Telecommunications: The Effect of Competition From Satellite Providers on
Cable Rates (Letter Report, 07/18/2000, GAO/RCED-00-164).

Pursuant to a congressional request, GAO provided information on the
effect of competition from satellite providers on cable rates, focusing
on: (1) the extent to which the level of subscribership (or penetration)
of direct broadcast satellite (DBS) has influenced cable rates; and (2)
other key factors that may influence the level of cable rates.

GAO noted that: (1) GAO did not find that in calendar year 1998--a time
when DBS firms did not generally transmit local broadcast signals as
part of the DBS package--greater DBS penetration was correlated with
lower cable rates; (2) GAO model results indicate that greater DBS
penetration was correlated with somewhat higher cable rates; (3) these
results suggest that, even though DBS increased the number of
substitutes available in the subscription video market, DBS did not
exert significant pricing pressure on cable companies to reduce rates at
that time; (4) however, GAO did find that the penetration of DBS was
correlated with nonprice competition--in particular, where DBS
penetration was high, cable systems tended to provide more channels to
subscribers; (5) the greater number of channels may contribute to the
higher prices in these areas; (6) DBS also appears to have been more
competitive with cable in nonmetropolitan areas; (7) GAO found DBS
penetration to be much higher--holding other factors constant--in
nonmetropolitan locations; (8) because DBS firms are making local
broadcast signals available in several cities, it is likely that DBS
will become a more important competitor to cable in the coming years;
(9) GAO's model indicated that several other factors influenced cable
rates in 1998; (10) GAO found--as have the Federal Communications
Commission and others--that a greater number of channels offered by a
cable system led to higher cable rates, suggesting that consumers were
willing to pay more for a greater number of channels and that providing
additional channels is costly for cable companies; (11) the presence of
a nonsatellite competitor had an important effect on cable rates; (12)
in particular, when a second cable system or other ground-based
competitor (such as a wireless cable provider) is operating in part or
all of a franchise area, cable rates were lower; and (13) when a cable
franchise was owned by one of the larger national cable systems, cable
rates tended to be slightly higher.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-00-164
     TITLE:  Telecommunications: The Effect of Competition From
	     Satellite Providers on Cable Rates
      DATE:  07/18/2000
   SUBJECT:  Telecommunication
	     Cable television
	     Communication satellites
	     Television broadcasting
	     Prices and pricing
	     Competition

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GAO/RCED-00-164

Appendix I: A Brief History of the Subscription Video Market

12

Appendix II: GAO's Cable Rate Model

17

Appendix III: Further Issues Pertaining to the Data Used in GAO's
Cable Rate Model

34

Appendix IV: Descriptive Statistics for Variables Included in GAO's
Cable Rate Model

39

Appendix V: Comments From the Federal Communications
Commission

40

Appendix VI: Comments From the National Cable Television
Association

43

Appendix VII: Comments From the Satellite Broadcasting and Communications
Association

46

Appendix VIII: GAO Contacts and Staff Acknowledgments

50

Table 1: Expected Effects of All Explanatory Variables on Cable
Rates 22

Table 2: Price and Nonprice Competition Relationships in Model 25

Table 3: 3SLS Model Results 28

Table 4: Regression Estimates of Reduced-Form Cable Rates
Equation 31

Table 5: Regression Estimates for Cable Rates, Sample Strata Analysis 33

Table 6: FCC Sample and GAO Data Set 36

Table 7: Table of Descriptive Statistics 39

DBS direct broadcast satellite

FCC Federal Communications Commission

MABLE Master Area Block Level Equivalency

MSO multiple system operator

NCTA National Cable Television Association

SBCA Satellite Broadcasting and Communications Association

SHVA Satellite Home Viewer Act

3SLS Three-Stage Least Squares

2SLS Two-Stage Least Squares

Resources, Community, and
Economic Development Division

B-284341

July 18, 2000

The Honorable Patrick Leahy
Ranking Minority Member
Committee on the Judiciary
United States Senate

The Honorable Mike DeWine
Chairman
The Honorable Herb Kohl
Ranking Minority Member
Subcommittee on Antitrust, Business Rights,
and Competition
Committee on the Judiciary
United States Senate

The Honorable Russell Feingold
United States Senate

For many years, cable television companies faced little competition in the
market for subscription video service. In 1994, however, a new generation of
satellite service known as direct broadcast satellite (DBS) was introduced.
This service enables subscribers to use small satellite reception dishes to
receive television programming. DBS has become the most important competitor
to the cable industry, but until recently, DBS firms' ability to compete
against cable was limited because they could not generally provide local
broadcast networks (such as ABC and NBC) in their programming packages in
most areas of the United States. Changes to the relevant law went into
effect in late 1999, and DBS operators are now permitted and have begun to
offer local broadcast signals in many markets throughout the United States.
(App. I provides a brief history of the subscription video market.)

Because of your interest in the degree of competitiveness between cable and
DBS providers, you asked us to provide information on (1) the extent to
which the level of subscribership (or "penetration") of DBS has influenced
cable rates and (2) other key factors that may influence the level of cable
rates. To respond to this request, we developed an econometric model that
examines whether, in 1998 (the most recent year for which cable rate data
from the Federal Communications Commission (FCC) were available), the
penetration of DBS subscribership and a variety of other factors influenced
the level of cable rates. This model indicates the influence of each factor
on cable rates, holding the effects of each of the other factors constant.
We discussed our model development with FCC and two academic experts on
telecommunications. A detailed description of the model is provided in
appendix II. Some limitations of this model are discussed at the end of this
letter and in appendix III.

We did not find that in calendar year 1998--a time when DBS firms did not
generally transmit local broadcast signals as part of the DBS
package--greater DBS penetration was correlated with lower cable rates. In
fact, our model results indicate that greater DBS penetration was correlated
with somewhat higher cable rates. These results suggest that, even though
DBS increased the number of substitutes available in the subscription video
market, DBS did not exert significant pricing pressure on cable companies to
reduce rates at that time. However, we did find that the penetration of DBS
was correlated with nonprice competition--in particular, where DBS
penetration was high, cable systems tended to provide more channels to
subscribers. The greater number of channels may contribute to the higher
prices in these areas. DBS also appears to have been more competitive with
cable in nonmetropolitan areas. We found DBS penetration to be much
higher--holding other factors constant--in nonmetropolitan locations.
Because DBS firms are currently making local broadcast signals available in
several cities, it is likely that DBS will become a more important
competitor to cable in the coming years.

Our model indicated that several other factors influenced cable rates in
1998. We found--as have FCC and others--that a greater number of channels
offered by a cable system led to higher cable rates, suggesting that
consumers were willing to pay more for a greater number of channels and that
providing additional channels is costly for cable companies. We also found
that the presence of a nonsatellite competitor had an important effect on
cable rates. In particular, we found, as have other studies, that when a
second cable system or other ground-based competitor (such as a "wireless
cable" provider) is operating in part or all of a franchise area, cable
rates were lower. Finally, we found that when a cable franchise was owned by
one of the larger national cable systems, cable rates tended to be slightly
higher.

Cable television is currently the dominant means of television program
delivery to U.S. households. According to FCC, as of June 1999, almost 97
percent of television households in the United States had access to a cable
television system, and approximately 67 percent of television households
subscribed to a cable service. Local cable systems are often owned by large
media companies and usually face little or no competition as a local
provider of subscription video service.

To date, the most significant competitor to cable is the home satellite
industry, particularly DBS, which was first launched in 1994. The monthly
subscription charges for DBS are generally comparable with cable, although
DBS subscribers typically need to purchase the equipment required to receive
the satellite signals. Today there are over 10 million DBS subscribers in
the United States, accounting for about 12.5 percent of households
subscribing to a video service.

Until recently, there was a significant difference between the programming
packages of cable and DBS in terms of local broadcast stations. DBS
providers were governed by the 1988 Satellite Home Viewer Act, as amended,
which was passed at a time when satellite providers did not possess the
technology to transmit local broadcast signals to many markets throughout
the country. This act gave DBS providers a copyright license to retransmit
broadcast network programming only to certain customers--those who could not
adequately receive broadcast signals over the air via traditional rooftop
antennas.

During the late 1990s, pressure grew on the Congress to provide DBS firms
with a broader license to transmit local broadcast signals. First, advances
in technology during the 1990s--for example, the ability of DBS providers to
use "spot beam" technology to target the signal from a local broadcast
station only to satellite subscribers within that station's viewing
area--provided DBS firms with the ability to include local broadcasts for
many markets. Second, there was a growing realization that the legal
restrictions on broadcast carriage had become an important disadvantage for
satellite companies. For example, according to FCC, consumers have
historically reported that their inability to receive local signals from DBS
operators may negatively affect their decision on whether to subscribe to
DBS. Therefore, in late 1999, to facilitate DBS companies' provision of
local broadcast signals, the Congress enacted the Satellite Home Viewer
Improvement Act, which provided a broader copyright license to these
carriers to provide broadcast signals. Many Members of Congress noted that,
in doing so, they hoped to make DBS a closer substitute for cable services.
As a result of that law, DBS subscribers in more than 20 major cities now
can watch their local broadcast stations' programming via satellite.

