreased advertising revenue, several networks said the quality of
programming available might be adversely impacted.

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-if not most-customers, if faced with an `a la carte
selection of networks, would choose to receive only a limited number of
networks. This assumption is consistent with the data on viewing habits-as
previously mentioned, a recent study has shown that most people, on
average, watch only about 17 networks. Nevertheless, under an `a la carte
scenario, cable companies may price large packages of networks in a way
that provides an incentive for subscribers to choose a wide number of
networks. Additionally, under this approach, cable operators may choose to
price cable services in an entirely different way. One option suggested
was that, similar to common pricing schemes in the electric and natural
gas industries, subscribers might pay a flat charge for the connection to
the cable operator's system plus additional charges for each network the
subscriber chooses to purchase. This could result in subscribers
purchasing only a few channels paying a higher rate per channel than
subscribers purchasing many channels. One of the issues that some industry
representatives discussed with us concerned the value consumers place 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. 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.

Creating Additional Tiers Another alternative to the `a la carte approach
that has been discussed is a of Service Is More move to minitiers, under
which subscribers would choose small tiers of Feasible, but Economic
programming that are grouped by genre (such as sports, news and

information, and general entertainment). Although industryand
Technological representatives told us that this approach might be more
viable than an `aConstraints Would Also la carte approach, we were also
told that all of the issues associated with Apply an `a la carte regime
would also apply to minitiers. Representatives of 8 of

the 15 cable networks we interviewed indicated that the creation of
additional tiers would be a disadvantage to the cable industry. Four cable
network representatives stated that increasing the number of tiers would
result in the same outcome as an `a la carte system: a decline in cable
network advertising revenue that would force networks to increase their
license fees to cable operators, which would result in higher cable rates.
Six of the 11 cable operators we interviewed also noted that a minitier
approach would also require more deployment of addressable converter
boxes. Finally, a representative of 1 cable operator told us that after
experimenting with genre tiers in the past, the operator determined that
this was not a successful strategy. This representative stated that
subscribers felt the cable operator was forcing them to buy many tiers,
since a typical household wanted to see one or more networks in several of
the tiers.

However, officials representing 5 of the 11 cable operators we interviewed
indicated that the tier concept might be viable in the case of sports
programming. A representative of 1 cable operator indicated that a sports
tier would be appropriate because sport fans are loyal customers and the
cost of sports programming is very high. A representative of another cable
operator noted that creating a sports tier should be an option, but that
other types of programming would not work on separate tiers. Recently,
several regional sports networks have been placed on sports-only tiers in
the New York City metropolitan area.40

Alternatively, representatives from two major sports leagues and a sports
network do not believe that a sports-only tier is necessary, and some of
these representatives did not believe such a tier would be viable. One
important objective of the major sports leagues is to obtain the widest
distribution of their games as possible. Therefore, many games appear
either on broadcast television or on cable networks carried on the basic
or expanded-basic tier. To ensure this wide distribution of their games,
the major sports leagues include provisions in their contracts with cable
networks that specify carriage of their games on a tier with broad
distribution. A representative of a sports network said that if their
network were offered on a sports-only tier, the nature of the network
would

40Recently, the Yankees Entertainment and Sports (YES) network was placed
on a sports-only tier, with Madison Square Garden and FOX Sports Net New
York, on selected Cablevision systems in the New York City metropolitan
area following a lengthy dispute between YES and Cablevision.
Subsequently, YES was offered on an `a la carte basis on Time Warner Cable
franchises in New York.

Industry Participants Have Cited Certain Options That May Address Factors
Contributing to Rising Cable Rates

change. In fact, representatives of the three leagues with whom we spoke
said that if sports networks were on a sports-only tier, the leagues would
not want to sell the right to carry certain events on those networks since
it would likely not be available to most viewers.41 One of these three
representatives said that under this scenario, sports-only networks might
cease to exist and any sports on cable would only be placed on general
entertainment networks that provide variety programming-similar to
broadcast networks. Finally, representatives from two of the sports
leagues and a sports network said that there is no reason to believe that
removing the sports networks from the expanded-basic tier would result in
any substantial reduction in the rate for expanded-basic tier cable
service. When two cable operators in the New York City metropolitan area
moved regional sports networks to a separate tier, these companies lowered
the expanded-basic cable rate by only 50 cents to a dollar.42

In recent years, there has been concern about the rapidity of cable rate
increases. As we previously noted, cable rates have risen by about 40
percent in the last 5 years, far outstripping increases in the general
rate of inflation. Several approaches for addressing the rise in cable
rates have been put forth. These approaches can be grouped into the
following two main categories: (1) the control of rates through regulation
and (2) the promotion of lower rates through market mechanisms, such as
through greater competition.

Some consumer groups have pointed to the lack of competition as evidence
that reregulation needs to be considered. One representative of a consumer
group noted that regulation might be the only alternative to mitigate
increasing cable rates and cable operators' market power. For example, one
consumer group has recommended, among a variety of options, returning
authority to reregulate cable rates to local and state governments.
However, some experts expressed concerns about cable regulation after the
1992 Act. First, some academic critics believe that cable regulation
lowered the quality of programming, discouraged investment in new
facilities, and imposed administrative burdens on the

41One sports league also requires its cable network carriers to arrange
for all cablecast games to be simulcast (subject to league sell-out rules)
on free over-the-air television in the home cities of the participating
clubs.

42In one case, the cable operator simultaneously added one or two other
networks to the expanded-basic tier.

industry and regulators. Second, according to these same critics, there is
no strong evidence that cable rates were significantly constrained during
that regulated era. Finally, regulation today could be considerably more
complex than it was 11 years ago. Today, video providers use varied
platforms (cable, DBS) to provide an array of communication services,
including video service, Internet access, and video on demand. A
regulatory scheme would need to consider which services and providers to
regulate, and how to allocate the common costs of a communications network
in a regulatory context across the various services provided.

Alternatively, taking steps to promote competition could help to reduce or
slow the growth of cable rates by leveraging the normal workings of the
marketplace. In those few local markets where a second wire-based provider
exists, we found that cable rates are about 15 percent lower than local
markets without this competition. Moreover, even though the influence of
DBS on cable rates is minor, our current finding-in contrast to our
earlier study and earlier studies by FCC that did not find such an
effect-is that the presence of DBS does help to lower cable rates
slightly. This may indicate that as more households subscribe to DBS
service, cable operators will ultimately respond by reducing rates. Below,
we discuss options that have been suggested for addressing the cable rate
issue. We note that in this overview, we are neither making any specific
recommendations regarding the adoption of any of these options, nor
suggesting that this list is a necessarily comprehensive review of
possible options.

Program access issues. The 1992 Act includes provisions aimed at, among
other things, enhancing competition in the subscription video industry. As
required by the act, FCC developed rules-commonly referred to as the
program access rules-which were designed in part 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. Since 1992, some
entering companies and consumer groups have stated that current program
access rules are not broad enough to provide assurances that entrants can
obtain necessary programming. In particular:

o  	Some have expressed concern that the law is too narrow because it
applies only to the satellite-delivered programming of vertically
integrated cable operators. In recent years, some regional cable networks
owned by cable operators have been delivered to their cable facilities
through wires-that is, they are not satellite delivered. When this is the
case, the cable operator need not make the programming available to

competitors. Additionally, although it is not clear how widespread this

practice is in local markets across the country, a recent report by a

consumer group raised concerns that it could become more prominent at a

national level.43 Although questions have been raised about this issue-

which has come to be called the terrestrial loophole-FCC has pointed out

that the statue is specific in that the program access rules apply only to

satellite-delivered programming.

o  	Although the program access rules generally prohibit exclusive
contracts for programming of vertically integrated cable operators, these
rules do not prohibit exclusive contracts between a cable operator and an
independent cable network.44 Some operators entering the market believe
that some programming may not be available to them because large incumbent
cable operators have secured such exclusive arrangements. 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. However, others have noted that altering
these provisions could reduce the incentive for companies to develop
innovative programming. That is, we were told that companies may have less
incentive to invest in certain new programming if they are not able to
market that programming through their own distribution channels on an
exclusive basis.45

Promoting wireless competition. The medium used to provide video services
over wireless platforms-radio spectrum-is a scarce and congested resource.
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.46 DBS companies

43U.S. Public Interest Research Group, The Failure of Cable Deregulation:
A Blueprint for Creating a Competitive, Pro-Consumer Cable Television
Marketplace (Washington, D.C.: August 2003).

44Under the Communications Act, the prohibition on exclusive contracts
enacted as part of the program access provisions in the 1992 Act were set
to sunset in October 2002 unless FCC determined the rules were still
necessary. In 2002, FCC extended the prohibition until October 2007
because the commission determined that the prohibition continues to be
necessary.

