Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 In the Matter of ) ) Reexamination of the Effective ) MM Docket No. 90-4 Competition Standard for the ) Regulation of Cable Television ) Basic Service Rates ) COMMENTS OF THE NATIONAL TELECOMMUNICATIONS AND INFORMATION ADMINISTRATION The National Telecommunications and Information Administration ("NTIA"), as the Executive branch agency principally responsible for the development and presentation of U.S. telecommunications and information policy, respectfully submits the following comments on the Commission's Notice of Proposed Rulemaking ("Notice") in the above-captioned proceeding.[1] I. INTRODUCTION The Cable Communications Policy Act of 1984 ("Cable Act")[2] states that no Federal or state authority may regulate rates for "basic cable service" in communities where the serving cable system faces "effective competition."[3] In 1985, the Commission concluded that a cable system faces "effective competition" if at least three unduplicated broadcast television signals are "available" within the community served by that system.[4] As a result of this decision, the vast majority of cable systems that were regulated prior to passage of the Cable Act were deregulated as of December 29, 1986.[5] Currently, more than 95 percent of all cable systems are free from state or local regulation of their basic service rates.[6] Without question, the three-year period since deregulation has seen further expansion in the range and quality of services offered by cable systems, with accompanying benefits to the viewing public. For example, nearly 87 percent of all subscribers are now served by cable systems with 30 or more channels, as compared with some 47 percent in April 1986.[7] Moreover, in January 1990, there were 64 national cable networks and 30 regional networks,[8] as opposed to 50 national networks and 19 regional networks in 1986.[9] As importantly, this growth in the number of programming services has been accompanied by sharply increased expenditures by cable systems and program suppliers to improve the quality of the services offered.[10] These developments have enhanced the value of cable service to many subscribers, as indicated by the fact that the percentage of television households subscribing to cable has increased from 48.1 percent in November 1986 to 57.1 percent in November 1989.[11] However, as NTIA noted in commenting on the Commission's parallel Notice of Inquiry on the cable television industry,[12] questions have arisen about whether, at least in some instances, these benefits may have come at too high a cost.[13] Available studies suggest that basic cable rates have increased at more than three times the rate of inflation since December 1986,[14] although there is some evidence that basic rate increases may have moderated in 1989, even falling below the inflation rate for that year.[15] Such rate increases, as well as problems with service quality,[16] have triggered concern about the potential exercise of market power by the cable industry and the efficacy of the Commission's "effective competition" standard.[17] In response to these concerns, and in keeping with the Commission's obligation under the Cable Act to "periodically review" its rules with respect to cable rate regulation,[18] the Commission initiated this rulemaking to reexamine the prevailing "effective competition" standard. As NTIA indicated in its comments on the Commission's cable Notice of Inquiry, the Commission would best serve television viewers in the long term by expanding competition in the provision of video services to the home.[19] However, as a short term measure, NTIA supports reexamination of the existing "effective competition" standard. Any increased regulation of cable systems resulting from this reexamination should be designed to encourage competitive entry into local video markets. As discussed more fully below, there is no need for radical changes in the current "effective competition" standard, such as expanding it to require the presence in a community of a competing multichannel video provider.[20] Because broadcast signals can exercise a limiting influence on a cable system's ability to set excessive basic cable rates, NTIA believes it reasonable and appropriate to continue to define "effective competition" in terms of the availability of broadcast signals. The number of signals required by the current standard (i.e., three), however, is too low. Even if the existing standard were correct when adopted, it has been undermined by the changing nature of basic cable service. Available evidence suggests that a higher number of broadcast signals must be "available" within a community in order to constrain basic cable rates at reasonable, if not fully competitive, levels. NTIA recognizes that selection of the appropriate "effective competition" standard will necessarily be imprecise. We therefore believe that a new standard should be selected conservatively -- that is, in the direction of minimizing regulation. Because regulation tends to be a costly, inefficient process, it should be employed only when clearly necessary. Accordingly, in our view, the better course would be for the Commission to adopt a less stringent "effective competition" standard that can be revised in the future, if necessary, rather than a more expansive standard that may soon cause more harm than good. NTIA therefore recommends that the new standard be set at no more than six signals. We believe that such a standard, coupled with improved monitoring of cable rates, will strike the best balance between protecting subscribers and minimizing the costs of regulation. Finally, in communities where "effective competition" does not exist, the Commission should require state and local authorities that elect to regulate basic cable service rates to do so pursuant to a modified "price cap" plan. If a cable system should restructure (or "retier") the "basic cable service" that existed on that date, the Commission should expressly allow state and local authorities to determine the initial rate for the tier or tiers that may continue to be regulated consistent with the Cable Act. II. REREGULATION IS NO BETTER THAN A "SECOND BEST" METHOD TO PREVENT EXCESSIVE BASIC CABLE RATES. Although NTIA will address cable rate regulation issues in this proceeding, we nonetheless strongly believe that the best way to remedy excessive cable rates, and the threat of cable system market power generally, is to introduce greater competition in local video markets served by cable operators. In comments and reply comments on the Commission's cable Notice of Inquiry, NTIA discussed in detail how this could be accomplished by adopting policies that would encourage telephone companies to provide video distribution facilities on a common carrier basis to unaffiliated programmers.