Cable as Competition, as “Television of Abundance”

Once the technology had established its ability to transmit multiple television signals, a variety of entrepreneurs started investigating whether cable could be more than a retransmitter of local television. The rapid adoption of television and cable seemed to indicate a demand for programming that was not always being met by over-the-air broadcasters. As early as the mid-1950s, a few entrepreneurs started looking into the idea of pay television as a distribution system for programming (primarily movies and sports) that was not available on local stations. In some smaller broadcast markets where there may have been only one or two local stations, people wanted access to the missing network programming or even the programming they’d heard was available on the independent TV stations in the largest markets. This prompted a reconsideration of what was cable’s product: Was it merely local broadcast television signals, or was it a wider range of television programming? The answer seemed clear: If people were willing to pay for local TV, they should be willing to pay more for even more television programming. As a multichannel service provider, cable had the unique ability to offer more television as its product.

The early attempts at pay-TV type systems were strongly opposed by both the television and motion picture industries, which fostered regulations limiting their ability to offer competitive programming. Those systems were also hampered by the early economics of cable—existing systems were in low-population areas, and acquiring and transmitting programming to multiple systems was quite expensive. The transition from CATV to cable began in earnest in the 1960s, when some cable systems started importing more distant signals in response to growing consumer interest in having access to a full range of television signals. Cable systems imported the signals from nearby network affiliates and independent stations. They paid little, if anything, for the signals themselves, and the emerging microwave technology offered a cheaper distribution

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system for higher bandwidth signals. With the additional programming options providing incentives for consumers in good reception areas to subscribe, cable began to spread into larger markets. It was still limited, however, by the limited range and value of the alternative programming it could offer consumers.

In the early 1970s, satellite technology had progressed to the point where it became economically viable for even small television networks to distrib- ute their programming nationally. Small-scale programmers saw the opportunity to take their signals national, allowing them to take advantage of the economies of scale offered by networking and the greater potential for advertiser support that a national reach would provide. Adoption of the new channels was also encouraged by the fact that many of these new networks offered to pay cable systems to get them to carry their signals in order to achieve the national distribution that their advertisers demanded. Cable networks were born and started to fulfill the promise of cable being able to offer “television of abundance.” With more channels and more choice, cable’s product began to differentiate itself from regular broadcast TV signals.

The Market & Economics. The additional channels helped to increase demand for service and to justify cable expansion into new markets, partic- ularly those already adequately served by over-the-air broadcast television stations. The real success were the premium channels that offered access to programs (primarily movies and some special sporting events) that were not yet available to broadcast networks and stations, and the genre channels that offered the sports fan or news junkie 24- hour access to their favor- ite types of content instead of broadcasters’ more limited offerings. Cable increasingly offered not just TV; it offered options not available from tradi- tional over-the-air broadcasting, providing choice and control to consumers. Consumers found that they valued this choice and control, and demand for cable jumped even as subscription rates increased.

The shift in product definition had some significant implications for the cable market and industry. Expanding the product helped to expand market viability. The larger scale and higher population density in the larger markets let cable systems realize some of the fundamental economies of scale and offered increased profit potential. There always had been the basic network economies of scale in cable infrastructure with the high fixed costs of building a comprehensive wired network and the relatively lower variable costs of operation. With construction costs often running at $20,000

a mile (or more), the more homes per mile and the higher the proportion of subscribers, the lower the average costs. On the other hand, the rapid rise in the number of cable networks, and the quickly apparent consumer demand for more choice, meant that many cable systems had to reinvest and up- grade their distribution networks and equipment.

8. THE ECONOMICS OF THE CABLE INDUSTRY

There were other scale economies as well. With the larger scale possible in the bigger markets, investment economies were available: Larger firms could attract better financing, and MSOs (multiple system operators) could even self-finance from operating profits of other systems. In addition, larger systems and MSOs could use their size to gain a degree of purchasing power (both for equipment and programming), and some operating economies became more apparent.

In this incarnation, cable’s scale was larger—it was moving into larger urban and suburban markets—with higher capital requirements for building and upgrading infrastructure, yet it was able to take advantage of scale economies and was able to offer higher value, higher demand, and signifi- cantly higher profit services. Offsetting these economies somewhat were the added costs involved with the new product. Systems needed regular upgrades to add channel capacity. Programming costs began to increase, as did promotion and marketing and customer service requirements.

The higher demand characteristics of cable as “more TV” allowed systems to increase revenues by both increasing penetration levels and increasing prices. This shift also brought new revenue streams to cable. Premium service networks, like HBO, were offered to subscribers at a sepa- rate, higher price. Other cable-only networks not only offered to pay for carriage, initially, they offered the opportunity for local cable systems to sell and insert local advertising. Shopping channels offered revenue-sharing opportunities. Over time, as some cable networks became more popular, drawing an ever-increasing share of the viewing audience, they were able to insist on cable systems paying them for carriage. That popularity, though, also increased the value of local advertising opportunities for cable systems, and as technology for ad insertion became more economical, systems found local advertising sales a profitable new revenue stream.