45In July 2003, FCC adopted a Notice of Inquiry asking for comment on a
variety of issues related to competition in the video market. One of the
issues related to program access issues.

46Recently, DIRECTV announced that it would provide local broadcast
stations in all 210 television markets by 2008.

gained the right to provide these local stations in 1999, and this has
been important in enabling them to compete more effectively with locally
based cable operators. However, 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.
According to executives at the two primary DBS companies, if DBS companies
only provided the local stations that they view as desired by their
subscribers, they might more quickly provide local broadcast stations in
more markets, thereby rendering DBS a more effective competitor to cable.
However, any modifications to the DBS carry one, carry all rules would
need to be examined in the context of why those rules were put into
place-that is, to ensure that all broadcast stations are available in
markets where DBS providers choose to provide local stations. In fact, a
U.S. Court of Appeals found that certain government interests promoted by
the carry one, carry all provisions applicable to DBS providers are
sufficient to justify this requirement under a First Amendment analysis.47
Additionally, any review of these rules would need to take into account
how they relate to other similar requirements, including, for example,
must-carry requirements for the cable industry as well as how must carry
will be applied to cable and DBS in the coming digital age. As with many
complex policy issues, balancing what are often conflicting considerations
is very complex.

Retransmission consent issues. 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 stations) could
receive compensation from cable operators in return for the right to carry
their broadcast stations. Prior to the 1992 Act, cable operators could
retransmit local broadcast stations without approval of the broadcasters
and without compensation. As cable operators began to carry more cable
networks that competed with broadcast networks for viewers and associated
advertising revenues, broadcasters argued that it was important for them
to be able to receive compensation for retransmission of their stations.
The retransmission consent provisions included in the 1992 Act allow local
broadcast stations and cable operators to negotiate for

47Satellite Broadcasting and Communications Association v. FCC, 275 3d 337
(4th Cir. 2001) cert. Denied 536 U.S. 922 (2002).

payment or some other form of compensation in exchange for the cable
operator's right to carry broadcast networks.48

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. We were told that, after
the passage of the 1992 Act, the cable industry indicated its reluctance
to pay for carriage of local broadcast stations-which they had previously
been carrying free of charge. The negotiations for retransmission consent
at that time quickly turned to examining carriage of broadcaster-owned
cable networks as compensation for the right to carry the local broadcast
station. Both the Congress and FCC had indicated that carriage of
broadcast-owned cable networks would be a possible way for broadcasters to
receive compensation for carriage of broadcasters' over-the-air stations.
A variety of parties with whom we spoke mentioned specific broadcast-owned
cable networks (such as ESPN2 and MSNBC) that were launched as part of
retransmission consent agreements during the 1990s.

One concern that was expressed to us regarding retransmission consent
relates to its influence on the carriage decisions of cable operators. In
particular, many representatives from cable operators and several
independent (nonbroadcast) cable networks told us that because the terms
of retransmission agreements often include the carriage of broadcast-owned
cable networks, cable operators sometimes carry networks they otherwise
might not have carried. Several of the cable networks we spoke with noted
that this practice can make it difficult for independent cable networks to
gain carriage, particularly in the case of new networks. Alternatively,
representatives of the broadcast networks told us that they did not
believe that cable networks had been dropped or that independent cable
networks could not gain carriage because of retransmission consent
agreements. Further, these representatives told us 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. Broadcast
executives also told us that the retransmission process has been very
important in preserving free over-the-air television.

48Each local broadcast station has the right to negotiate for
retransmission or to assert must-carry status. Under must carry, the cable
operator is required to carry a local broadcast station, but can do so
without paying any compensation.

Several of the industry representatives with whom we met also expressed
concern that ownership relationships between broadcast networks and cable
networks could lead to higher cable rates for consumers. Although we did
not find that license fees are higher when such an ownership relationship
exists, we did find that cable networks owned by broadcast networks are
more likely to be carried on cable systems than networks not owned by
broadcasters or by cable operators.49 (See app. V for a discussion of our
carriage model). As such, the influence of retransmission consent on
consumer rates is not clear, since these rates could be affected by the
carriage patterns.

Certain parties 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.50 However, other parties have stated that
such provisions serve to enable television stations to obtain a fair
return for the retransmitted content they provide-which they believe was
not the case prior to 1992. Moreover, these industry representatives noted
that retransmission rules help to ensure the continued availability of
free television for all Americans. Currently, there is a petition pending
before FCC that asks for a review of the impact of retransmission consent.

In the last decade, the subscription video industry has undergone dramatic
changes. The regulatory and competitive environments have both evolved;
cable rates have been regulated and later partially deregulated; and
limited wire-based competition has been supplanted by nationwide
competition from satellite-based companies. It appears that this evolution
has created problems for FCC's monitoring and reporting on the industry.
As mandated by the Congress, FCC prepares a yearly report on cable rates
in the United States. But, aspects of how information for the report is
collected-such as the cost factors underlying cable rate increases-are
closely associated with the earlier, regulated era of the cable industry.
For example, information on cost changes underlying cable rate increases
are reported to FCC on a survey form that requires the cost factors and
rate changes to balance. Because rates and costs need not balance in an
unregulated environment, cable franchise representatives filing out the

49We also found that cable networks owned by cable operators are also more
likely to be carried than networks not owned by broadcasters or cable
operators.

50One possible option would be to replace the retransmission consent
provisions with a must-carry right.

Conclusions

form made accommodations in their answers that may have compromised the
accuracy of the cost data they were reporting. Similarly, maintaining
current information on the effective competition status of cable operators
under FCC's current process has proven difficult. Some expected
competitors have emerged but did not fully deploy their networks and, in
some cases, discontinued service altogether, and DBS companies-which were
not yet providing service in 1992-have thrived, but information on their
market participation is not readily available on a local level. We found
that because FCC's current process does not provide for updates to the
status of effective competition, some designations do not appear to
reflect current competitive conditions.

In the face of the rapid evolution of the subscription video industry, it
remains important for accurate, current, and relevant information to be
available to the Congress and FCC. Both the Congress and FCC monitor and
provide oversight of this industry, for which FCC's report can serve as an
important input. Additionally, FCC's report can provide information
relevant to the Congress, as it considers important policy decisions,
including the regulation of cable rates and/or services, media
consolidation, and the convergence of video, voice, and data services.
Lacking reliable information, the Congress and FCC face the challenge of
performing monitoring and oversight, as well as making important policy
decisions, without the benefit of important price, cost, and competition
information. As such, it is important for FCC's report to provide
accurate, current, and relevant information about the cable industry.

Recommendations for To improve the quality and usefulness of the data that
FCC collects on cable television rates and competition in the subscription
video industry,Executive Action we recommend that the Chairman of the FCC
take the following actions:

o  	take immediate steps to improve the cable rates survey by (1)
including more detailed, standardized instructions and examples for how to
calculate the cost changes that the cable operators experienced in the
previous year and (2) eliminating the requirement for the cost increases
to sum to the change in rates and

o  	review the commission's process for maintaining the status of
effective competition among franchises in order to keep these designations
more up to date.

Agency Comments
and Our Evaluation

We provided a draft of this report to FCC for comment. FCC had two key
comments on the draft report. First, FCC stated that they are taking steps
to redesign their survey questionnaire in an attempt to obtain more
accurate information. Second, FCC questioned on a cost/benefit basis the
utility of adopting a revised process to keep the status of effective
competition in franchises up to date. We believe that providing the
Congress with reliable information on cable rates and competition is
important, and that improving the accuracy of effective competition
designations would help to accomplish this. We recognize that there are
costs associated with FCC's cable price survey, and we recommend that FCC
examine whether cost-effective alternative processes exist that would
enhance the accuracy of its effective competition designations. FCC's
comments are contained in appendix VI, along with our responses to those
comments.

We also provided a draft of this report to several industry participants
and other experts for their review and comment. In particular, we provided
the draft to representatives of Consumers Union, the Consumer Federation
of America, the American Cable Association, the National Association of
Telecommunications Officers and Advisors, the National Association of
Broadcasters, the National Cable and Telecommunications Association, the
Satellite Broadcasting and Communications Association, Walt Disney
Company, the National Broadcasting Company, Viacom, and the News
Corporation. The comments received covered a broad range of issues and
each groups' comments are summarized in appendix VII. In addition, these
groups provided clarifications to the draft report. As appropriate, we
made changes in our report that are based on the broad comments summarized
in appendix VII as well as the technical clarification provided to us by
these parties.

As agreed with your office, unless you publicly announce 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 send copies to
interested congressional committees; 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 cost on the GAO
Web site at http://www.gao.gov.

If you or your staff have any questions concerning this report, please
contact me on (202) 512-6670 or at [email protected]. Key contacts and
major contributors to this report are listed in appendix VIII.