With Lower Cable Rates

We did not find that greater DBS penetration was correlated with lower cable
rates in 1998. In fact, our model found that greater DBS penetration was
statistically associated with somewhat higher cable rates. While this
finding may indicate that, in 1998, the penetration of DBS did not exert
significant pricing pressure on cable companies, we also found that the
presence of DBS was correlated with nonprice competition. In particular, our
findings suggest that cable companies responded to DBS entry by increasing
the number of channels they provide to consumers. Another possible
explanation for the estimated relationship between DBS penetration and cable
rates is that it is the level of cable rates that influences DBS
penetration. In other words, our results could indicate that in places with
higher cable rates, subscribers were more likely to migrate to DBS. In fact,
we found some evidence that this could be the case. A further discussion of
this issue is contained in appendix II.

Our model results indicate that in cable franchises outside of metropolitan
statistical areas, DBS penetration tended to be much higher--holding other
factors that affect the penetration of DBS constant. Thus, in 1998, rural
subscribers may have viewed DBS as a closer substitute for cable than urban
and suburban subscribers did. This could be due to several factors. For
example, urban dwellers can have more problems installing a satellite dish
that is able to "see" the appropriate satellite because of foliage or tall
buildings that block the necessary line of sight between the reception dish
and the satellite. Also, it was only in 1996 that FCC imposed rules
requiring building owners and homeowners' associations to allow homeowners
to install satellite reception dishes and only in 1999 that many of these
provisions were effectively extended to renters. It is also possible that,
at that time, people in rural areas were more familiar with satellite
services than those in urban areas because satellite services had been
marketed in rural areas for many years. And finally, the law in 1998
provided DBS companies with a copyright license to provide broadcast signals
to households in "unserved" areas but not elsewhere. Thus, it may be that in
some rural areas that came under the "unserved" definition, DBS actually
operated as a very close substitute for cable because some of these
subscribers were already receiving broadcast signals over the DBS system.

Our finding that DBS did not impose significant pricing pressure on cable
rates may be short-lived. In 1998, consumers were not very familiar with
DBS, and the programming packages the companies offered did not generally
include local broadcast signals. Today, on the other hand, the two DBS
companies are making local broadcasts available in many cities. Therefore,
it seems likely that DBS will become a more important competitor to cable
systems in the near future.

With Cable Rates

We found that several key factors influence the level of cable rates. In
particular, our model results indicate that the following factors related to
consumer demand for cable, the cost of providing cable service, and the
competitiveness of the market were correlated with cable rates:

ï¿½ The number of channels provided by a cable system had the greatest
influence on rates of all the variables included in the model. This
finding--that a greater number of channels was correlated with considerably
higher cable rates--is likely related to both demand and cost. Consumers are
willing to pay more for a higher-quality cable channel lineup, and the cost
of providing more channels is higher for cable companies.

ï¿½ The presence of a nonsatellite competitor--such as another cable company
or a wireless cable operator--was associated with lower cable rates. In
particular, we found that when such a competitor was operating in part or
all of a franchise area, cable rates were, on average, 10 percent lower than
in franchise areas with no ground-based competitors.

ï¿½ Rates were slightly higher in cable franchise areas that had had a cable
system in place for a long period of time. This finding has been attributed
in other studies to demand for the service growing ever greater as consumers
become more aware and knowledgeable of a well-established system.

ï¿½ Cable rates were slightly higher if the owner of a system in a particular
franchise area was one of the larger national cable companies. There has
been no consensus on how this result should be interpreted.

ï¿½ Finally, we did not find average wages in a franchise area to be related
to higher cable rates.

With the exception of our findings for the wage factor, these basic model
results are generally consistent with the findings of other studies. (See
app. II for a full discussion of our results.) The stability of these model
results over time may also be affected, however, by changes in the
marketplace. Many of the factors affecting cable rates relate to demand,
cost, and market structure characteristics that are likely to be influenced
by the dramatically changing market for telecommunications, of which cable
is a part. As varied telecommunications companies move to provide several
services over a given infrastructure--a phenomenon that has been called
"convergence"--the cost of providing each service may come to be influenced
by the overall costs of providing the bundle of services. Additionally,
demand factors are likely to be influenced by convergence as well since
consumers' choices for telecommunications services are increasingly affected
by their decisions about the entire bundle of telecommunications services
that they purchase. And finally, the convergence of technologies is also
influencing the competitive nature of the market as companies that
traditionally provided only one service over a given infrastructure enter
new markets by providing an array of telecommunications services over that
same infrastructure. Therefore, the manner in which cable rates are set is
likely to change as the telecommunications marketplace develops.

We provided a draft of this report to FCC for review and comment. FCC
recommended that we clarify our finding that DBS did not exert significant
pressure on cable companies to reduce rates during 1998, suggesting that our
results could also be interpreted as showing that when cable rates are high,
more consumers switch to DBS. We believe that our report thoroughly
discusses the two possible relationships between cable rates and DBS
penetration and that the model we developed allows us to appropriately
interpret the results as we have. The discussion appears primarily in
appendix II. FCC also believed that we should better highlight that DBS
providers are an important multichannel alternative to cable. Once again, we
believe our report adequately makes this point. FCC's comments and our
response are contained in appendix V. In addition to the written comments,
FCC staff also provided technical comments and corrections related to our
model design and other issues, which we incorporated as appropriate.

In addition, we provided a draft of this report to the National Cable
Television Association and the Satellite Broadcasting and Communications
Association for comment. Generally, both associations believed that the time
period studied was too early to detect the full effect of DBS on cable
rates. We agree with this concern, particularly in light of the dramatically
changing telecommunications marketplace. We suggest that a full
understanding of the response to the entry of DBS into the video market will
require continued analysis in the coming years. Our view is that this study
provides a helpful baseline for such further studies. The comments of the
National Cable Television Association are presented in appendix VI. The
comments of the Satellite Broadcasting and Communications Association are
presented in appendix VII.

To address the objectives of this report, we developed an econometric model
to ascertain whether the penetration of DBS and several other factors were
associated with the level of cable rates in various franchise areas across
the country in 1998. In particular, the model sought to determine whether
and how two categories of key factors affected cable rates: (1) factors that
relate to subscribers' demand for cable service and cable companies' costs
of providing service and (2) factors that relate to the degree of
competition in the market. The penetration of DBS is one of the competition
variables included in the model. We discussed our model development with FCC
and two academic experts on telecommunications.

There are some important limitations to the interpretation of our model
results. Generally, econometric models provide measures of statistical
correlations between explanatory factors and the factor to be explained and
do not imply causation between these factors. Some specific limitations of
our model relate to the characteristics of the sample of franchise areas
chosen by FCC. In particular, our statistical analysis was performed on a
sample of 698 cable franchise areas that were included in a survey conducted
by FCC. This survey asked questions about cable services, rates, and system
characteristics. The survey included all "competitive"--as defined under
statute--franchise areas, while the remaining "noncompetitive" franchises
were selected within several size classifications (or "strata"). We found
that the average number of subscribers within some strata in our sample is
substantially greater than the average number of subscribers among all
franchises within those strata. Accordingly, the results of our analysis are
most applicable in describing the influences on cable rate-setting in larger
franchise areas. At the same time, however, we conducted additional analyses
on the available data that suggested that the nonrepresentativeness of FCC's
franchise data set did not impose a serious problem for our model estimation
and interpretation.

A complete discussion of the model development, data sources, estimation
design, model results, and model limitations is contained in appendixes II
and III. A table of descriptive statistics for all variables included in the
model appears in appendix IV.

We conducted our review from September 1999 through July 2000 in accordance
with generally accepted government auditing standards.

As agreed with your offices, unless you publicly release its contents
earlier, we plan no further distribution of this report until 14 days after
the date of this letter. At that time, we will provide copies to interested
congressional committees; the Honorable William E. Kennard, Chairman,
Federal Communications Commission; and other interested parties. We will
also make copies available to others upon request.

If you or your staffs have any questions about this report, please contact
me at (202) 512-7631. Key contributors to this report are listed in appendix
VIII.

Stanley J. Czerwinski
Associate Director, Housing, Community
Development, and Telecommunications Issues

A Brief History of the Subscription Video Market

Cable television systems were originally deployed in rural or mountainous
areas where traditional broadcast television reception was poor. As cable
systems expanded their channel offerings, however, the demand for cable
services grew, and cable deployment spread throughout the country. Satellite
television companies also focused first on serving rural areas, but these
services are now marketed to consumers in urban and suburban areas as well,
and the acceptance of satellite television services among consumers has
enabled these providers to become the cable industry's most viable
competitor. While restrictions on satellite firms' carriage of broadcast
signals previously limited these firms' competitive viability, the recent
passage of a law allowing satellite providers to include broadcast signals
as part of their satellite offerings was designed to enhance competition in
the video market.

Transmission Gaps and Evolved to Be the Dominant Means of Television
Delivery

In the early 1950s, the Federal Communications Commission (FCC) helped
advance the deployment of broadcast television by devising a system to
assign broadcast television channels. The resulting local broadcast system
provided licenses for television stations in local areas--rather than in
larger regional areas. Because rural areas with few households provided less
economic opportunity for a local television station, these areas had fewer
stations than did more urbanized areas. As a consequence, households in
rural and mountainous areas were often unable to receive broadcasts from
local television stations. To fill these gaps in the availability of
over-the-air television, cable systems (known at the time as "community
antenna TV") began to develop.1 These systems employed large antennas to
capture the broadcast signals of nearby television stations and then
retransmitted those signals--for a fee--to homes through coaxial cable wires
owned by the cable companies. Most early cable systems focused solely on the
retransmission of broadcast networks.