[21] The Commission could also increase competition by seeking to remove regulatory and other barriers to entry and expansion by other alternative video providers, such as MMDS, SMATV, DBS, and home satellite dishes.[22] Experience has shown that, in most cases, a competitive market will provide the mix of services most valued by consumers, at prices that reflect the economic costs of providing such services. The same cannot be said of regulated markets. Most importantly, regulation entails substantial costs for both regulators and regulated firms. Consequently, even if regulated rates are identical to those that would prevail in a competitive market, which is seldom the case, the benefit to consumers will always be reduced to some degree by the increased costs of providing service caused by regulation. Moreover, regulation generally cannot replicate the dynamic efficiencies of a competitive market. For example, regulation, if effective, can ensure a reasonable relationship between prices and underlying costs. However, regulation cannot readily create incentives for regulated firms to minimize costs similar to those that exist when firms face competition. As a result, although regulated rates may reflect costs in some sense, such rates, and the underlying costs of the regulated firms, will often be higher than they would be if regulated firms faced competitive pressures to operate efficiently. Indeed, some forms of regulation, like those based on maintaining a fixed rate of return, may motivate the regulated firm to increase investment and incur costs inefficiently. While it is possible to craft a regulatory regime that produces increased incentives for efficient operation,[23] the Commission's experience with price cap regulation suggests that the process of crafting such a regime can be lengthy, contentious, and in the end, uncertain.[24] The potential effectiveness of basic cable service regulation is also limited by the Cable Act in its present form.[25] First, the Act sharply restricts the range of services that may be regulated to only those service tiers that include retransmission of local television broadcast stations.[26] Second, the Cable Act apparently gives cable operators significant flexibility to rearrange the services offered on their basic service tiers.[27] As a result, cable systems could restructure their basic offerings to limit the range of "basic cable services" that are lawfully subject to regulation. Third, the Cable Act entitles cable operators to raise regulated basic rates five percent annually.[28] In short, the Act gives cable operators ample opportunity to minimize the impact and, perhaps, the effectiveness of any expanded rate regulation the Commission might adopt in this proceeding. Introducing greater competition from multichannel providers into local video markets would avoid many of the problems associated with attempting to regulate basic cable rates. As importantly, such increased competition could ameliorate potential competitive problems stemming from concentration of cable ownership, which cannot be remedied by regulating basic cable rates. However, NTIA recognizes that it will take time for multichannel competition to develop.[29] Accordingly, we understand the Commission's interest in addressing the possibility of some short-term regulatory safeguards to protect cable subscribers until competition takes hold. We address these issues below. III. THE CURRENT "EFFECTIVE COMPETITION" STANDARD SHOULD BE CHANGED TO REQUIRE SIX OFF-THE-AIR BROADCAST SIGNALS. NTIA believes that the current "effective competition" standard should be redefined. We emphasize, however, that a new definition, and any accompanying new regulatory regime, must be developed in a way that ultimately will promote competitive entry and ensure reasonable basic cable rates without imposing excessive regulatory costs. For the reasons set forth below, NTIA believes that the existing standard should be redefined to require the availability of six broadcast television signals. A. The Commission Should Continue To Base its Standard for Regulation Primarily on the Availability of Television Broadcast Signals. Although NTIA believes that the Commission's "effective competition" standard should be made somewhat more stringent, we think it reasonable in the short term to continue to define "effective competition" primarily in terms of the availability of television broadcast signals. Such an approach both comports with congressional intent and provides regulatory protection for those cable subscribers who have the fewest alternative sources of video programming. Among other things, Congress emphasized that the "effective competition" standard must be "readily applicable for determining on a community-by-community basis whether a cable system is subject to effective competition."[30] Because a number of sources can easily be used to determine how many television broadcast stations are available within a particular cable community,[31] an "effective competition" standard based on broadcast signals will be administratively easy to apply, thus significantly reducing the potential costs of regulation. Moreover, available studies suggest that the presence of broadcast signals within a community can constrain basic cable service rates.[32] One study showed that, other things being equal, the more television signals that are available off-the-air within a community, relative to the number of broadcast signals carried by the community's cable system, the fewer subscribers that system will have.[33] Similarly, a 1985 study by NCTA found that the availability of a first, second, and third local television broadcast signal in a community each had a significant downward effect on basic cable service rates.[34] A recently completed study by Dertouzos and Wildman also found that broadcast television signals "do constitute significant competition to cable service."