Sincerely yours,

Mark L. Goldstein
Director, Physical Infrastructure Issues

                       Appendix I: Scope and Methodology

To respond to the first objective of this report-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. See appendix IV for a further
discussion of this model. In addition, we spoke with an array of industry
stakeholders and experts (see below) to gain further insights on these
issues.

The second objective of this report 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 (see
app. II). 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.

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

Appendix I: Scope and Methodology

Additionally, to address part two of the second objective-assess FCC's
classifications of effective competition-we examined FCC's classification
cable franchises regarding whether they face effective competition. Using
responses to FCC's 2002 cable rate survey, we tested whether the responses
provided by cable franchises were consistent with the various legal
definitions of effective competition, such as the low-penetration test.
Further, we reviewed documents from FCC proceedings addressing effective
competition filings and contacted franchises to determine whether the
conditions present at the time of the filing remain in effect today. We
also reviewed filings for effective competition that were based on DBS
subscribership to assess how data from SkyTRENDS are used in these
filings.

To address the third, fourth, fifth, and sixth objectives (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

Appendix I: Scope and Methodology

provided the financial and operating data we sought. We also acquired data
from Kagan World Media,2 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.3

o  	We compared the average license fees among three groups of networks:
those that are majority-owned by a broadcaster, those that are
majority-owned by a cable operator, and all others. We preformed t-tests
on the significance of these differences. We also ran a regression (our
cable license fee model) in which we regressed the license fee across 90
cable networks on the age of the network, the advertising revenues per
subscriber (a measure of network popularity), dummy variables for sports
and news programming, and a variety of factors about each franchise.

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. This model is discussed in greater detail
in appendix V. Further, we developed descriptive statistics on the
characteristics of various tiers of service and the channels included in
the various tiers.

2Kagan World Media, Economics of Basic Cable Networks 2003 (Carmel, CA:
2003).

3Due to the confidential requirement of industry contracts, we could not
independently verify the data from Kagan World Media. To assess the
reliability of these data, we asked cable networks that we interviewed
about the Kagan data. Eight of the 12 national cable networks we
interviewed said that Kagan data on license fees, revenues, and
programming expenses were fairly accurate.

                  Appendix II: GAO Survey of Cable Franchises

                  Appendix II: GAO Survey of Cable Franchises

                  Appendix II: GAO Survey of Cable Franchises

Appendix III: GAO's Modifications to FCC's Competition Classification

To determine the status of competition from a wire-based competitor for
our cable-satellite model, we took steps to review the accuracy of FCC's
classification of effective competition for the cable franchises surveyed
in 2001-the year of data used in our model. For those cases in which a
finding of effective competition had been made because of the presence of
a local exchange carrier (LEC) or a competitive overbuilder, we took steps
to determine if that competition was still present as of 2001. For cases
without a designation of effective competition, we checked to see if there
was a possible LEC or overbuilder operating in the areas. This process was
only designed to check the status of competition other than that provided
by DBS. This is because we did not rely on FCC's competitive
classifications related to DBS because information on DBS for our model
was obtained from a different source, and we did not use FCC's
classification at all in that case.

Our sample contained 705 cable franchises, of which 133 had been found to
face effective competition from a LEC or overbuilder, and 572 had not. In
most cases in which a finding of effective competition had been made (95
of the 133), we found evidence that, in fact, a nonsatellite provider was
competing with the incumbent cable provider. In the other 38 cases, we
found evidence suggesting that a nonsatellite provider was not present in
2001.1 To make these determinations, we used various sources of
information, including FCC's master list of cable franchises. We noted
that if there were competitive cable franchises, we would expect to find
two franchises operated by different companies in the same geographic
area. If, for example, we found only one operating franchise in an area
but that franchise was listed as having effective competition, we
investigated further. Also, if we found two franchises operating in an
area that were classified as having effective competition, but both were
operated by the same company, we also investigated further. Also, in some
cases, we made attempts to determine if the nonsatellite competitor was
operating as an MMDS, which is sometimes referred to as wireless cable.
This further investigation usually involved Web research and information
obtained through contacts with local franchising authorities. In those
instances for which we were able to gather information indicating that an
incumbent cable provider that once faced a nonsatellite competitor no
longer did in 2001, we defined our nonsatellite competition variable
accordingly.

1In the course of our review, we also identified some cable franchises
that were apparently sampled because of clerical-type mistakes, such as
the transposition of a franchise identification number or an inconsistency
between franchises identified in the effective competition report and the
franchises ultimately sampled.

Appendix III: GAO's Modifications to FCC's Competition Classification

To check whether franchise areas without a designation of effective
competition might have nonetheless faced nonsatellite competition in 2001,
we used lists of service areas of cable overbuilders and compared these
areas with the list of sampled franchises. We also examined FCC's master
franchise list for areas in which more than one company appeared to
operate an active franchise. We investigated these lists further by
calling local franchising authorities to determine whether those franchise
areas were geographically distinct or whether this pattern could represent
competition. We also attempted to identify areas where wireless cable
companies provided video service and whether any of those areas overlapped
sampled franchises. In all, we found a number of cases where a
nonsatellite provider appeared to be offering service in areas where no
filings for effective competition had been made. In these cases, we
defined our variable to reflect this competition. Of the 572 franchises
without a designation of effective competition, we found that 28 were
facing some form of nonsatellite competition in 2001.

Finally, we made a distinction between those franchises that were found to
face effective competition because of the availability of MMDS versus
areas with a wire-based overbuilder. We separated these kinds of
competition into distinct variables under the assumption that they may
have a differential effect on cable operators. We believed that this might
be the case because many MMDS providers have been modifying their business
plans and placing less emphasis on their video businesses. For example,
FCC noted that "MMDS has never become a significant competitor in the
market for the delivery of video programming, rather many MMDS providers
are focusing on data transmission rather than video service."2

2See 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).

                       Appendix IV: Cable-Satellite Model

This appendix provides a brief description of our model of cable-satellite
competition. With this model, we estimate the influence of wire-based,
MMDS, and DBS competition, along with other variables, on cable prices and
services through a system of structural equations in which certain
variables that may be simultaneously determined are estimated jointly. The
model includes equations for cable prices, the number of cable
subscribers, the number of cable channels, and the DBS penetration rate.
Our October 2002 report provides a more detailed discussion of the data
sources, our process for merging various data into a single dataset, and
the specification of our model.1

Definitions and 	Table 1 includes a list of all the variables included in
our model, with the definition and source identified for each variable.

Sources for Variables

                  Table 1: Definition and Source for Variables

Variable Definition Source

Cable price The monthly rate charged for the Basic Service Tier, Cable
Programming FCC 2001 Cable Rate

     Service Tier, and rental of a converter box and remote control. Survey

Number of subscribers   The number of subscribers to the    FCC 2001 Cable 
                             Basic Service Tier and Cable                Rate 
                               Programming Service Tier.           Survey     
    Number of channels    The number of channels provided with FCC 2001 Cable 
                              the Basic Service Tier and Cable           Rate 
                          Programming Service Tier (the most                  
                               commonly purchased tier).           Survey

Direct broadcast satellite (DBS) penetration rate

The fraction of housing units in a cable franchise area that have
satellite service.

                                   SkyREPORT

  DBS provision of local stations A binary variable that equals 1 if both DBS
 operators offer local broadcast National Association of stations in the cable
  franchise area. Broadcasters Television market size The number of television
                households in the market. Neilsen Media Research

Horizontal concentration	A binary variable that equals 1 if 1 of the 10
largest national multiple system operators (MSO) provides service in the
franchise area.

FCC 2001 Cable Rate Survey

 Vertical relationship A binary variable that equals 1 if the cable operator is
                     affiliated with an FCC 2001 Cable Rate

MSO that has an ownership interest in a national or regional video
programming service.

Survey and 2001 Annual Video Report

Presence of a wire-based A binary variable that equals 1 if a second
wireline company provides FCC 2001 Cable Rate

competitor 	cable service (including, for example, a local exchange
telephone carrier Survey and GAO offering video services) in the franchise
area. analysis

1See GAO-03-130.

                       Appendix IV: Cable-Satellite Model

Variable Definition Source

Presence of multichannel A binary variable that equals 1 if a company
provides cable service via FCC 2001 Cable Rate multipoint distribution
system MMDS technology in the franchise area. Survey and GAO (MMDS)
competitor analysis

Average wage	The average weekly wage for telecommunications equipment
installers Bureau of Labor and repairers in the state where the cable
franchise is located. Statistics

Population density The ratio of population to square miles in the
franchise area. U.S. Census Bureau

 Number of broadcast stations The number of over-the-air broadcast stations in
                   the television market. BIA MEDIA AccessPro

Urbanization 	The percentage of the county's population that is classified
as urban by the U.S. Census Bureau U.S. Census Bureau.