In the 1970s, cable systems began to expand their programming packages by
adding channels that had been developed specifically for distribution on
cable systems, such as Home Box Office and Cable News Network.2 This greater
array of channels available on cable systems led to a broadening of demand
for cable television, and cable was rapidly deployed throughout urban and
suburban areas across the country. According to FCC, as of June 1999, almost
97 percent of television households in the United States have access to a
cable system, and approximately 67 percent of television households
subscribe to a cable service, making cable the dominant means of television
delivery to U.S. households.

As cable system deployment and subscribership grew, the ownership structure
of the industry changed. Early on, the cable industry was characterized by
privately owned small systems scattered throughout the country. Cable's
success in the 1980s, however, attracted the interest of large media
companies such as Tele-Communications, Inc.,3 and Time Warner.4 These
companies, and others, purchased cable systems throughout the country,
emerging as large national cable owners known as multiple system operators
(MSO). Several of these MSOs also invested in the development of cable
programming and thereby established ownership ties between two vertically
connected markets: companies producing and supplying cable programming and
companies purchasing that programming. This greater concentration of cable
properties, combined with ownership ties to cable programming, sparked
concerns about the market power of the cable industry and the need for
greater competition in the delivery of subscription video services.5

Become an Important Competitor to Cable

To date, the most significant competitor to cable is the satellite
television industry. Satellite subscription service emerged in the early
1980s as an alternative to cable service in rural areas where over-the-air
broadcast and cable systems were inaccessible, and it has become popular in
many areas in recent years. The most successful of these satellite services
has been direct broadcast satellite (DBS). First introduced in 1994, DBS
quickly became one of the fastest-growing product lines in the history of
consumer electronics. DBS operators have always marketed the technical
advantages of DBS' fully digital systems, comparing them to cable's
continued reliance on an older technology. Because DBS is fully digital,
every video signal can be "compressed" to make more efficient use of
satellite capacity and provide hundreds of channels to subscribers. This
technical advantage, however, will be short-lived as cable operators move to
upgrade their systems to include digital technology.

Monthly service charges for DBS are roughly similar to monthly cable rates,
although DBS subscribers may have higher up-front costs because they
generally must buy satellite reception equipment.6 DirecTV and EchoStar, the
two providers of DBS in the United States, currently have over 10 million
subscribers, accounting for about 12.5 percent of the households subscribing
to a multichannel video service.7 According to FCC, in 1998 almost two out
of every three new subscribers to a multichannel video service chose DBS,
and from 1998 to 1999, DBS subscribership grew 39 percent. Despite the
growing popularity of DBS, FCC reported that 82 percent of all multichannel
video service subscribers still receive their video programming from a
locally franchised cable operator.

Broadcast Satellite Is Covered Under Different Laws

Until recently, a fundamental difference between the service offerings of
DBS companies and those of the cable industry was due to technological and
legal limitations on DBS operators' transmission of local broadcast station
signals. On the cable side, a 1976 copyright law permits retransmission of
local television signals by local cable franchises through permanent
copyright licenses. Under this copyright license scheme (17 U.S.C. 111),
commonly referred to as a compulsory cable copyright license, copyright
owners are required to license their works to cable systems at
government-set prices, terms, and conditions. Generally, cable operators pay
minimal or no copyright fees to carry local broadcast signals.

A different compulsory copyright license scheme, however, applies to
satellite operators. DBS providers were governed by the 1988 Satellite Home
Viewer Act, as amended (17 U.S.C. 119), which was originally passed at a
time when satellite providers did not possess the technology to transmit
local broadcast signals to many markets throughout the country.8 Until
recently, the act granted only a limited exception to the exclusive
programming copyrights of television networks and their affiliates. This
limited exception gave satellite companies license to deliver broadcast
network programming only to those customers living in "unserved households."
9 A household so defined generally would not adequately receive broadcast
signals.10 DBS firms had no license to provide broadcast signals to
households in urban or suburban areas that generally could receive adequate
over-the-air local broadcast signals.

Recently, the technical ability of DBS operators to provide local broadcast
signals improved because of more advanced digital compression technologies
as well as "spot beam" technology, which allows DBS to target the signal
from a local broadcast station only to the satellite subscribers within that
station's viewing area. Thus, the legal restrictions on broadcast carriage
had become an important disadvantage for satellite companies: While cable
subscribers were able to receive their local broadcast stations as part of
their programming package, most DBS subscribers could not. According to FCC,
consumers have historically reported that their inability to receive local
broadcast signals from DBS operators made subscribing to DBS less
attractive.

In late 1999, the Congress enacted the Satellite Home Viewer Improvement Act
(P.L. 106-113) to, among other things, allow DBS companies to provide local
broadcast signals. Both EchoStar and DirecTV began rolling out local network
television service to more than 20 major cities in November 1999. However,
according to the satellite industry, DBS is unlikely to provide local
stations to all markets because DBS satellites have limited capacity.11

GAO's Cable Rate Model

The purpose of this appendix is to describe our model of cable rate-setting.
In particular, we discuss (1) the conceptual development of the model, (2)
the data used for the model, and (3) the estimation results of the model.
See appendix III for a discussion of the nature of the franchise sample used
in the model and data-processing tasks related to matching information
across varied geographic contexts. See appendix IV for a table with
descriptive statistics on variables included in the model.

In response to a congressional request for a study examining the effects of
DBS service on cable rates, we developed an econometric model to examine the
influence of satellite penetration, among other factors, on the cable rates
charged in a large sample of cable franchise areas in 1998. We surveyed the
existing empirical literature on cable rates to develop a model that would
appropriately analyze these issues. Relying on that literature and our
assessment of the contemporary subscription video marketplace, we developed
a model that included a variety of explanatory factors--or variables--that
have been included in previous models but that also extends those analyses
by adding new variables to account for the recent emergence of DBS as an
important competitor to cable and for recent system upgrades among many
cable firms.

Market

In 1998, the national market share of cable systems--as measured by
subscribership--in what we call the subscription video market was about 85
percent, and the share of the DBS carriers was about 12 percent. In the
context of this market, cable operators can be thought of as the "dominant"
distributors of video programming, while the other providers can be thought
of as "fringe" suppliers. Therefore, to examine the competitive influence of
DBS providers on cable rates, we employed a model based on the subscription
video market, rather than on the narrower market for cable TV.12

Our model is based on the generalized form of an economic model known as the
"dominant firm-competitive fringe model."13 Cable providers and satellite
providers can be regarded as "differentiated," not so much because they use
different technologies but because the services they provide are perceived
to be different by subscribers and because these varied providers face
different laws and regulations that influence their cost structures as well
as the type of product they provide. For example, Consumer Reports reported
that satellite subscribers were generally more satisfied with their services
than were cable subscribers.14 Also, cable companies must pay local
franchise fees and are required to provide capacity for public, educational,
and government channels. Satellite providers, on the other hand, had only a
limited compulsory copyright license to provide broadcast channels during
the period our model examined. In sum, cable and satellite providers are
differentiated in consumers' perception, legal context, and their product
offerings.

Under a generalized dominant firm-competitive fringe model, cable rates will
depend broadly on the demand and cost conditions affecting both the cable
and noncable providers of subscription video services. A desirable attribute
of this model framework was that we could incorporate the competitive
influence of noncable providers--such as DBS firms--on cable rates. DBS
providers represent the single largest competitor to cable operators, and
industry reports indicate that in 1998, almost two thirds of new video
subscribers were choosing satellite over cable. To measure the competitive
influence of the noncable providers (the competitive fringe), we use the DBS
share of video subscribers in each franchise area.15 Because provisions of
the 1988 Satellite Home Viewer Act (SHVA) constrained the provision of
broadcast carriage by DBS providers in 1998, DBS providers may have been
unable to fully compete with cable companies. The dominant firm-competitive
fringe framework makes it possible for us to also incorporate this influence
on cable rates.

We believe our measure of DBS penetration provides an appropriate measure to
investigate the competitive influence of DBS on cable rates. However, the
issue of estimating the influence of DBS penetration on cable rates is
complicated by the possibility that the level of DBS penetration in an area
is itself determined, in part, by the level of cable rates in that area. One
method of statistical estimation in this situation is to estimate a system
of structural equations in which certain variables that may be
simultaneously determined are estimated jointly. In previous studies that
defined the market more narrowly to be cable television, equations for cable
rates, the number of cable subscribers, and the number of cable channels
have been estimated jointly.16 To incorporate the influence of DBS on cable
rates in the broader subscription video market, we also include an equation
for DBS penetration. We therefore estimated the effect of DBS penetration on
cable rates within a four-equation structural model in which cable rates,
the number of cable subscribers, the number of cable channels, and the DBS
share of the subscription television market (DBS penetration) are jointly
determined.

One implication of this estimation technique is that the estimated effects
that we report for the effect of DBS penetration on cable rates must be
interpreted as direct effects on price. At the same time there are indirect
effects of DBS on price wherein the effect on price works through its effect
on other endogenous variables. For instance, the level of DBS penetration
may influence a cable operator's decision about the number of channels to
include in programming packages, which can in turn affect its cable rate. We
later present a table with results from a reduced-form cable rate equation
to show how the exogenous variables not included in the price equation
affect cable rates.

