Economic Adjustments and Reregulation

There is a fundamental difficulty with basing regulations on economic predictions—the predictions may be wrong. The 1979 Economic Inquiry Re- port, for example was predicated in the FCC’s “estimates of what will happen to cable and to broadcasting on the basis of the best economic information at our disposal” (Inquiry, 1979, p. 659). The “best economic information” in 1979, however, was not very impressive at the threshold of the 1990s. In 1979, the Commission found that “all of the available information

2. ECONOMICS AND MEDIA REGULATION

suggests that under foreseeable circumstances cable penetration is unlikely to exceed about 48% of the nation’s television households” (p. 713). But 10 years later, the FCC found that cable penetration had grown from 37.3% of all television households (32 million homes) in 1985 to 56.4% (50.9 million homes) by mid-November 1989. By 1995, cable penetration rose to 65.2% (61.7 million homes).

Growth in all segments of the cable television industry was phenomenal through that decade. By 1990 there were approximately 9,010 cable systems in the United States—more than twice the number that existed in 1980. The average size of cable systems increased. In 1984, 57.4% of all cable subscribers were served by systems with channel capacity exceeding 30 channels. By 1989, the number had increased to 86.8% and to 96% in 1995. Cable systems with more than 53 channels accounted for the biggest growth during 1994, with a 9.9% increase in the number of such systems. Total cable revenues reached $9.94 billion (Second Cable Report, 1995).

Available programming also mushroomed. HBO became the first national cable network when, in 1975, it distributed uncut movies and sport- ing events to cable systems via satellite. By 1990, however, there were 104 cable-specific networks, including 39 regional network and 65 national networks. By 1995, the number of national programming services increased to 129, and by 2002, the number had more than doubled to 287 (NCTA, 2002). Between 1984 and 1989, investment in cable programming doubled—go- ing from $1 billion to $2 billion per year.

These vast changes led Congress and the Commission to reconsider the regulatory regime for cable television. The FCC in 1988 reimposed syndicated exclusivity and network nonduplication rules (Amendment, 1988). The resurrection of rules that were interred in 1980 was based on the con- clusion that the economic situation had fundamentally changed. The Com- mission concluded that “time has proved these predictions [about the growth of cable television] inaccurate” (p. 5304). The Commission found that cable had grown far faster than anticipated, thus presenting a serious competitive threat to over-the-air broadcasters. The FCC determined that “largely as a consequence of [measures deregulating the cable industry], the potential for duplicating broadcasters’ programs, diverting broadcasters’ audiences and advertising as a result of an unbalanced regulatory regime is far greater than we expected it to be when we rescinded our syndicated exclusivity rules” (p. 5305). Thus, the Commission reimposed the rules in order to help shift the economic balance of power between the two industries, and to insure the economic value of programs for local TV stations.

In December 1989, the FCC initiated another far-reaching inquiry to determine whether cable television had abused its market power because the industry was substantially deregulated by the Cable Communications Pol-

62 CORN-REVERE AND CARVETH

icy Act of 1984 (Competition, 1989). It was prompted, in part, by increasing consumer complaints about rising cable rates, poor service quality, and the dropping or repositioning of broadcast signals. Additional motivation for the inquiry came from allegations that vertically integrated cable operators were denying other video service providers access to programming services such as HBO, ESPN, and other cable networks.

The common denominator of the complaints was that the cable industry was alleged to be excessively concentrated, allowing it to impede competition by alternative video services. Consequently, the FCC sought to gather “hard evidence and empirical analyses” to determine the validity of the charges. Given the nature of the allegations at issue, it was predictable that the proceeding would focus almost entirely on the economics of the cable television industry.

Thus, it is not surprising that the Commission’s conclusions were also cast in economic terms. The 1990 Cable Report concluded, for example, that “robust competition in the video marketplace has not yet fully evolved, but that the development of a fully competitive marketplace is possible (Compe- tition, 1990, p. 9). The Commission found that cable operators possessed varying degrees of market power over the local distribution of video programming, but did not recommend imposing a wide array of new regulations. Instead, the Report proposed reliance on market forces to curb abuses, interceding only when a lack of competition can be explained by naturally occurring market forces. Further, the Report proposed that the government should encourage a more competitive marketplace for cable and other video services. Thus, the Commission’s policy recommendations were the direct product of economic analysis.