Age of cable franchise	The number of years between when the cable
franchise began operation and 2001.

FCC Master List of Cable Franchises

Homes passed by cable The number of homes passed by the cable system that serves
                            the FCC 2001 Cable Rate

system

     franchise area, including homes outside of the franchise area. Survey

Median per-capita income The median per-capita income in the franchise
area. U.S. Census Bureau System megahertz The capacity, measured in
megahertz, of the cable system that serves the FCC 2001 Cable Rate

 franchise area. Survey U.S. Census Bureau Angle (or "elevation") of The angle
relative to the ground that a DBS subscriber must mount the Web pages of DIRECTV

                          The percentage of housing units         U.S. Census 
Percentage of multiple accounted for by structures with five        Bureau 
                          or                                      
       dwelling units               more housing units.           
                          A binary variable that equals 1 if the  
Nonmetropolitan areas  franchise area is outside of a          
                           metropolitan statistical area (MSA).   

satellite dish

satellite dish to "see" the satellite. and EchoStar Regulation A binary variable
  that equals 1 if the cable franchise is subject to regulation FCC 2001 Cable
          Rate of the rate charged for the Basic Service Tier. Survey

Source: GAO (2003).

Estimation We employed the three-stage least squares method to estimate
our model.2

Table 2 includes the descriptive statistics for the variables included in
our Methodology and model, and table 3 includes the estimation results for
each of the four Results structural equations. All of the variables,
except dummy variables,3 are

expressed in natural logarithmic form, so coefficients can be interpreted
as elasticities-which is the percentage change in the value of the
dependent variable associated with a 1 percent change in the value of an

2See GAO-03-130 for a discussion of why we use the three-stage least
squares method, rather than the two-stage least squares method.

3A dummy variable takes a value of 1 if a certain characteristic is
present and a value of 0 otherwise.

                       Appendix IV: Cable-Satellite Model

independent, or explanatory, variable.4 The coefficients on the dummy
variables are elasticities in decimal form.

                        Table 2: Descriptive Statistics

             Variable                Mean  Standard   Minimum   Maximum value 
                                          deviation    value    
           Cable price              36.15       5.02      14.00         47.84 
     Cable price per channel         0.66       0.19       0.30 
        Cable subscribers       21,460.68  43,673.73       4.00    302,964.00 
          Cable channels            58.17      14.06      10.00         99.00 
         DBS penetration            15.91      11.31       1.59         63.64 
      DBS provision of local         0.52       0.50       0.00 
             stations                                           
            Regulation               0.36       0.48       0.00 
Number of broadcast stations     12.00       5.64       1.00         25.00 
          Median income         43,965.25  16,202.17  13,529.00    139,997.00 
     Horizontal concentration        0.85       0.36       0.00 
      Vertical relationship          0.55       0.50       0.00 
      Presence of wire-based         0.16       0.37       0.00 
            competitor                                          
Presence of MMDS competitor       0.01       0.10       0.00 
      Nonmetropolitan areas          0.25       0.43       0.00 
           Urbanization             73.53      28.12       0.00        100.00 

Percentage of multiple dwelling units 14.38 13.70 0.00 98.12 Age of cable
franchise 24.11 9.52 2.00 50.00 Homes passed by cable system 181,024.81
235,085.38 30.00 1,260,734.00 Cable system megahertz 638.98 172.13 216.00
870.00 Television market households 1,459.89 1,664.50 50.00 7,301.00
Population density 2,888.92 7,144.36 2.25 87,139.78 State-level wages
788.91 102.28 575.38 1,045.58 Dish angle or elevation 40.29 6.67 27.19
57.28

Source: GAO (2003).

4The dummy variables in the model include the following: horizontal
concentration of cable systems, vertical relationship, regulation,
presence of a wire-based competitor, presence of a MMDS competitor, DBS
provision of local channels, and nonmetropolitan area. Also, because the
natural log of 0 is undefined, we added 1 to the observed value of any
continuous variable that can take the value of 0.

                       Appendix IV: Cable-Satellite Model

                Table 3: Three-Stage Least Squares Model Results

                       Cable prices      Cable         Cable              DBS 
                                      subscribers    channels     penetration 
        Variable           equation        equation    equation      equation 
     Cable price per                        -1.5368                    0.7839 
         channel                                                
                                          [0.0001]a                 [0.0001]a 
    Cable subscribers        0.0079                      0.0603 
                           [0.3938]                   [0.0001]a 
     Cable channels          0.2428                             
                          [0.0001]a                             
     DBS penetration        -0.0441         -2.2403     -0.0174 
                          [0.0898]c       [0.0001]a    [0.5933] 
    DBS provision of        -0.0063          0.4276      0.0527        0.3386 
          local                                                 
        stations           [0.7285]       [0.0800]c   [0.0408]b     [0.0001]a 
       Regulation           -0.0213                             
                           [0.1157]                             
Number of broadcast                       0.5896             
        stations                          [0.0081]a             
      Median income                         -0.3772      0.0672        0.1903 
                                          [0.0813]c   [0.0032]a     [0.0023]a 
       Horizontal            0.0528                             
      concentration                                             
                          [0.0006]a                             
        Vertical            -0.0051                     -0.0335 
      relationship                                              
                           [0.6682]                   [0.0351]b 
       Presence of          -0.1636         -1.2766      0.0339       -0.3797 
       wire-based                                               
       competitor         [0.0001]a       [0.0001]a    [0.1832]     [0.0001]a 
    Presence of MMDS         0.0420         -0.2247      0.0426       -0.1350 
       competitor          [0.3697]        [0.7350]    [0.5391]      [0.4596] 
     Nonmetropolitan                                                   0.4456 
          areas                                                 
                                                                    [0.0001]a 
      Urbanization                           0.0541             
                                           [0.5117]             
      Percentage of                                     -0.0228       -0.2162 
        multiple                                                
     dwelling units                                   [0.0261]b     [0.0001]a 
      Age of cable                           0.3027                   -0.1778 
        franchise                                               
                                          [0.0463]b                 [0.0001]a 
     Homes passed by                         0.2918             
          cable                                                 
         system                           [0.0001]a             

Appendix IV: Cable-Satellite Model

                    Cable prices      Cable          Cable                DBS 
                                   subscribers     channels       penetration 
       Variable         equation        equation      equation       equation 
     Cable system                                       0.5038        -0.0434 
      megahertz                                                
                                                     [0.0001]a       [0.5304] 
      Television          0.0072         -0.2902       -0.0023        -0.1195 
        market                                                 
      households        [0.3639]       [0.0670]c      [0.8489]      [0.0001]a 
      Population         -0.0120                               
       density                                                 
                       [0.0256]b                               
     State-level          0.0392                               
        wages                                                  
                        [0.3676]                               
    Dish angle or                                                      0.6028 
      elevation                                                
                                                                    [0.0001]a 
      Intercept           2.4077         14.1843       -0.3218         0.5324 
                       [0.0001]a       [0.0001]a      [0.3259]       [0.5601] 
     Sample size             705             705           705 

Source: GAO (2003).

Note: System-weighted R-square: 0.65. P-values are shown in square
brackets.

aSignificance at the 1 percent level.

bSignificance at the 5 percent level.

cSignificance at the 10 percent level.

We found that competition has an effect on the subscription video market.
Competition from a second wire-based operator appears to significantly
lower cable prices-cable prices were approximately 15 percent lower in
areas where a second wire-based operator provides service. 5 Yet, this
competition had no effect on the quality of cable service, as measured by
the number of channels the cable operator provides. Additionally, we found
that higher DBS penetration rates were associated with a slight reduction
in cable prices; a 10 percent higher DBS penetration rate was

5For dummy variables (those variables that can take a value of 0 or 1
depending on the presence of a condition (e.g., presence of wire-based
competitor, DBS providers offering local broadcast stations)), we report
the percentage change arising from a discrete change from 0 to 1. We
calculated this percentage change as: [exp(parameter estimate)-1] times
100.

Appendix IV: Cable-Satellite Model

associated with a 15 cent reduction in cable rates.6 In areas where both
DBS operators provide local broadcast stations, we found that cable
operators offer subscribers approximately 5 percent more channels than
cable operators in areas where both DBS operators do not provide local
stations. Unlike wire-based and DBS competition, we found that the
presence of a company providing video service via MMDS technology was not
associated with a different level of cable rates or number of channels
provided to subscribers.7

We found that a variety of other factors affect the level of cable prices
and the quality of cable service. Cable prices are higher in areas where
the cable operator provides more channels, indicating that some consumers
may be willing to pay for additional channels and that providing
additional channels raises a cable company's costs. We found that cable
prices were 5 percent higher when the cable operator was affiliated with 1
of the 10 largest MSOs. Finally, we found that cable operators affiliated
with a cable network provided their subscribers with 3 percent fewer basic
and expanded-basic cable networks than similar cable operators
unaffiliated with a cable network.