Other findings of our model that we emphasize relate to the presence of
nonprice competition. In particular, some key findings suggest that in
response to DBS, cable companies increased the quality of their services--in
particular, the number of channels that they offered consumers. Such
nonprice competitive responses have been noted by many observers as a key
aspect of the contemporary subscription video market, in addition to price
competition.

We estimated the following four-equation structural model of the
subscription television market:

ï¿½ Cable rates are hypothesized to be related to (1) the number of cable
channels, (2) the number of cable subscribers, (3) the DBS share of the
subscription television market, (4) average wages, (5) regulation, (6)
horizontal concentration, (7) vertical relationships, and (8) the presence
of a nonsatellite competitor. The cable rate variable used in the model is
defined as the total monthly rate charged by a cable franchise to the
"typical subscriber," including fees paid for the most commonly purchased
programming tier and rented equipment (a converter and remote).17 The
explanatory variables in the cable rate relationship are essentially cost
and market structure variables.

ï¿½ Number of cable subscribers is hypothesized to be related to (1) cable
rates (per channel), (2) DBS share, (3) the number of broadcast channels,
(4) urbanization, (5) the age of the cable system, (6) homes passed by the
cable system, (7) median income, and (8) the presence of a nonsatellite
competitor. The number of cable subscribers is defined as the number of
subscribers in a franchise area that subscribe to the most commonly
purchased programming tier. This represents the demand equation for cable
services, which depends on rates and other demand-related factors.

ï¿½ Number of cable channels is hypothesized to be related to (1) the number
of cable subscribers, (2) DBS share, (3) median income, (4) system
megahertz, (5) the extent of multiple dwelling units, (6) vertical
relationships, and (7) the presence of a nonsatellite competitor. The number
of cable channels is defined as the number of channels included in the most
commonly purchased programming tier. The number of cable channels can be
thought of as a measure of cable programming quality and is explained by a
number of factors that influence the willingness and ability of cable
operators to provide high-quality service and consumers' preference for
quality.

ï¿½ DBS share of subscription television market is hypothesized to be related
to (1) cable rates, (2) the age of cable system, (3) median income, (4)
system megahertz, (5) dummy variable for areas outside metropolitan areas,
(6) regulation, and (7) the presence of a nonsatellite competitor. The DBS
variable is defined as the number of DBS subscribers in a franchise area
expressed as a share or proportion of the total subscription video market in
the area (that is, DBS subscribers plus cable subscribers). As hypothesized,
the DBS share is expected to depend on the rates set by the "dominant" cable
providers as well as on the demand, cost, and regulatory conditions in the
subscription video market that directly affect DBS.

Several of the explanatory variables in our model have been used in previous
studies of cable rates.18 The explanatory variables included in those
studies fall into two general categories: demand and cost factors, and
market structure and regulatory conditions. Table 1 presents the expected
effects of all the explanatory variables in the structural model on cable
rates and notes whether a variable has been used previously in cable rate
studies. Table 2 presents a description of some variables in the model that
provide evidence on price and nonprice competition occurring in the market.

(Continued From Previous Page)

                                                              Included in
   Explanatory variable    Expected effect on cable rates       previous
                                                                studies
                          Consumers will be willing to pay
                          more for a greater number of
 Number of channels       channels. Also, costs are greater Yes
                          for the cable operator to provide
                          more channels.
                          Costs per subscriber of providing
                          cable services can increase or
 Number of subscribers    decrease with the number of       Yes
                          subscribers, depending on scale
                          economies.
                          Areas with higher average wages
 Average wages            have higher costs of operation,   Yes
                          which will make cable rates
                          higher.
                          Regulation may be associated with
                          lower cable rates when compared
                          with rates that would prevail
                          under profit-maximizing pricing
 Regulationa              by monopoly cable systems.        Yes
                          However, cable rates could be
                          higher under regulation if the
                          unregulated cable systems are
                          more competitive.
                          This market structure variable
                          denotes whether a franchise area
                          is operated by a large national
                          multiple system operator (MSO).
 Horizontal concentration If large MSOs have some cost      Yes
                          advantages, rates could be lower;
                          if MSO ownership imposes
                          competitive disadvantages to
                          potential entrants, cable rates
                          could be higher.
                          This market structure variable
                          captures the effects of vertical
                          ownership ties between cable
                          companies and cable programming
                          networks. The expected effect of
                          the variable is not clear because
 Vertical relationship    a vertical relationship could     Yes
                          lower cable system costs if
                          programming costs are reduced or
                          efficiencies are gained, but
                          vertical relationships could
                          signify market power that would
                          tend to lead to higher cable
                          rates.
                          This competitive variable
                          signifies whether a cable company
                          faces direct competition from
                          another cable operator
                          (including, for example, a local
 Presence of nonsatellite exchange telephone carrier
 competitor               offering cable services) or a     Yes
                          wireless cable company in part or
                          all of its franchise area. Few
                          cable companies face such
                          competition, but rates should be
                          lower when they do.
                          We expect the presence of DBS to
                          restrain cable rates if cable and
                          satellite were close substitutes
                          in 1998. However, because of the
 DBS share of the         provisions of the law at that
 subscription television  time, DBS providers could not     No
 market                   provide local broadcast signals
                          to many of their subscribers, so
                          the competitive pricing pressure
                          on cable rates may not have been
                          great then.

 Number of broadcast      Consumers will pay more for a
 channels                 greater number of broadcast       Yes
                          channels on the cable system.
                          Consumers will have a lower
                          demand for cable services in more
                          urban settings that have many
 Urbanization             alternative forms of              Yes
                          entertainment competing with
                          cable, which will lead to lower
                          cable rates.
                          Subscribers have a higher demand
                          in franchise areas with older
                          cable systems because they are
 Age of cable system      more likely to be aware of the    Yes
                          availability and quality of the
                          cable system. Therefore, cable
                          rates will be higher.
                          A higher number of homes passed
                          means a greater potential market
                          size and, therefore, higher
                          demand leading to higher cable
 Homes passed by cable    rates. Conversely, the costs of
 system                   operations could increase with    Yes
                          the number of homes passed since
                          the scale of operations will be
                          larger--however, the costs per
                          subscriber should decline if
                          there are scale economies.
                          As consumers' incomes rise,
 Median income            demand for cable services should  Yes
                          increase, which will increase
                          cable rates.
                          Higher-megahertz systems may
                          enable the provider to offer more
                          channels and to bundle several
                          services together--video, voice,
                          and high-speed Internet access.
                          This could increase demand for
 System megahertzb        cable, leading to higher rates;   No
                          or cable rates may be discounted
                          to attract consumers to the other
                          (new) services. Conversely, lower
                          cost of operations could arise
                          with new technology, which will
                          lead to lower cable rates.
                          Where there are more multiple
                          dwelling units, the market has
 Extent of multiple       been found to be more naturally
 dwelling units           competitive because cable systems Yes
                          may face greater actual or
                          potential competition, which will
                          lead to lower cable rates.
                          We expect the competitive impact
                          of DBS on cable rates to be
 Nonmetropolitan areas    stronger in franchise areas that  Yes
                          lie outside of metropolitan
                          statistical areas.

aThe basic service tier (and equipment) is regulated by municipal
franchising authority (which is a state or local entity empowered by
federal, state, or local law to grant a franchise). FCC's authority to
directly regulate rates for the expanded basic tier expired on Mar. 31,
1999; see CS Report No. 99-5, NRCB 9005, FCC (released Mar. 29, 1999).

bIt is possible that cable operators upgrade to higher megahertz to meet
competition from nonsatellite or satellite competitors.

 Explanatory variable  Equation       Expected effect
                                      We expect higher cable rates to be
                                      associated with higher DBS share if
 Cable rate            DBS share      high cable prices induce consumers to
                                      migrate to DBS from cable or if cable
                                      and DBS are close substitutes.
                                      We expect more capacity to be
                                      associated with lower DBS share if
 System megahertz      DBS share      cable providers are able to offer
                                      more channels and bundled
                                      services--telephony and high-speed
                                      Internet services.
                                      We expect nonmetropolitan status to
                                      be associated with higher DBS share
 Nonmetropolitan area                 if DBS is a closer substitute for
 status                DBS share      cable in nonmetropolitan areas, owing
                                      to, for instance, "line of sight" and
                                      SHVA considerations.
                                      We expect higher DBS shares to be
 DBS share             Number of      associated with more cable channels
                       cable channels if cable providers increased channels
                                      to meet competition from DBS.

We required several data elements to build the data set used to estimate
this model. The following is a list of our primary data sources. (App. III
discusses two data issues in greater detail: (1) FCC's stratified sample
design for its cable franchise survey and (2) how we matched data across
varied sources when geographic boundaries for data did not match.)