Shortly after the FCC released its general cable inquiry, it issued a Notice of Proposed Rulemaking to reexamine the standard for allowing rate regulation of cable television systems (Competition, 1990). In 1985, as part of its implementation of the Cable Act, the Commission adopted a “three-signal standard” for determining whether cable systems were subject to “effective competition” and thus exempt from regulation of basic subscriber rates. Under this standard, a cable system was not subject to rate regulation if the community in which the system was located received three over-the-air broadcast signals. As with other aspects of cable regulation, growth of the industry and evolution of the marketing aspects of the business led the FCC to reevaluate its initial standard.

The Commission eventually adopted a new standard for measuring “effective competition” in June 1991. Again, the policy choice was a function of economic analysis. The Commission noted that since the three-signal test was adopted, the marketplace had rendered the standard obsolete. As the number of available cable channels increased, it took a great amount of over-the-air television signals to constitute a competitive alternative for

2. ECONOMICS AND MEDIA REGULATION

viewers. Based on the comments filed by the various parties in the proceeding, the Commission found that six unduplicated over-the-air broadcast signals in a community would provide some type of market discipline for cable operators. Those communities with six broadcast channels were con- sidered under the rules to be subject to “effective competition” and the cable operator exempt from rate regulation. Additionally, cable operators are exempt from rate controls in communities where there is a viable multi- channel competitor to cable—such as in the form of a second cable system, direct broadcast satellite, microwave “wireless” cable system, or some other alternative (Report and Order, 1991).

Congress similarly took note of the changes in the media marketplace, passing over President George Bush’s veto of the Cable Television and Com- petition Act of 1992. The new Act substantially reregulated cable television, imposing new standards for rate regulation, must-carry of broadcast signals, retransmission consent, cable programming access by competing technologies, customer service standards, and so on. Implementation of most provisions of the Act was vested with the FCC. Key economic concepts, such as when a cable system is subject to “effective competition” and what consti- tutes a “reasonable profit” were left to regulatory reevaluation.

The 1996 Telecommunications Act, in turn, repealed many of the major provisions of the 1992 Cable Act. On rate regulation, current FCC rules cap- ping cable service rates were repealed on March 31, 1999, except for the “basic tier” that includes over-the-air channels and pubic and educational channels. Price caps were repealed for “small” cable operators (less than $25 million in revenues) immediately or for any cable system once it faced “effective competition” from local telephone companies offering “compa- rable” video services over telephone facilities.

The Act also repealed the FCC’s “telco-cable cross-ownership” restric- tions. Telephone companies were authorized to offer video services either by distributing programming as a cable television system or by establish- ing an “open video system” for transport of video programming on a common carrier basis. State and local regulation of telecommunications services provided by cable systems was prohibited.

One of the economic theories driving the Telecommunications Act of 1996 was that only companies of sufficient size would survive in the emerging global broadband marketplace. In other words, only companies with massive financial resources would be able to upgrade their infrastructures to provide high-capacity interactive services demanded by consumers and investors. In addition, cable companies would be competing in a develop- ing international marketplace, sometimes against foreign competitors sup- ported by subsidies from their governments.

Consequently, the large multiple systems operators (MSOs) sought new acquisition targets, which in turn drove up system prices. Many small,

64 CORN-REVERE AND CARVETH

midsized and even large cable companies decided to cash in. For example, in 1999 one half of the top 10 cable MSOs were bought out. The largest purchase involved AT&T, which bought TCI for $48 billion in 1998. The next year, AT&T acquired MediaOne in a $60 billion takeover of MediaOne (which also netted the company a 25% stake in Time Warner Entertain- 5 ment). AT&T eventually merged with Comcast in November 2002.

The cable industry also moved to consolidating itself geographically, a process known as clustering. Cable companies began acquiring (either through purchase, or system swapping with other large MSOs) geographically adjacent systems to cluster them. Cox Communications, for example, has clusters in Arizona, Southern California, Florida and Texas. Such clustering allows the companies to take advantage of scale economies in both marketing as well as emerging technologies. As a result of clustering, the number of areas which had competing cable companies dwindled, so that the number of cable systems actually declined from a high of 11,200 in 1994 to less than 10,000 in 2002 (NCTA, 2002).

The end result of both FCC and Congressional action was a cable industry that in 2002 served 73,559,550 households (69.8% of all U.S. households), employed over 130,000 people, had a total annual revenue of over $48 billion, derived nearly $14.5 billion in advertising, and was delivering more services (e.g., the Internet) to more people than ever. On the other hand, from a competitive point of view, the top four MSOs serve over 47 million subscribers or about 64% of all subscribers. Although other video programming services, such as direct broadcast satellite, now capture about 18% of the video services market, it is hard to see where Congress and the FCC have defined effective competition. One thing is clear—as the marketplace changes, the Commission and Congress are forced to react and adapt to new conditions.

Economic Adjustments and Reregulation