DBS operators' provision of local broadcast stations is associated with
significantly higher DBS penetration rates. As shown in table 3, our model
results indicate that in cable franchise areas where these local stations
are available from both DBS operators, the DBS penetration rate is
approximately 40 percent higher than in areas where local stations are not
available via satellite from both DBS operators. This finding suggests
that in areas where local broadcast stations are available from both DBS
operators, consumers are more likely to subscribe to DBS service;
therefore, DBS appears to be more competitive with cable than in areas
where local stations are not available from both DBS operators.

6In our October 2002 report (GAO-03-130), we did not find that DBS
penetration was associated with lower cable rates. As part of our analysis
for this report, we further refined our measure of competition to more
accurately reflect the actual status of competition at the time our data
were gathered. These refinements contributed to our finding that DBS
penetration was associated with lower cable rates.

7In our October 2002 report(GAO-03-130), MMDS competitors were included in
our variable that measured nonsatellite competition. For this report, we
removed MMDS competitors from the nonsatellite competition variable,
thereby creating a wire-based only competition variable, and created a
separate variable for MMDS competition. We made this adjustment because
(1) MMDS relies on a different technology than either wire-based or DBS
competitors and (2) many MMDS operators are scaling back or discontinuing
video service.

Appendix IV: Cable-Satellite Model

Several additional factors also influence the DBS penetration rate. Our
model results indicate that the DBS penetration rate is greater in
nonmetropolitan areas and also tends to increase as the size of the
television market decreases. 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. That is, a dish aimed
more toward the horizon (as opposed to 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.

                    Appendix V: Cable Network Carriage Model

Set-up of Our Cable Network Carriage Model

This appendix describes our model of cable network carriage that we
developed to test whether ownership affiliations influence cable
operators' decisions about what networks they will carry. Specifically, we
discuss (1) the set-up of our model, (2) the data sources and descriptive
statistics, (3) the estimation methodology and results, and (4) an
alternative specification.

A cable operator will carry a cable network if, on the margin, the network
increases the operator's profit or increases its profits more than an
alternative cable network. Cable operators receive revenue associated with
cable networks from both subscriber fees and local advertising. Therefore,
the addition of a popular cable network will likely increase the
operator's revenues by allowing the operator to impose higher monthly
cable rates on subscribers and sell additional local advertising at higher
rates than would be possible with a less popular network. At the same
time, the cable operator will incur programming costs associated with the
cable network. Thus, the cable operator will balance these various revenue
and cost factors when deciding whether to carry a given cable network.

In interviews with 11 cable operators, we were told that broadcast
networks often link carriage of cable networks to retransmission of local
broadcast stations. In addition to these broadcaster affiliations with
cable networks, some cable operators are also affiliated with cable
networks. In fact, several studies have indicated that cable ownership of
cable networks influences the carriage of cable networks-so there is some
precedent that ownership, albeit of a different form, influences carriage
decisions.1 To examine whether these ownership affiliations-broadcaster
and cable operator ownership of cable networks-influence the carriage of
cable networks by cable franchises, we employed a model that tests whether
certain variables increase or decrease the probability of a cable network
being carried on a particular cable franchise. To empirically test

1For example, see Waterman, D. and A.W. Weiss, "The Effects of Vertical
Integration Between Cable Television Systems and Pay Cable Networks,"
Journal of Econometrics, 72 (1996): 357-395 and Chipty, T., "Vertical
Integration, Market Foreclosure, and Consumer Welfare in the Cable
Television Industry," American Economic Review, 91(3) (2001): 428-453.
These studies found that cable operators were more likely to carry
networks that they owned. These studies, however, did not test whether
cable operators were more likely to carry a network owned by a
broadcaster.

                    Appendix V: Cable Network Carriage Model

these hypotheses, we estimated the following. Carriage of a cable network
on a cable franchise is a function of

o  the age of the cable network,

o  	the popularity of the cable network as measured by advertising
revenues per subscriber,

o  	whether the cable network primarily distributes news- or
sports-related programming,

o  	whether the cable network is affiliated with a broadcast network or a
cable operator,

o  cable system capacity in terms of megahertz,

o  the number of households passed by the cable system,

o  the percentage of people in the franchise area between ages 25 and 65,

o  	the percentage of households in the franchise area that own their
homes, and

o  whether the cable franchise is owned by a cable multiple system
operator.

We required several data elements to build the dataset used to estimate
this model. The following is a list of our primary data sources. In
addition, we list all of the variables, definitions, and sources in table
4 and basic statistical information on all of the variables in table 5.

o  	We obtained data on the carriage of individual cable networks on cable
franchises from FCC's 2002 survey of cable franchises. FCC's survey asked
a sample of cable franchises whether the franchise carried various cable
networks. We used the survey to define a variable representing whether a
given cable network was carried on either the basic or expanded-basic
tier. In addition, we used the survey to define variables measuring (1)
the system megahertz (the capacity of the cable system in megahertz), (2)
the number of households passed by the cable system, (3) the affiliation
of the cable franchise with a multiple system operator, and (4) the
ownership affiliation of the cable operator.

o  	From Kagan World Media, we obtained data on cable networks, including
(1) the year the cable network launched, (2) the number of cable

Data Sources and Descriptive Statistics

                    Appendix V: Cable Network Carriage Model

subscribers that received the cable network in 2002, (3) the advertising
revenue the cable network received in 2002, and (4) the ownership
affiliation of the cable network.

o  	We used the most recent data from the U.S. Census Bureau to obtain the
following demographic information for each franchise area: proportion of
the population between ages 25 and 65 and the percentage of the households
that reside in owner-occupied housing.

                 Table 4: Definitions and Sources of Variables

Variable Definition Source

Carry A binary variable that equals 1 if the cable network is carried on
the basic or FCC 2002 cable rate

                          expanded-basic tier. survey

     Age 2003 minus the launch year of the cable network. Kagan World Media
Advertising revenue per The cable network's advertising revenues divided by the
                          number of Kagan World Media

subscriber

subscribers that could receive the cable network in 2002.

News 	A binary variable that equals 1 if the cable network primarily
delivers news-GAO analysis related programming.

Sports 	A binary variable that equals 1 if the cable network primarily
delivers sports-GAO analysis related programming.

Broadcaster affiliation 	A binary variable that equals 1 if the cable
network is affiliated with a Kagan World Media broadcast network group
(Disney/ABC, Viacom/CBS, News Corporation/Fox, General Electric/NBC, or
Scripps), and the cable network began operation in 1992 or later.

Cable affiliation 	A binary variable that equals 1 if the cable network is
affiliated with a cable Kagan World Media operator (Time Warner,
Cablevision, or Comcast).

Homes passed by cable The number of households passed by the cable system
that serves the FCC 2002 cable rate system franchise, including homes
outside of the franchise area. survey

Cable system megahertz 	The capacity, measured in megahertz, of the cable
system that serves the FCC 2002 cable rate franchise area. survey

Multiple system operator 	A binary variable that equals 1 if the cable
franchise is affiliated with a cable FCC 2002 cable rate multiple system
operator. survey

Population between ages 25 The percentage of the population in a franchise
area between ages 25 and 65. U.S. Census Bureau and 65

Home ownership 	The percentage of households in the franchise area
residing in owner-U.S. Census Bureau occupied housing units.

Source: GAO (2003).

                    Appendix V: Cable Network Carriage Model

                        Table 5: Descriptive Statistics

              Variable                  Mean  Standard  Minimum Maximum value 
                                             deviation   value  
               Carry                    0.43       0.50    0.00 
                Age                    10.68       6.61    1.00         27.00 
      Advertising revenue per           1.91       2.19    0.00         10.98 
             subscriber                                         
                News                    0.06       0.24    0.00 
               Sports                   0.09       0.28    0.00 
      Broadcaster affiliation           0.25       0.43    0.00 
         Cable affiliation              0.20       0.40    0.00 
    Homes passed by cable system  178,212.05 244,160.35   73.00  1,286,698.00 
       Cable system megahertz         672.57     171.08  212.00        870.00 
      Multiple system operator          0.95       0.23    0.00 
Population between ages 25 and      52.09       2.92   37.26         62.94 
                 65                                             
           Home ownership              68.16      10.02   19.46         84.90 

Source: GAO (2003).

Estimation Because we are estimating a binary choice model-that is, the
cable

franchise either carries or does not carry a given cable network-we
Methodology and employed the logit method to estimate our reduced-form
equation of cable Results network carriage.2 We present the estimation
results for our reduced-form

equation in table 6.