ï¿½ We obtained data on cable rates and service characteristics from the 1998
survey of cable franchises that FCC conducted as part of its mandate to
report yearly on cable competition. FCC's survey asked a sample of franchise
areas to provide information about a variety of items pertaining to cable
rates, service offerings, subscribership, franchise area reach, franchise
ownership, and system capacity. We used the survey to define measures of
each franchise area's cable rates, number of subscribers, and number of
cable channels as described above. In addition, we used the survey to define
variables measuring (1) the number of broadcast television channels, (2)
system age--the number of years since the cable system went online, (3)
system megahertz--the capacity of the cable system in megahertz, (4) homes
passed by the cable system serving the franchise area and perhaps other
franchises in the same area, (5) regulatory status--a dummy equal to 1 if in
1998 the basic service tier was regulated by a local franchise authority or
FCC was regulating the cable programming service tier, and (6) competitive
status--a dummy variable equal to 1 if the franchise faced "nonsatellite"
competition from an unaffiliated subscription video company (or
"overbuilder") or from a local exchange telephone company.

ï¿½ FCC also provided satellite subscriber counts as of 1998 for each zip code
in the United States.19 We used this information to calculate the number of
DBS subscribers in a cable franchise area, which, when used in conjunction
with the number of cable subscribers, was used to define DBS share. The data
actually includes other satellite subscribers--such as C-band users.
However, we refer to the variable as DBS throughout the report.

ï¿½ We used the most recent data from the Census of Population (1990) to
obtain the following demographic information for each franchise area: median
household income, proportions of urban and rural populations, proportion of
housing units accounted for by structures with more than five units
(multiple dwelling units), and nonmetropolitan statistical areas.

ï¿½ We used state-level information collected by the Bureau of Labor
Statistics on the average weekly wages for cable television employees.

ï¿½ To define the dummy variable indicators of vertical integration and large
MSOs, we used information on the corporate affiliations of the franchise
operators provided in FCC's master file of franchises. To define the
indicator of vertical integration, we then used this information in
conjunction with industrywide information on vertical relationships between
cable operators and suppliers of program content gathered by FCC in its 1998
annual video report. To define the indicator of large MSOs, we compared the
information on corporate affiliations against a list maintained by the
National Cable Television Association that ranks the largest MSOs. Cable
franchises affiliated with one of the 10 largest MSOs received a value of 1.

We employed Three-Stage Least Squares (3SLS) to estimate our model.20 The
majority of the results are consistent with our expectations and with
findings of previous studies. We also performed various diagnostics to test
the stability of our model results. None of these tests implied that the
results we report were highly sensitive to model specification, the nature
of the stratified sample, or to measurement of key variables included in the
model.

Table 3 includes the estimation results for each of the four structural
equations. All the variables, except dummy variables,21 are expressed in
natural logarithmic form.22 This means that coefficients can be interpreted
as "elasticities"--the percentage change in the value of the dependent
variable associated with a 1-percent change in the value of an independent,
or explanatory, variable. The coefficients on the dummy variables are
elasticities in decimal form.23 Most of our results are consistent with the
economic reasoning that underlies our model as well as with the results from
several previous studies. We compare our findings concerning various
influences on cable rates with those found in previous empirical studies.

(Continued From Previous Page)

                                       Cable         Cable          DBS
      Variable       Cable rates    subscribers     channels       share
                      equation
                                     equation      equation      equation

 Cable rate                       -3.2222                      0.1984
                                  [0.0001]a                    [0.7924]

 Cable channels      0.1687
                     [0.0007]a

 Cable subscribers   0.0363                      0.1321
                     [0.0006]a                   [0.0001]a

 DBS share           0.0876       -1.2653        0.1767
                     [0.0030]a    [0.0001]a      [0.0250]b

 Broadcast channels               0.2087
                                  [0.0015]a

 Average wages       0.0246
                     [0.4159]

 Regulation          0.0302                                    -0.6991
                     [0.0539]c                                 [0.0001]a

 Median income                    -0.0487        0.1133        0.2041
                                  [0.0083]a      [0.0088]a     [0.1245]
 Horizontal          0.0879
 concentration       [0.0056]a
 Vertical            -0.0690                     -0.0542
 relationship        [0.0401]b                   [0.0299]b
 Presence of
 nonsatellite        -0.0702      -1.5471        0.1777        -0.8843
 competitor          [0.0093]a    [0.0001]a      [0.0055]a     [0.0001]a
 Nonmetropolitan                                               0.4724
 areas                                                         [0.0001]a

 Urbanization                     0.0354
                                  [0.0116]b
 Extent of multiple                              0.0074
 dwelling units                                  [0.0657]c

 Age of cable system              0.2445                       -0.4596
                                  [0.0077]a                    [0.0001]a
 Homes passed by                  0.3093
 cable system                     [0.0001]a

 System megahertz                                0.2200        -0.6109
                                                 [0.0001]a     [0.0001]a
 Sample size         698          698            698           698

Notes: System-weighted R-square: 0.62.

P-values are in square brackets.

aSignificance at the 1-percent level.

bSignificance at the 5-percent level.

cSignificance at the 10-percent level.

We did not find that greater DBS penetration was associated with lower cable
rates. In fact, as shown in table 3, we found that the direct effect of DBS
penetration on cable rates was positive and significant. This finding
suggests that, in 1998, DBS penetration did not translate into significant
pricing pressure on cable providers. In addition, the results of our primary
specification, shown in table 3, do not suggest that cable prices influenced
the level of DBS market share.24 However, the results of alternative
specifications suggest that such an effect does hold. Thus, we find some
evidence that subscribers migrate to DBS in locations with higher cable
rates.

We also found strong evidence of nonprice competition in response to
increased DBS penetration. For instance, in the cable channels equation, we
found that DBS share is positively related to the number of cable channels.
This result is consistent with the view that cable operators responded to
DBS competition by increasing the number of channels they offered.
Correspondingly, in the DBS share equation, we found that cable system
megahertz was negatively related to DBS share. This is consistent with the
notion that where cable operators have invested to upgrade their systems,
DBS represented a smaller share of the subscription video market, thereby
limiting the competitive impact of DBS on cable rates. Also, in the cable
subscribers' equation, we obtained an estimate of the price elasticity of
demand for basic cable services that was much greater (in absolute value)
than found in previous estimates.25 This is consistent with the view that
the subscription video market now has more substitutes, making the market
generally more competitive.

Several conditions existed in 1998 that suggest rural subscribers may have
viewed DBS as a closer substitute for cable. For example, in urban and
suburban areas, satellite companies have technical problems with installing
a satellite dish that is able to "see" the appropriate satellite because of
foliage or tall buildings that block the necessary line of sight between the
reception dish and the satellite. And finally, because the law in 1988
provided DBS companies with a copyright license to provide broadcast signals
to households in "unserved" areas but not elsewhere, it may be that in some
rural areas that came under the "unserved" definition, DBS actually operated
as a very close substitute for cable because some of these subscribers were
already receiving broadcast signals. We therefore expected a nonmetropolitan
status dummy to be positively related to DBS share, reflecting more intense
competition from DBS. In fact, in the DBS equation, DBS penetration was
estimated to be about 50 percent higher in nonmetropolitan areas. This
suggests that the competitive influence of DBS was greater in
nonmetropolitan areas in 1998.

Finally, we present a reduced-form cable rate equation (see table 4) in
which all exogenous variables in the system are included to show the net
effects on cable rates of the exogenous variables. For example, these
results show that the number of broadcast channels--included in the cable
subscriber equation--is associated with higher cable rates. Also, these
results show that cable systems that have been in place longer tend to have
higher rates. The age of the cable system was included in the subscriber and
the DBS share equations.

(Continued From Previous Page)

              Variable               Cable rates equation
 Cable rate                          NA
 Cable channels                      NA
 Cable subscribers                   NA
 DBS share                           NA

 Broadcast channels                  0.0329
                                     [0.0004]a

 Average wages                       0.0323
                                     [0.3023]

 Regulation                          0.0268
                                     [0.0456]b

 Median income                       0.0022
                                     [0.9138]

 Horizontal concentration            0.0921
                                     [0.0065]a

 Vertical relationship               -0.1069
                                     [0.0017]a

 Presence of nonsatellite competitor -0.0984
                                     [0.0001]a

 Nonmetropolitan areas               -0.0930
                                     [0.0001]a

 Urbanization                        -0.0086
                                     [0.0001]a

 Extent of multiple dwelling units   -0.0004
                                     [0.8259]

 Age of cable system                 0.0250
                                     [0.0215]b

 Homes passed by cable system        0.0264
                                     [0.0001]a

 System megahertz                    0.0359
                                     [0.1118]
 Sample size                         698

Notes: R-square: 0.25.

NA means not applicable.

The p-values are based on consistent covariance estimates. See, H. White, "A
Heteroscedasticity-Consistent Covariance Matrix Estimator and a Direct Test
for Heteroscedasticity," Econometrica (48) (1980), pp. 817-38.

aSignificance at the 1-percent level.

bSignificance at the 5-percent level.

The results obtained from a regression model can be sensitive to the sample
design and how the model is specified. A potential concern involves the use
of stratified sampling. FCC used a complex sampling design (see app. III for
a further discussion of the sample design) to gather information on cable
franchise areas. We investigated whether our results were sensitive to the
stratification of the sample by investigating the stability of the
coefficients across the strata for a key variable (specifically, DBS share)
in the cable rate equation and believe that our results are not influenced
by the sampling design. We report these results in table 5. The estimated
DBS share effects were similar in the competitive and noncompetitive strata.
This is particularly important because the overall model results do not
appear to be driven by the competitive subsample of cable franchises, which
were, by design, overrepresented in the FCC sample in comparison with their
numbers in the universe of franchises. The estimated DBS share effects were
insignificant in all of the size-related strata. This could mean that DBS
shares were related to the stratification scheme--for example, larger
systems tend to be more urban and may have lower average DBS penetration--in
such a way that there was insufficient variation within the strata to
establish a significant relationship between DBS share and cable rates. This
suggests that the overall results were not driven by the results of a
particular size-related stratum.