Larger systems could also benefit more from cable advertising, both in terms of their larger audiences having greater value and in their ability to cover the added costs of the insertion and tracking systems necessary to transmit local advertising over those channels. As the value of local advertising increased, systems also found emerging economies of scale and scope through system aggregation, through combining adjacent local systems. This prompted a wave of MSO “rationalization” in the late-1990s, as larger MSOs traded systems to concentrate activities in geographic clusters to take advantage of both advertising and general operating economies of scale and scope.

Impact and Structure. Cable also began to pose more of a threat to local television, whose programming now had to compete with the imported program choices for a fragmenting audience. Broadcasters began pressur- ing the FCC to do something about cable. The problem was that the FCC

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had the legal authority to regulate all forms of radio (broadcasting), and telephony, but cable was a new medium. Being a wired system, it did not use the airwaves. Neither did it fit the definition of telephony as a switched common carrier system. The FCC tried a variety of rationales to regulate cable throughout the 1960s and 1970s, sometimes supported and sometimes overturned by the courts. These attempts created a degree of uncertainty during this period and imposed some additional costs, thus tending to slow the expansion of cable somewhat.

The trend toward cable as additional television programming took off in the 1970s with the development of cable programming networks. Tech- nical advances and changes in regulations made satellite distribution of network programming economically viable. That opened up programming markets, prompting a rapid expansion in the number of signals available to cable systems, and thus to subscribers. Cable rapidly expanded throughout the 1970s and 1980s, reaching into larger markets and suburban areas. The number of cable systems grew from roughly 2,500 in 1970 to more than 9,000 by the end of the 1980s, and cable penetration al- most tripled between 1980 and 1990 from 22.6% to 59% (National Cable Television Association, 2002b).

Growth was aided by the passage of the 1984 Cable Act. The first explicitly cable federal legislation, the 1984 Cable Act finally provided the FCC with the direct legislative authority to regulate cable, nationalizing what had previously been primarily local regulation of cable systems. Cable systems needed access to utility rights-of-way in order to build their networks, and thus had to make arrangements with local governments. They were also interested in protecting those investments by obtaining local service monopolies, and thus found themselves accepting local franchise conditions, which evolved into local regulations. If there was competition for the local monopoly, bidding firms would compete by offering more services or granting greater regulatory authority. The licensing and regulatory conditions could vary widely across communities, however, and the monopoly grants being limited in term-subjected cable systems to local demands at renewals. Although not a big problem for many smaller systems, larger firms operating in multiple communities (multiple system operators [MSOs]) found the variation in regulatory structures and the uncertainties of license renewal a bit more problematic. As more and more local systems were acquired by MSOs, pressure to rationalize regulation increased, and the 1984 Act was passed following negotiations between the cable and broadcast TV industries.

Ostensibly nationalizing regulation, the 1984 Act was, in essence, more deregulatory. While explicitly shifting regulatory authority from states and local bodies to the FCC, both Congress and the FCC were in a deregulatory phase. National standards were set low, as was the threshold for permitting

8. THE ECONOMICS OF THE CABLE INDUSTRY

price regulation. The Act specified that basic service prices could only be regulated in the absence of competition. Competition was defined as the availability of several broadcast stations serving the community, a condi- tion that over 90% of cable systems met. Thus, most cable systems found themselves effectively freed from most price regulation.

As might be expected, cable consumers found themselves facing several rounds of price increases, fueled by both the relaxing of local price regulation and the rapid expansion in the number of programming channels offered. The large consumer response raised concerns in Congress, and prompted the 1992 Cable Act. By redefining the conditions of competitiveness, the 1992 Act brought most cable systems back under price regulation and set conditions for significant price rollbacks in many systems. The re- definition also illustrated the changing perception of cable’s basic nature: The 1984 Act deemed competitiveness in terms of available local broadcast signals, whereas the 1992 Act specified competition in terms of a competitive multichannel service provider available in the community.

New technologies also contributed to the growth in consumer demand and the rise of alternative revenue streams. Cable had experimented with interactivity in the 1980s, but the tree and branch architecture of networks made truly interactive systems problematic and expensive. However, increased intelligence in set-top boxes permitted a high degree of address- ability in the system, providing a form of interactivity that fostered new services such as pay-per-view and expanded premium service options.

This higher demand (which has held fairly steady at about two thirds of homes passed for most of the last decade) pushed cable expansion to the point where cable was available to about 97% of U.S. homes with television sets. This era of higher demand and profitability also prompted the entry of larger firms, and an increase in consolidation as those firms sought to take advantage of various economies of scale and scope. This era saw the rise of the large MSO and an increase in mergers and acquisitions in the cable industry. The high-demonstrated demand for cable programming also encouraged the development of alternative multichannel video systems (SMATV, MMDS, and home satellite systems).

In the meantime, the telecommunications industry was booming. De- mand for video programming was rapidly growing, but that was nothing compared to the growth forecasts for other telecommunications sectors. Te- lephony was ubiquitous, and the rise of cellular and faxes multiplied both supply and demand to the point where the United States was running out of phone numbers. Add to that the rise in computer communications and data transmissions and you have a rapidly growing demand for communi- cation networks and services. In this emerging digital communications market, cable found itself positioned with the largest pipe, if only it could solve the interactivity problem.

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Cable as Competition, as “Television of Abundance”