2An alternative method to estimate the reduced-form equation is the probit
model. In a binary choice model, the differences between the logistic and
probit models are generally not significant. Differences can arise in the
multinomial model, where there are three or more choices, because the
logistic model imposes independence conditions that sometimes do not
reflect the conditions being modeled. Such was not the case in our model,
since we estimated a binary choice equation.

Appendix V: Cable Network Carriage Model

Table 6: Logistic Model Results

                   Variable Parameter estimate and [p-value]

Age 0.1558 [0.0001]a

Advertising revenue per subscriber 0.7537 [0.0001]a

News 0.6769 [0.0001]a

Sports 0.0812 [0.0472]b

Broadcaster affiliation 0.8265 [0.0001]a

Cable affiliation 0.5817 [0.0001]a

Homes passed by cable system 0.0000 [0.0011]a

Cable system megahertz 0.0029 [0.0001]a

Population between ages 25 and 65 0.0061 [0.1191]

Home ownership 0.0068 [0.0001]a

Multiple system operator 0.3059 [0.0001]a

Intercept -6.5658 [0.0001]a

                               Sample size 55,728

                            Rescaled R-square 0.5075

Source: GAO (2003).

aSignificance at the 1 percent level.

bSignificance at the 5 percent level.

Our model results indicate that ownership affiliation does influence the
carriage of cable networks, as both broadcaster affiliation and cable
operator affiliation are associated with a greater probability of a cable
network being carried on a cable franchise. When calculated at the mean
values for all of the variables in the model, cable networks affiliated
with broadcast networks are 46 percent more likely to be carried than
networks

                    Appendix V: Cable Network Carriage Model

Alternative Specification

that do not have broadcast ownership.3 Similarly, when calculated at mean
values for all of the variables included in the model, cable networks
affiliated with a cable operator are 31 percent more likely to be carried
on a cable franchise than noncable-affiliated networks.

The remaining variables generally had the expected impact on the
likelihood of a cable network being carried on a cable franchise. Popular
networks-as represented by high levels of advertising revenues per
subscriber-and news- and sports-related networks were more likely to be
carried on franchises than less popular networks and networks primarily
delivering other program genres. Also, cable franchises with larger
capacity were more likely to carry any given cable network, and franchises
with a high percentage of people residing in owner-occupied housing were
also more likely to carry any given network.

In addition to the above specification, we also considered a narrower
definition of cable affiliation. In this specification, a cable network
was only considered to be cable affiliated if the cable operator that
owned the cable network also owned the cable franchise. For example, a
cable network owned by Comcast would be considered cable affiliated when
it appeared on a Comcast cable franchise, but not on another cable
company's franchise, such as a Time Warner franchise. In this
specification, cable networks affiliated with a cable operator are 64
percent more likely to be carried on the affiliated cable franchise than a
nonaffiliated cable network. Cable networks affiliated with broadcast
networks remain more likely to be carried than cable networks not
affiliated with broadcasters. We present the estimation results for this
alternative specification in table 7.

3We calculated these percentages by taking the mean values of all
variables included in the model and deriving a predicted value of carriage
for a broadcast-affiliated network and a nonbroadcast-affiliated network.
We then took the percentage differences in these predicted values. The
same methodology was used for determining the relative likelihood that a
cable-affiliated network would be carried.

Appendix V: Cable Network Carriage Model

Table 7: Logistic Model Results

                   Variable Parameter estimate and [p-value]

Age 0.1558 [0.0001]a

Advertising revenue per subscriber 0.7360 [0.0001]a

News 0.6495 [0.0001]a

Sports 0.1558 [0.0001]a

Broadcaster affiliation 0.6877 [0.0001]a

Cable network owned by operator 1.4091 [0.0001]a

Homes passed by cable system 0.0000 [0.0131]b

Cable system megahertz 0.0029 [0.0001]a

Population between ages 25 and 65 0.0054 [0.1677]

Home ownership 0.0069 [0.0001]a

Multiple system operator 0.2915 [0.0001]a

Intercept -6.3393 [0.0001]a

                               Sample size 55,728

                            Rescaled R-square 0.5065

Source: GAO (2003).
aSignificance at the 1 percent level.
bSignificance at the 5 percent level.

Appendix VI: Comments from the Federal Communications Commission

Note: GAO comments supplementing those in the report text appear at the
end of this appendix.

See comment 1.

Appendix VI: Comments from the Federal Communications Commission

                                 See comment 2.

                                 See comment 1.

                         See comment 1. See comment 3.

                                 See comment 1.

                                 See comment 4.

                                 See comment 5.

                                 See comment 6.

Appendix VI: Comments from the Federal Communications Commission

                                 See comment 7.

                                 See comment 6.

                                 See comment 7.

Appendix VI: Comments from the Federal Communications Commission

Appendix VI: Comments from the Federal Communications Commission

                                 See comment 8.

                                 See comment 9.

                                See comment 10.

Appendix VI: Comments from the Federal Communications Commission

                                See comment 10.

Appendix VI: Comments from the Federal Communications Commission

GAO Comments

The following are GAO's comments on the Federal Communications
Commission's letters dated September 24 and October 9, 2003.

1. 	In a letter dated September 24, 2003, FCC contended that under the
statutory framework to which the commission is legally obligated to adhere
in making effective competition determinations, it would be ultra vires
for the commission to update designations of effective competition on a
periodic basis. In other words, FCC stated that it did not have the legal
authority to update periodically its view of the competitive situation in
individual franchise areas. We disagree that the commission's authority is
so limited. In order to better understand the view that the commission
stated in its letter (i.e., it was prohibited from modifying its rules to
ensure that effective competition designations are reflective of current
conditions and continue to meet the statutory definition to the maximum
extent possible), we contacted FCC. On the basis of a conversation between
commission staff and GAO staff, FCC provided us with a second letter dated
October 9, 2003, that modified its views as expressed in the September 24
letter. In the second letter, FCC acknowledged that it was not statutorily
prohibited from revising its process (see GAO's comment 8).

2. 	Although local franchising authorities do see the information that a
cable franchise provides to FCC in an application for effective
competition, from filings that we reviewed, we found that these
authorities at times question the validity of the data and/or estimation
methodologies. For example, some have noted that reliance on 2000 census
data on housing units can lead to an overstatement of DBS penetration
because in areas with growing populations, housing estimates from 2000
will understate the current number of housing units in an area. Such an
understatement will result in an overstatement of the DBS penetration
rate. Moreover, under FCC's rules, local franchising authorities have
limited time to review such information after it is submitted.

3. 	Resources could clearly be an issue for taking steps to update the
status of effective competition, and FCC should consider this issue when
revising its process to keep the status of effective competition up to
date. FCC could consider requiring cable operators to certify on a
periodic basis that they still meet the statutory definition and if no
certification is provided, the finding would be removed. Alternatively, as
part of the cable rate survey, FCC could ask any franchise having a
designation of effective competition to provide information if that

Appendix VI: Comments from the Federal Communications Commission

status has changed and, under modified rules, use this as a basis for
changing the effective competition finding.

4. 	To develop our measure of competition, we reviewed many sources of
information, including information from FCC, information from and about
particular providers, as well as information gathered through discussions
we had with local franchising authorities. We were not attempting to
determine which franchises would have effective competition under the
legal definition. Instead, we focused on establishing when meaningful
competition, from an economic perspective, was likely to exist.

5. 	We cite FCC's finding on the difference in prices in places with and
without effective competition, but the more direct comparison for our
model is FCC's output from its econometric model contained in its 2002
Cable Pricing report. In that model, FCC tests for the price reduction
that occurs where there is wireline competition. Although FCC did not
explicitly define this term in their report, our review of that analysis
led us to believe that this measure is equivalent or very close in concept
to our definition of wire-based competition. That is, FCC is attempting to
measure how prices differ when a cable franchise faces a direct wireline
overbuilder in the area, which does not include all places that have
effective competition. Thus, we believe that the two measures of wireline
competition-that is FCC's and GAO's-did not differ in concept.

6. 	We performed standard statistical tests for the evidence of
multicollinearity in our model and did not find a significant problem.
Moreover, we tested FCC's variable for wireline competition in our model,
and we tested our measure of wireline competition on FCC's model. Since we
know the findings from each agencies' variable on its own model, we were
able to discern whether the differences in the findings from the two
models were caused by differences in the two models or by the measure of
wireline competition. We found that using FCC's measure of wireline
competition in our model produced a finding similar to that reported by
FCC, and using our measure of competition in FCC's model produced a
finding similar to that found in our model. From these findings, we have
concluded that any differences between the findings of FCC and those of
GAO are not caused by differences in the two models, but are due to
differences in how the wireline variable was measured. Further, the GAO
and FCC models have much overlap in the independent variables specified in
the model, and, as such, the degree to which there are concerns about
multicollinearity, this would be true of both models.