The effect of DBS was the primary focus of this model. Because we
hypothesized that DBS penetration levels could differ across different kinds
of markets--in particular, metropolitan and nonmetropolitan markets--we
included a dummy measure of nonmetropolitan status in the DBS equation to
test this hypothesis. As an alternative, we used a continuous
variable--population density--in the DBS share equation. Model results using
this alternative specification also supported our finding that DBS
penetration was more pronounced in nonmetropolitan areas than it was in
metropolitan areas.

We also investigated the extent to which our model results were sensitive to
the inclusion of those franchise areas with very high DBS penetration. We
did this because our model was based on the assumption that the cable
franchise was the "dominant" provider of subscription video services, but
this assumption may not always hold at the level of the individual
franchise. However, when we excluded observations with DBS market shares
exceeding 30 percent, our overall results were quite similar (based on a
sample of 618 franchises).

 Variable      Full      Competitive Noncompetitive Large    Medium     Small
               sample

 Cable channels0.1687    0.4398      0.1680         0.1106   0.1745     0.2774
               [0.0007]a [0.0001]a   [0.0036]a      [0.0392]a[0.0804]a  [0.0016]a
 Cable         0.0363    -0.0485     0.0401         0.0033   0.0057     -0.0165
 subscribers   [0.0006]a [0.0302]a   [0.0001]a      [0.5969] [0.7183]   [0.6037]

 DBS share     0.0876    0.0977      0.0670         -0.0128  0.0607     0.0200
               [0.0030]a [0.0001]a   [0.0825]a      [0.2854] [0.1313]   [0.7370]

 Average wages 0.0246    -0.0508     0.0428         0.0483   -0.0671    0.1296
               [0.4159]  [0.3112]    [0.1754]       [0.0797]a[0.2417]   [0.2066]

 Regulation    0.0302    0.1533      -0.0135        -0.0239  0.0784     0.0314
               [0.0539]a [0.0001]a   [0.3759]       [0.0724]a[0.0032]a  [0.4985]
 Horizontal    0.0879    0.0253      0.0760         0.0992   0.0927     0.0749
 concentration [0.0056]a [0.5691]    [0.0280]a      [0.0152]a[0.0433]a  [0.5422]
 Vertical      -0.0690   0.0438      -0.0788        -0.1191  -0.0874    -0.0230
 relationship  [0.0401]a [0.3480]    [0.0292]a      [0.0046]a[0.0697]a  [0.8126]
 Presence of
 nonsatellite  -0.0702   NA          NA             -0.1264  -0.0973    -0.1448
 competitor    [0.0093]a                            [0.0001]a[0.0146]a  [0.0612]a
 Sample        698       224         474            287      253        158

Notes: The values reported are the coefficients; p-values are in square
brackets.

a Significant at the 10-percent level or less.

Further Issues Pertaining to the Data Used in GAO's Cable Rate Model

This appendix provides further information on two issues pertaining to the
data used in the cable rate model. First, we provide details about the FCC
sample of franchise areas and our use of that data. Second, we describe how
we linked information from these franchise areas--which represent a wide
range of community types--to other data that we used. That is, we describe
how we combined various data sources that were reported across varied
geographic coverage areas.

but the Sample Selection of Noncompetitive Areas May Not Represent the
Universe of Noncompetitive Areas

Because there are a very large number of cable franchise areas in the United
States--roughly 30,000--FCC selected a sample of these areas for the
analysis of cable competition it is required under law to conduct
annually.26 FCC used a complex sampling design to select the cable
franchises it surveyed. Because of its focus on competitive issues, FCC sent
a survey to all 286 franchise areas in which the cable system was found to
face "effective competition."27 For the remaining "noncompetitive"
franchises--which constitute about 99 percent of all franchise areas--FCC
used a stratified sample. Noncompetitive cable franchise areas were assigned
to size groups, or strata, according to the number of subscribers in the
cable system with which each franchise was affiliated. The largest group
contained cable systems with 50,000 or more subscribers, the medium group
contained systems with between 10,000 and 49,999 subscribers, and the
smallest group contained systems with fewer than 10,000 subscribers. FCC
sampled a higher proportion from the largest group than it did from the
medium group and a larger proportion of the medium group than of the small
group. A key goal of this sampling design was to ensure that, in comparison
to what was likely to have occurred under a simple random sample, the survey
would include many more of the competitive franchises as well as franchises
from the larger systems from which more consumers receive service.

FCC's sampling procedure produced a sample of franchise areas that
overrepresented larger franchise areas within some of the size strata. In
particular, we found that most of the larger franchise areas within some of
the strata were selected into the sample. As a consequence, the average
number of subscribers for the sample of franchises for two of the strata are
much larger than the average number of subscribers for those strata in the
universe of franchises. While this calls into question the overall
representativeness of the FCC sample, we found that model results, as
reported in table 5, were reasonably consistent--particularly for the DBS
variables--across strata. This suggests that the nonrepresentativeness of
the sample is not a critical problem for our estimated results. The sample
of franchises we used to estimate the model accounts for over 17 million of
the approximately 65 million cable subscribers in 1998, or about 26 percent
of all subscribers.

Of the data we received from FCC, we were not able to use the information
for all of the 783 franchise areas that responded to FCC's survey. Not all
of them provided answers to all of the questions on the survey, and we could
not successfully merge demographic data from other data sources with some
franchise areas. We also excluded two franchise areas in Hawaii because DBS
service as envisioned in our model was not provided in Hawaii in 1998. As a
consequence, we were able to use observations on 698 cable franchise areas
in estimating the model.28 Table 6 provides information, by strata, on the
number and type of cable franchises nationally, the number surveyed by FCC,
and the number we were able to include in our analysis.

 Type of
 franchise          Number of franchises
                                                       With responses to
                    In        Surveyed   Responding to all survey and
                    universe  by FCC     FCC survey    nonsurvey variables
                                                       used in GAO model
 Competitive        286       286        253           224
 Noncompetitive     29,595    560        530           474
 Large              3,145     289        265           247
 Medium             7,046     190        186           163
 Small              19,404    81         79            64
 Total              29,881    846        783           698

Source: FCC and GAO.

Geographic Definitions

To match data from franchise areas with other data, the geographic
boundaries of each franchise had to be determined to match them against
other geographic areas, such as counties or towns. We were able to define
the boundaries of many franchise areas using information in the survey and
in other FCC records, but for some franchise areas, there was not enough
information to easily determine their true geographic extent.29 This problem
with insufficient information occurred in several contexts. Where multiple
franchises existed in a jurisdiction, particularly in unincorporated areas
of counties30 and in large cities,31 we acquired additional information on
the franchises' boundaries or used allocation rules to estimate the
geographic context and retain the franchise areas in the sample.32 However,
in some other contexts, we were unable to retain franchise areas. In
particular, some observations had an associated community type that was
listed as a recognizable census term, such as town or city, but no census
place or county subdivision33 could be matched. Also, some franchise areas
were associated with a community type that was not recognizable in terms of
census geography.34

The satellite subscriber information we used to calculate our measure of DBS
penetration was organized by zip code, and because zip codes often do not
share boundaries with other geographies, we had to relate the zip code data
to our set of franchise areas. Because different places (in this context,
cable franchise areas) can share the same zip code, we needed to identify
different franchise areas that might share the same zip code in order to
accurately calculate the degree of satellite penetration in each franchise
area. For most franchise areas--that is, those that correspond to census
places, county subdivisions or entire counties as well as those franchises
in multiple-franchise jurisdictions for which we were able to identify
franchise boundaries--we accomplished this directly by using software
designed to relate varied geographic units to one another.35 In this way, we
were able to identify each zip code that was associated with a particular
place (or county, county subdivision, or census tract) and to find the share
of each zip code's population that was contained in that area. We then used
these population shares to allocate shares of each zip code's total
satellite subscribers among franchises.36 For other multiple-franchise
jurisdictions for which we did not have more precise franchise boundaries,
we first determined the total number of satellite subscribers in zip codes
associated with those jurisdictions, and then allocated subscribers to each
franchise area on the basis of the number of franchises in the place.37

Descriptive Statistics for Variables Included in GAO's Cable Rate Model

Table 7 provides basic statistical information on all of the variables
included in the cable rates model. We calculated these statistics using all
698 observations in the GAO data set.