Appendix VI: Comments from the Federal Communications Commission

7. 	We agree that FCC's estimate of the percentage of the yearly rate
increase that can be attributed to programming costs is relatively
accurate because, as we note in our report, most of the 100 cable
franchises we interviewed noted that they used actual data when
calculating these costs. However, we did find that other cost items, such
as infrastructure investment, were reported with less accuracy and, in
some instances, were simply "plugs" to ensure that the cost and rate
increases were equal. In fact, while FCC found that in 2002 about 6.2
percent of the rate increase was attributable to infrastructure costs, the
findings from our survey of 9 large cable operators shows that overall
infrastructure costs increased by $2.23 per month per subscriber-or about
84 percent of the average rate increase reported in 2002. While these
estimates of infrastructure costs vary considerably, we recognize that our
reported infrastructure cost are not directly comparable to the average
rate increase since the average cost of $2.23 per month per subscriber
includes some infrastructure costs not attributable to the basic and
expanded-basic tiers of video service. We believe that these findings are
consistent with a major point in our report: that is, the data reported on
cost increases for programming were largely accurate, but the requirement
that the sum of cost increases equal the average rate increase may have
caused reduced estimates for other cost factors.

8. 	In its October 9 letter, FCC recognizes that while the statute
authorizes it to make findings of effective competition, the commission
implements this authority through the rules it has established. The
commission notes that its current rules do not contemplate a reassessment
of effective competition adjudication, except through the Local Franchise
Authority recertification process. However, FCC states that the statute
neither explicitly prohibits nor authorizes the commission from revising
its rules. Accordingly, FCC now acknowledges that it could possibly modify
the procedural rules associated with findings of effective competition,
although the commission notes that it is unclear, in its view, whether
this would work in communities lacking an effective competition
designation.

9. 	We believe that when effective competition designations more
accurately reflect current conditions, the resulting analysis provides a
better measure of the impact of competition on cable rates. As we note in
our report, we found that wire-based competition was associated with 15
percent lower cable rates, while FCC's report found that cable rates were
approximately 7 percent lower with this competition. We believe the
difference in these results is primarily the result of steps

Appendix VI: Comments from the Federal Communications Commission

we took to update FCC's wire-based competition variable (see GAO's comment
6).

10. In our subsequent conversation with FCC staff, they asked us to
identify possible ways that effective competition determinations could be
kept more up to date. We identified a number of possible options that the
commission could consider, recognizing that the commission would be the
appropriate party to determine how this could best be done. We made a
number of suggestions including (1) having effective competition
determinations be time limited, (2) having the cable operator periodically
certify that the circumstances under which the effective competition
determination had been made had not changed, and (3) utilizing the
information gathered as part of its Annual Price Survey to update the
effective competition determinations. In its October 9 letter, the
commission questions from a cost/benefit perspective the utility of such
approaches.

FCC's underlying concerns about these approaches is that the market has
changed. The commission notes that the level of competition is increasing
year to year so that the number of communities reverting to a
noncompetitive status is likely to be limited, while the number of
communities facing effective competition for the first time is likely to
be significant. For example, the commission provides that DBS penetration
has reached an average of 15 percent or more (the threshold for a finding
of effective competition) in at least 40 states. In our view, these
changes in the market emphasize the need for FCC to review its process for
making effective competition determinations. Moreover, as FCC emphasizes,
the commission has a statutory mandate to report on average prices
comparing cable systems that it has found are subject to effective
competition with cable systems that it has found are not subject to
effective competition. We believe that this report should, to the maximum
extent possible, reflect the current conditions in order to ensure its
utility.

Appendix VII: Comments from Industry Participants

American Cable Association

Consumer Federation of America

Below we summarize the written and oral comments that we received from
industry participants that reviewed a draft of our report. Because many of
these comments are opinion-based, we are not offering our views on them.
In one case, however, we provide some clarifying information about the GAO
model on cable rates.

The American Cable Association (ACA) noted that because we focused much of
our analysis on larger cable operators, the report does not address issues
of great importance to ACA and its membership, which are mostly small
cable operators. ACA noted that for smaller cable operators, DBS providers
are highly competitive, and programming costs are an even higher
percentage of overall costs than is the case for larger cable operators.
As a result, ACA disagreed with our suggestion that greater competition is
a potential solution to increasing cable rates.

ACA provided, in its comments, a number of policy solutions that would
address, in their view, the level of programming costs. Such options
include mandating public disclosure of programming rates, requiring an `a
la carte or minitier regime, overhauling of the retransmission consent
process, and requiring similar regulatory obligations for the DBS and the
cable industries. Additionally, ACA disagreed with our conclusion that an
`a la carte system would impose additional technical costs and not cause
cable rates to generally decline. Further, ACA did not believe that we
adequately addressed the link between increased carriage of cable networks
affiliated with broadcasters and higher cable rates.

A representative of the Consumer Federation of America suggested that the
costs associated with infrastructure upgrades were recouped from revenues
generated by advanced services, such as the digital tier and cable modem
service, and should not influence cable rates for the basic and
expanded-basic tiers. Therefore, this representative believes that we
overstate the contribution of infrastructure costs to increasing cable
rates. Moreover, this representative noted that we do not fully account
for the revenue obtained from advertising, which in this representative's
view, should mitigate the need for increasing cable rates.

This representative also provided several comments on GAO's cable network
carriage econometric model. First, this representative suggested that
advertising revenues per subscriber could be treated as an endogenous
variable-that is, it is a variable that is codetermined with other
dependent variables in the model. Second, this representative

Appendix VII: Comments from Industry Participants

Consumers Union

suggested that we include a table reporting the results for the
alternative specification, in which we consider cable networks owned by a
cable operator.

A representative of Consumers Union believes that our finding that cable
rates are 15 percent lower where a second wire-based competitor is present
is evidence of cable operators' market power. He believes that we should
measure the savings to American consumers that would accrue if cable rates
were 15 percent lower in all franchises throughout the country.
Additionally, this representative believes that our draft overstated the
negative aspects of regulation. He stated that regulation may be the only
viable option for addressing cable operators' market power because
wire-based competition may not be feasible on a widespread basis.

Regarding our analysis of ownership affiliations, this representative
believes that we should test for the impact of lower ownership thresholds,
in addition to the analysis of majority-owned networks.

This representative made numerous comments regarding an `a la carte
system. First, he suggested that we overstated the costs of equipment
associated with an `a la carte system, and he noted that (1) the necessary
equipment is currently being deployed and (2) the Congress is pushing the
cable industry toward a digital conversion. Second, he noted that our
discussion assumed that cable operators would pay any increases in license
fees arising from a decline in cable networks' advertising revenues. But,
he believes cable operators will exercise their market power and therefore
refuse to fully pay the higher license fees that cable networks will seek.
Moreover, this representative did not accept that advertising revenues
would dramatically decline in an `a la carte regime, and he stated that
advertising revenues for the most popular cable networks might increase
because advertisers will be able to clearly target subscribers viewing
these networks. Third, he stated that GAO understates how many subscribers
could benefit from an `a la carte approach. He also stated that a
substantial percentage of subscribers-perhaps as many as 40 percent- could
see their monthly bill decline because most subscribers do not watch many
networks. Finally, he noted that fundamentally there is tremendous
uncertainty regarding the outcome under an `a la carte regime.

Appendix VII: Comments from Industry Participants

National Association of Broadcasters

National Association of Telecommunications Officers and Advisors

National Association of Broadcasters officials identified several issues
associated with the cable industry. First, they stated that while our
report implies that a greater number of channels are a benefit to
subscribers, it is not clear whether this is the case. Second, they also
noted a concern about how we measured the popularity of cable networks for
the cable network carriage model.

These officials noted that in discussing pricing under an `a la carte
system, we should include the possibility of cable operators implementing
a pricing scheme wherein subscribers are charged a flat monthly fee for
access to the cable network and additional fees for each network selected.
They believe that this would be the pricing structure implemented because
cable operators must be able to recoup costs associated with their
networks and overhead that are currently imbedded in the price for the
basic and expanded-basic tiers.

Regarding retransmission consent, these officials do not believe there was
sufficient discussion in our report of the history of retransmission
consent. In particular, the option for cable network carriage in lieu of
cash payment for retransmission of the broadcast station was largely
supported by the cable industry. Additionally, they noted that our
discussion regarding how retransmission consent is used was too broad
because it implied that all broadcast stations use retransmission consent
to gain carriage, while there are only a limited number of stations that
do so.

The National Association of Telecommunications Officers and Advisors
(NATOA) noted that the focus of our review was cable rates for the basic
and expanded-basic service tiers, but equipment rental-such as converter
boxes-are also rising. NATOA noted that we correctly pointed out that the
benefits of infrastructure investment may confer largely to subscribers of
advanced services, but it noted that FCC rules continue to allow these
costs to be allocated to basic rates and rates for equipment.

NATOA also raised concerns about the lack of government data on cable
rates and related issues. NATOA expressed concerns that we relied on FCC
data-which we have noted may not be of high reliability-as well as on data
from Kagan World Media, a cable industry data vendor. For example, NATOA
expressed concern that we had no hard data on expenditures on customer
service. NATOA noted that we should recommend to the Congress that some
responsible agency (such as the Department of Justice) conduct an audit of
the cable industry, including

Appendix VII: Comments from Industry Participants

an examination of the contracts between cable networks and cable operators
for the purchase of programming.

NATOA also raised concerns about how we analyzed the effect of ownership
relationships on the cost of programming. NATOA's comments noted that our
analysis of the effect of "majority-owned" programming was too limited,
and that we should have included a broader definition of ownership
affiliations, including, for example, agreements between companies that
are separately owned, for this analysis.

According to NATOA, infrastructure investments are largely a benefit to
subscribers of advanced services and, to the extent that basic and
expanded-basic rates rise due to these investments, it represents a
cross-subsidy.

NATOA also pointed out that, as we have noted, DBS penetration data used
for effective competition filings have not been fully validated and are
generally not available to stakeholders other than the cable operators.
Moreover, NATOA noted that the Congress should reevaluate the 15 percent
penetration level required under law for a finding of effective
competition when the basis is competition from DBS providers. NATOA also
noted that our finding of a 15 percent price reduction in areas with a
wire-based competitor may be the result of temporary price discounts by
new companies. Finally, NATOA noted that we do not fully discuss in this
report the ramifications of a finding of effective competition. In
particular, NATOA noted that we did not discuss that cable franchises with
such a finding no longer have to price uniformly across the franchise area
and are no longer subject to the tier buy-through provisions of the Cable
Television Consumer Protection and Competition Act of 1992.

Lastly, NATOA noted that it is critical for us to make it clear that, on
the basis of the model results, there is only a slight reduction in cable
rates due to the level of DBS penetration.

National Broadcasting Company (NBC) officials suggested that we explain
why broadcaster-owned cable networks are more frequently carried than
other cable networks. In their view, cable operators, as a rule, do not
pay any license fees for the right to carry a local broadcast station,
notwithstanding the value of that programming to the cable operator. They
also noted that, according to our data, cable operators also do not pay
higher license fees for the right to carry these broadcaster-affiliated
networks. Instead, NBC officials said that the sole compensation that

National Broadcasting Company

Appendix VII: Comments from Industry Participants

National Cable and Telecommunications Association

broadcasters receive in exchange for retransmission of the local broadcast
stations' programming is an arguably higher penetration of cable carriage
for their affiliated programming networks.

The National Cable and Telecommunications Association (NCTA) had serious
concerns about the finding from our econometric model, which indicates
that cable rates are 15 percent lower in markets with a second wire-based
competitor. NCTA officials noted that only about 45 franchise communities
have such an overbuilder compared with about 10,000 cable systems
nationwide. They also noted that the number of such overbuilders has
declined in recent years, and the type of companies operating these
businesses has been changing. As such, they believe that it is not
appropriate to extrapolate these findings for the vast majority of markets
that currently have no wireline competition. In its written comments, NCTA
noted that "given the limited nature of wireline overbuild competition, it
is important not to overstate its importance to determining a
`competitive' rate."1

NCTA officials stated that there is no link between the possible exercise
of market power and the increase in cable rates. They noted that,
according to FCC's survey, rates for areas with effective competition have
actually risen in the last 2 years at a slightly faster pace, on a
percentage basis, than rates in areas without effective competition.

These officials also noted that our study did not take into account the
rise in the quality of cable programming. In particular, they noted that a
recent study by Professor Wildman, of Michigan State University, found
that when analyzed on a price per-viewing-hour basis, cable rates have
declined significantly in recent years. Additionally, they noted that
there have been enormous benefits from the upgraded infrastructure of
cable systems. They also noted that important benefits to those upgrades
accrue to video subscribes (even if they do not take advanced services) in
the form of better picture quality and more reliable cable service.

1In our model, we included approximately 100 franchises that were
classified as facing wire-based competition-we believe that FCC's number
of only 45 overbuilders, as cited by NCTA, does not include all wire-based
competitors. Moreover, the sample of franchises included in our model was
only about 720, which were randomly selected by FCC to be representative
of the universe of franchises. As such, approximately 16 percent of the
franchises included in our model were classified as having a wire-based
competitor.

Appendix VII: Comments from Industry Participants

News Corporation

NCTA officials had two comments related to cable operators ownership of
cable networks. First, they stated that our discussion of program access
rules implied that there could be a significant problem for entrants'
gaining access to programming. Conversely, they noted that program access
concerns have always been minimal and that, if anything, these problems
have declined in recent years, in part because few cable networks are
owned by cable operators. Second, in terms of the carriage benefits that
accrue to cable networks owned by cable operators, these officials noted
that few cable networks are owned by cable operators. As such, they
believe that while these cable networks may have an advantage in carriage,
this is not a serious concern.

Regarding programming costs, News Corporation (Fox) officials stated that
the 59 percent increase in the cost of sports programming that we reported
seemed high, and they suggested that we mention that the analysis did not
include regional sports networks. Further, these officials also noted that
the 72 networks that we compared with the sports programming networks
include some networks that are not widely distributed. They said that our
inclusion of such networks could exacerbate the difference in programming
costs between the sports and nonsports networks because some of the less
distributed networks would have low license fees.

News Corporation officials noted that one reason the sports leagues might
have told us that the cost of sports rights has not increased much in the
past year is because the leagues are in the middle of multiyear contracts.
These officials noted, however, that when compared with previous multiyear
contracts, there has been a large increase in the cost of sports rights.

Regarding retransmission consent, News Corporation officials noted that
broadcast networks are highly valuable to consumers. Further, they noted
that there are important objectives served by the retransmission
provisions that should be more fully discussed in the body of our report.

These officials cited two concerns regarding our cable network carriage
model. First, they indicated that we should include an explanatory
variable for the price, or license fee, for each cable network. Second,
they believe our model should include a variable that incorporates launch
fees.

News Corporation officials believe that it is important to note that even
if people only watch 17 channels, consumers value having access to more

Appendix VII: Comments from Industry Participants

than 17 channels. Moreover, they indicated that consumers may not choose
to watch the same 17 channels in any given year.

Satellite Broadcasting 	The Satellite Broadcasting and Communications
Association chose to provide no comments.

and Communications Association

Viacom Viacom (CBS) chose to provide no comments.

                              Walt Disney Company

Walt Disney Company (ABC) officials said that our draft provided extensive
information on how programming costs have increased over time, but did not
provide enough coverage of how infrastructure costs have changed over
time. Additionally, they believe the figures for programming costs that we
reported are too high, and similarly that advertising revenues offset a
greater portion of programming costs than we reported.

Disney officials noted that the value of cable service today is much
greater than it was in the past in terms of the number of networks and
quality of programming that subscribers receive. As evidence, they said
that subscribers are watching cable networks more and broadcast networks
less. They referred to a study prepared by Professor Wildman, of Michigan
State University, which estimated the "real" cost of cable by considering
viewing hours; the study finds that the value of cable service to
subscribers has risen dramatically in recent years.

Regarding a sports tier, these officials noted that a sports tier only
exists in New York, and that it has been bitterly fought-over, involved
mediation, and is only a 1-year agreement. Moreover, they believe we
should emphasize that the Yankees Entertainment and Sports (YES) network
agreement only applies to regional sports networks, not ESPN. They said
that the YES arrangement does not represent a trend and noted, for
example, that cable operators continue to place cable-affiliated sports
networks on the expanded-basic tier.

Regarding retransmission consent, Disney officials said that we should
provide more discussion about why the Congress passed this provision. They
believe that without retransmission consent, free over-the-air television
would be undermined. Moreover, they said that, prior to

Appendix VII: Comments from Industry Participants

retransmission consent, broadcasters were required to provide content free
of charge to cable operators that they subsequently sold to subscribers.
Additionally, they said that it is important to note that the option of
carriage of broadcaster-affiliated cable networks instead of payment for
retransmission was discussed by Congress and has been endorsed by FCC.
More importantly, according to these officials, Disney always offers a
cash option to cable operators-their most recent offer was 70 cents per
subscriber per month.

Appendix VIII: GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

(545024)

Amy Abramowitz, (202) 512-2834 Michael Clements, (202) 512-2834

In addition to those named above, Stephen Brown, Julie Chao, Andy Clinton,
Keith Cunningham, Michele Fejfar, Sally Moino, Tina Sherman, Wendy
Turrene, Mindi Weisenbloom, and Carrie Wilks made key contributions to
this report

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