 Variable                            Mean      Standard   MinimumMaximum
                                               deviation  value  value
 Total monthly cable TV rate paid by
 a "typical" subscriber, June 1998   29.71     4.54       10.95  42.07
 (dollars)
 Number of cable subscribers         24,102.3  37,920.6   1      293,774.0
 Number of cable channels            50        14         10     103
 Number of local broadcast channels  10        4          0      23
 Urbanization (percentage)           64.58     45.82      0      100
 Age of cable system (years)         20.80     9.52       1      47
 Homes passed                        117,774   153,928    123    1,031,023
 Median household income (dollars)a  40,495    14,262     12,815 131,648
 Average weekly wages (dollars)b     682       146        414    1,074
 System megahertz                    537       163        220    900
 Regulation                          0.48      0.50       0      1
 Horizontal concentration            0.43      0.49       0      1
 Vertical relationships              0.40      0.49       0      1
 Extent of multiple dwelling units
 (percentage)                        17.27     14.03      0      95.66
 Presence of nonsatellite competitor 0.11      0.32       0      1
 DBS share of subscription
 television market (percentage)      12.21     18.15      0.02   97.71
 Nonmetropolitan area status         0.19      0.43       0      1

a1989 median household income, expressed in 1998 dollars using Consumer
Price Index-All Urban Consumers.

b1997 wages, expressed in 1998 dollars using the Consumer Price Index-All
Urban Consumers.

Comments From the Federal Communications Commission

1. We do not believe that we need to further clarify our finding that DBS
did not exert significant pressure on cable companies to reduce rates in
1998. We believe we discuss in sufficient detail and with sufficient
prominence the issue of disentangling two possible relationships between
cable rates and DBS penetration: (1) the "competitive" effects of DBS share
on cable rates and (2) the "switching" or "migration" effects that can occur
if high cable rates lead subscribers to drop their cable in favor of DBS. We
tested the first of these relationships by including the DBS penetration
variable in the cable rates equation of the model and the second
relationship by including cable rates in the DBS equation of the model.

We also note that FCC stated in its recently released report on 1999 cable
industry prices that it "sought information on the number of DBS subscribers
in each surveyed cable franchise area in order to determine if DBS
penetration has had an effect on the demand for cable as well as on the
monthly charges for cable service." Although FCC does not examine whether
DBS penetration has an effect on cable rates, its recent study does examine
whether DBS penetration influences the demand for cable services. FCC finds
no significant statistical relationship between DBS penetration and cable
demand and provides an interpretation that is very similar to our own:
"… that DBS exerts only modest influence on the demand for cable
services." (See FCC, Report on Cable Industry Prices, June 9, 2000, p. 37.)
Ultimately, we believe that our results are fundamentally consistent with
FCC's own views.

2. We agree with FCC that DBS provides an important multichannel alternative
to cable. However, we believe our report sufficiently presents this issue.
First, we note that our empirical findings suggest that the presence of DBS
led to important nonprice competition as cable companies in areas with high
DBS penetration offered consumers more channels. Second, we note that DBS
penetration is much higher in rural areas--supporting our hypothesis that
DBS and cable services were seen as more substitutable products in rural
areas in 1998. Finally, we suggested that DBS and cable will become viewed
as more similar services in the future because of the ability of DBS
providers to now offer local broadcast signals as part of their programming
packages.

3. We agree that more detailed data enables an analyst to study issues with
greater clarity. However, our cross-sectional analysis, which is based on
variations in cable rates and DBS penetration across nearly 700 franchise
areas, allowed us to reasonably investigate the influence that DBS may have
on cable rates. A time-series analysis would have been difficult because of
the lack of readily available data on all variables necessary. Moreover, it
is not clear how much would have been gained from such an analysis. Our
study looked at the industry in a very early stage of competition between
cable and DBS. It will be more useful to include a time-series component in
such a model in the future when DBS penetration is greater and the effects
of the legislative change allowing DBS firms to provide local broadcast
channels can be better estimated. FCC's most recent cable rates study also
does not include a time-series component in its econometric model, although
it does provide estimates of a single-year model for 2 adjacent years.

4. We believe that the model specification that we used allowed us to
disentangle the two possible relationships between DBS penetration and cable
rates. FCC staff had questioned the appropriateness of our initial proposed
presentation of a single-equation reduced-form cable rate model that
included DBS share and the number of cable channels as explanatory variables
because these variables could be jointly determined with cable rates (i.e.,
they are endogenous). Partly in response to FCC's concerns, we based the
findings presented in this report on a four-equation structural model--which
we had indicated was the basis of the initial single-equation model--in
which cable rates, DBS market share, cable subscribers, and cable channels
are jointly determined. In addition, we do present a reduced-form pricing
equation in the report that we included for the purpose of discussing how
those variables that are not determined in the system of equations affect
cable rates. The reduced-form cable rates equation includes no endogenous
variables--that is, channels, DBS penetration, and cable subscribers are
excluded from this equation. Accordingly, we are uncertain what remaining
concerns FCC has with "the econometric specification of the model."

Comments From the National Cable Television Association

1. We agree that the subscription video market is very dynamic and that an
analysis of the contemporary market environment will require up-to-date
information and data. The National Cable Television Association (NCTA)
suggests that we should have used data from a period prior to the
introduction of DBS in 1994 to understand the effect of the introduction of
this service on the cable industry. Such an analysis was not feasible
because of limited data. However, there was enough variation in the level of
DBS penetration across cable franchise areas for us to capture the
competitive effects of DBS on cable rates.

2. We understand that DBS has grown dramatically in the last 2 years. We
caveat our overall finding with the view that these model results are likely
to change as the nature of this market unfolds. We believe that a full
understanding of the issues we examine will require more analysis using more
recent data. In particular, to understand the effects of the legislative
change enabling DBS firms to include local broadcast signals in their DBS
programming packages will require using data for some period after that law
went into effect.

3. Because this is a cross-sectional model, it is not relevant that cable
rates may have been high at that time. This model examines what drives
differences in rates across local markets within a given period: It can
examine a year when rates are on average high or on average low, and we
would expect similar findings.

4. One of our major findings is that the competitive response to greater DBS
penetration was largely in the form of nonprice competitive response.

Comments From the Satellite Broadcasting and Communications Association

1. Although 1999 DBS data were available, we could not do the analysis for
1999 because the cable data, which constitute a major, important part of the
database for our study, were not available at the time we began this
analysis. Thus, we had to use 1998 as the year of observation for this
model.

2. We understand that DBS has grown dramatically in the last 2 years. We
caveat our overall finding with the view that these model results are likely
to change as the nature of this market unfolds. We believe that a full
understanding of the issues we examine will require more analysis using more
recent data. In particular, to understand the effects of the legislative
change enabling DBS firms to include local broadcast signals in their DBS
programming packages will require using data for some period after that law
went into effect.

3. Copyright fees do not vary across localities and therefore cannot be
included in this model. However, we note in our discussion of the model's
development that cable and satellite providers are differentiated in many
ways, including their cost structures. Thus, these underlying cost
differentials play an important role in this kind of model.

GAO Contacts and Staff Acknowledgments

Stanley J. Czerwinski, (202) 512-7631

Amy D. Abramowitz, (202) 512-4936

In addition to those named above, Stephen M. Brown, Jay Cherlow, Venkareddy
Chennareddy, John A. Karikari, and Faye Morrison made key contributions to
this report.

(385826)

Table 1: Expected Effects of All Explanatory Variables on Cable
Rates 22

Table 2: Price and Nonprice Competition Relationships in Model 25

Table 3: 3SLS Model Results 28

Table 4: Regression Estimates of Reduced-Form Cable Rates
Equation 31

Table 5: Regression Estimates for Cable Rates, Sample Strata Analysis 33

Table 6: FCC Sample and GAO Data Set 36

Table 7: Table of Descriptive Statistics 39
  

1. The Congress has divided the authority to regulate cable systems between
federal and state authorities. Over the years, FCC has adopted a variety of
rules regulating cable, while local communities have explicit power to
regulate cable through franchise agreements. These local franchises give
cable systems the right to operate in a specified area and to install cables
beneath streets or along other public rights-of-way. In some cases,
municipalities granted exclusive cable franchises, although the
Communications Act now prohibits this.

2. By the early 1990s, dozens of such cable programming networks had been
developed, many targeting niche audiences.

3. Tele-Communications, Inc., merged with AT&T in 1999 and is now known as
AT&T Cable Services.

4. American Online (AOL) has proposed purchasing Time Warner in an all-stock
transaction valued at $350 billion. The new company would be named AOL Time
Warner, Inc.

5. The Congress responded to these concerns, and to numerous consumer
complaints about rising cable rates, by passing the Cable Television
Consumer Protection and Competition Act of 1992. Under this act, FCC rolled
back and began to regulate cable television rates and prohibited exclusive
contracts between cable systems and their affiliated program suppliers. Four
years later, the Congress moved toward a more deregulatory approach in the
Telecommunications Act of 1996, which sought to open the subscription video
market to greater competition and ended most cable rate regulation on Mar.
31, 1999 (although rates for the basic service tier of programming on cable
systems, which is not subject to effective competition, remain regulated).

6. However, prices for DBS equipment have fallen since 1994.

7. Dominion Video Satellite, Inc., also currently provides DBS service.
However, Dominion offers religious-oriented programming on a smaller number
of channels than DirecTV or EchoStar. Also, a fourth satellite service,
called Primestar, was acquired by DirecTV in May 1999. Primestar was a
medium-powered service that required a larger reception dish and had lower
channel capacity; its subscribers are being moved to DirecTV's high-powered
DBS service.

8. Several changes to the 1988 law were included in the 1994 amendments.

9. The broadcast programming that satellite providers generally offered
these subscribers consisted of a package of "distant network signals," or
the signals of stations from faraway markets such as Los Angeles or New
York.

10. Specifically, an unserved household was defined in the Satellite Home
Viewer Act as one that is not capable of receiving an acceptable
over-the-air television signal using a conventional rooftop antenna and that
has not received a network signal from the local cable operator within the
previous 90 days. An acceptable television signal under the statute is "a
signal of Grade B intensity," which is a measure of a signal's strength
defined by FCC. The 90-day waiting period before switching from cable to
satellite network service was recently deleted by legislation.

11. According to executives of DirecTV and EchoStar, the provision of local
broadcast stations to more cities by satellite will be limited because of
rules--known as "must-carry rules"--included in the act that require DBS
firms to include all broadcast signals in markets in which they choose to
provide any broadcast signals. The must-carry rules take effect on Jan. 1,
2002.

12. This is consistent with the FCC approach to analyzing cable rates. See
FCC's Fifth Annual Report, "Annual Assessment of the Status of Competition
in Markets for the Delivery of Video Programming," CS Dkt. No. 98-102, FCC
98-335 (released Dec. 23, 1998).

13. Economists have traditionally used the dominant firm-competitive fringe
model to analyze markets where there is a dominant firm and a competitive
fringe of small firms. See, for example, H. Yamawaki, "Dominant Firm Pricing
and Fringe Expansion: The Case of the US Iron and Steel Industry,
1907-1930," Review of Economics and Statistics (Aug. 1985), pp. 429-37.
Moreover, the dominant firm-competitive fringe model provides an excellent
theoretical link between economists' measure of market power and
quantifiable variables such as market share and price elasticity of demand.
This model is closely aligned with what has been dubbed the New Empirical
Industrial Organization. See p. 36 of L. Blank, D. L. Kaserman, and J. W.
Mayo, "Dominant Firm Pricing With Competitive Entry and Regulation: The Case
of IntraLATA Toll," Journal of Regulatory Economics, 14 (1998), pp. 35-53.
The authors used a generalized dominant firm-competitive fringe model to
derive a fully reduced-form price equation for dominant carriers in the
local exchange telephone toll market subject to regulation.

14. Dec. 1999, p. 25.

15. Blank, Kaserman, and Mayo measure the competitive presence of the fringe
as the number of fringe firms. However, in the subscription video context,
there are two DBS providers operating in every local market. Therefore, we
cannot use the number of firms for this purpose because the number of firms
does not vary across franchise areas. However, because there is variation
across franchise areas in the degree of DBS penetration, we use the DBS
share variable to measure the degree of competition cable operators face
from noncable providers.

16. See, for example, G. S. Ford and J. D. Jackson, "Horizontal
Concentration and Vertical Integration in Cable Television Industry," Review
of Industrial Organization, 12(4) (1997), pp. 501-18; and R. N. Rubinovitz,
"Market Power and Price Increases for Basic Service Since Deregulation,"
RAND Journal of Economics, 24(1) (1993), pp. 1-18.

17. The price paid for cable services should reflect their value to the
customer. A higher cable rate may be due to the higher quality or value of
the services provided. One of the ways to measure the value of cable
services, albeit, an imperfect one, is to use the cable rate per channel;
see, for example, "Report on Cable Industry Prices," MM Dkt. No. 92-266, FCC
99-091 (May 7, 1999), p. 7. Our key results were unchanged when we used the
cable rate per channel as the dependent variable. In our model, we used the
number of channels to capture the idea that higher cable rates may be due to
higher quality or value resulting from the availability of more channels.

18. See, for example, R. W. Crandall and H. Furchtgott-Roth, Cable TV:
Regulation or Competition? (Washington, D.C.: Brookings Institution, 1996);
W. M. Emmons III and R. A. Prager, "The Effects of Market Structure and
Ownership on Prices and Service Offerings in the U.S. Cable Television
Industry," RAND Journal of Economics, 28(4) (Winter 1997), pp. 732-750; Ford
and Jackson (1997); J. W. Mayo and Y. Otsuka, "Demand, Pricing, and
Regulation: Evidence from the Cable TV Industry," RAND Journal of Economics,
22(3) (1991), pp. 396-410; and Rubinovitz (1993).

19. The satellite subscriber counts also include C-band and medium-power
satellite subscribers. The number of these subscribers has been declining in
recent years, in part because of the growth of DBS.

20. We preferred the 3SLS to Two-Stage Least Squares (2SLS) because the 3SLS
accounts for the contemporaneous relationships among cable rates, cable
subscribers, cable channels, and DBS penetration by using all available
information. Our results for the 3SLS and the 2SLS are generally similar.
Also, we assumed that price per channel in the subscriber equation is
exogenous because cable providers simultaneously decide how many channels to
provide and what to charge for a package of channels, rather than deciding
how much to charge for each channel. However, considering that price and
channels are endogenous in the model, we considered the possibility that
price per channel might also be appropriately considered as an endogenous
variable. The overall results under this assumption were substantively the
same as our base-case model results.

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

22. The dummy variables in the model include the following: horizontal
concentration of cable systems, vertical relationship, regulation,
overbuilders and local exchange telephone companies, and metropolitan
statistical 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.

23. That is, 0.10 means 10 percent.

24. In particular, we found that cable price was significant in the DBS
market share equation only when the number of cable channels was included as
an explanatory variable in the equation.

25. The price elasticity of demand is estimated to be −3.22, which is
highly elastic; this means that a 1-percent decrease in cable rates results
in a 3.22-percent increase in the quantity demanded of cable. In previous
studies, Mayo and Otsuka (1991), using 1982 data, found the price elasticity
to be between −0.69 to −1.51; Rubinovitz obtained a value of
−1.46 between 1984 and 1990; and Ford and Jackson (1997) estimated the
value to be −2.41 in 1994. The estimates of the price elasticity of
basic cable demand have been increasing over time, which is an indication of
the declining market power of cable systems.

26. Cable Television Consumer Protection and Competition Act of 1992.

27. There are four tests for effective competition in a cable franchise area
under the 1992 Cable Act: (1) low penetration by cable operators in the
franchise area; (2) competition between two or more unaffiliated
subscription video competitors (also called overbuilders); (3) operation of
the cable system by a municipal franchising authority; and (4) competition
from local exchange telephone carriers.

28. We found little evidence that the cable franchise areas that we were not
able to include in the analysis for whatever reason differed systematically
from the cable franchise areas that we were able to include. For example,
the average cable rate for the included franchise areas was $29.71, and the
average rate for the excluded franchise areas was $30.20. The average DBS
share for the included franchise areas was 12.2 and was 12.48 for the
excluded franchise areas. Nonmetropolitan franchises made up 19 percent of
the included franchise areas and 31 percent of the excluded franchise areas.

29. Our general approach was to identify the geographic extent of each
franchise area by combining the community name field with an indicator of
community type and matching this name to census place or county subdivision
(minor civil division) files.

30. For those franchise areas in which the community type was identified as
"county," we attempted to first identify whether other franchises in that
county were identified with particular places and, if so, to approximate
that area of the county that was not contained in these other franchise
areas. For purposes of assigning demographic information, however, we used
county-level data for these franchises.

31. Many large cities have multiple cable franchise areas. For instance, Los
Angeles has 14, New York City has 9, and Chicago has 5 franchise areas and 7
franchises.

32. For those jurisdictions for which there were multiple franchises, we
attempted to define more precise geographical boundaries for each franchise
area, especially in larger cities. Specifically, we contacted local
government offices responsible for cable franchise oversight and received
maps or other information linking the specific franchise areas to zip codes,
census tracts, local government districts, or some other boundary
information. When local governments did not directly provide zip code or
census tract information, we used the information they did provide in
conjunction with zip code overlay maps to assign zip codes to the franchise
areas. We then used census data at either the zip code or census tract level
to calculate the demographic measures associated with each franchise area.

33. Places consist of what are known as census-designated places and places
that are incorporated according to the laws of their respective states.
Generally, incorporated places can be thought of as cities, boroughs, towns,
townships, and villages. However, towns and townships in some states are not
considered places in terms of census reporting, even though they might both
serve some local government purpose and have large populations. Census data
for many franchise areas designated as towns in the franchise master file
are found in the county subdivisions file rather than the places file.

34. For instance, FCC has a category called "unincorporated area adjacent to
an incorporated community" that can describe a situation in which a cable
system primarily designed to serve a particular jurisdiction may spill over
into an unincorporated part of the county and serve a small number of homes
that are more easily connected to that system than to another system that
serves other portions of the county.

35. In particular, we used the MABLE/Geocorr correspondence engine
(http://www.census.gov/plue). MABLE is an acronym for Master Area Block
Level Equivalency file. The code was developed by John Blodgett, senior
programmer/analyst at the University of Missouri St. Louis, under contract
with CIESIN/SEDAC, and is jointly owned by John Blodgett and CIESIN.

36. As an illustration, assume we have a cable franchise area that
corresponds to the town of Anytown, which is served by zip code 12345.
Assume further that zip code 12345 had a population of 10,000 people in
1990, of which 8,000 were in Anytown proper and 2,000 were in the
surrounding area. In this case, 80 percent of the zip code population is
associated with Anytown, so that our approach would assign 80 percent of the
satellite subscribers in zip code 12345 to the cable franchise in the town
of Anytown.

37. For each county-type franchise area, we had already approximated that
area of the county that was not contained in these other franchise areas and
calculated the number of satellite subscribers in the zip codes associated
with that portion of each county.
*** End of document. ***