[35] Because the availability of television broadcast signals thus appears to have a beneficial effect upon basic cable rates, it is reasonable for the Commission to continue to base the "effective competition" standard on the presence of a certain number of television broadcast signals. In addition, NTIA recognizes that a competing multichannel provider can provide "effective competition" to an existing cable system. If a party can show that a competing multichannel provider, whether an MMDS system, a DBS operation, or a telephone company-provided video distribution system, serves a significant part of a particular community, the Commission should deem "effective competition" to exist. B. Three Television Broadcast Signals Are Not an Appropriate Measure of "Effective Competition." A critical issue in this proceeding is what number of television broadcast signals within a community provides an "effective competition" standard that results in the imposition of regulation where necessary, but only where necessary. At this point, NTIA cannot determine what that precise number is. However, there are good reasons for believing that it is somewhat more than three. For example, the Commission suggests that the current standard has been outstripped by a fundamental change in the nature of basic cable service since December 1986.[36] Available evidence supports the Commission's assertion that, since 1986, basic cable service has been transformed from the retransmission of local broadcast signals to "a menu that now includes cable networks, superstations and other services beyond local broadcast stations."[37] From NTIA's random sample of 216 cable systems, we identified 178 for which service data was available for both 1986 and 1989. Table 1 depicts the average number of services offered over those systems on the lowest basic service tiers for those two years. TABLE 1 Average Number of Offerings per Cable System 1986 1989 Local Broadcast Signals 7.320 7.140* Basic Cable Networks 4.635 8.843* on Lowest Tier Superstations 1.410 1.596* TOTAL 13.365 17.579 * Differences in average values between 1986 and 1989 are statistically significant at the 95 percent confidence level. Table 1 demonstrates that basic cable service has changed substantially since 1986. The number of basic cable network channels offered by the average system in our sample has nearly doubled over that period.[38] Moreover, the ratio of local broadcast channels carried to total channels offered has declined from 54.8 percent in 1986 to 40.6 percent in 1989.[39] Even if this situation had not changed since 1986, NTIA believes that the current "effective competition" standard should be modified because it was flawed in several respects when it was adopted. As the Commission points out, the current standard was based, in part, on a 1985 Commission staff study of the relationship between availability of off-the-air broadcast signals and viewing shares for non-broadcast basic cable programming.[40] However, the study relied on data from late 1981 and early 1982.[41] It is questionable whether this report's analysis and conclusions adequately reflected the competitive environment between broadcast and cable that prevailed in April 1985, when the Commission adopted the current "effective competition" standard. The existing standard also does not differentiate among the three types of broadcast signals -- network affiliates, independents, and non-commercial stations. As a result, the current standard treats three independent or non-commercial stations as providing the same level of competition to basic cable as three network affiliates.[42] We believe that an "effective competition" standard that differentiates among types of signals could better account for that fact the viewers value one type of broadcast signal (e.g., network affiliates) more other types.[43] Thus, the availability of a network signal within a community would be a better substitute for cable service (and would, thus, have a stronger downward effect on basic rates) than would an independent or non-commercial station. In short, the Commission's existing "effective competition" standard could be strengthened by differentiating among types of broadcast signals.[44] C. Evidence Suggests That a Reasonable "Effective Competition" Standard Should Require the Presence of Six Television Broadcast Signals. NCTA relies upon two studies that suggest the proper number of broadcast signals for the "effective competition" standard is five. Dertouzos and Wildman conclude that "five broadcast signals are sufficient to achieve the maximum competitive effect" upon basic cable rates,[45] asserting further that "[a]dditional signals beyond five have no discernable effect on the behavior of cable operators."[46] Another study, by Jaffe and Kanter, examines cable system sales prices before and after deregulation.[47] The authors "hypothesized that if cable operators had market power . . . this would be reflected in an increase in prices paid for cable systems following deregulation as the elimination of price controls imposed by local franchise authorities allowed systems to raise service prices to profit maximizing levels."[48] Sales prices for systems located outside of the top-100 broadcast markets showed a significant increase after deregulation, suggesting the presence of market power. On the other hand, sales prices within the 100 largest broadcast markets experienced no significant increase, indicating the absence of market power. Dertouzos and Wildman assert that these findings support their conclusion that five signals constitute "effective competition" because "top-100 market status is highly correlated with the presence of five or more television signals available off-air."[49] While these studies provide some valuable information and insights on the relationship between cable rates and the availability of broadcast signals, they each have limitations that restrict their usefulness in selecting a new "effective competition" standard. For example, as Dertouzos and Wildman acknowledge, the cable system data used in their analysis is highly skewed towards larger systems.[50] Therefore, the results of their analysis may not extend generally to the overall population of cable systems. Additionally, the explanatory power of many of Dertouzos and Wildman's models appears to be relatively low (reflected in "R-squared" values in the .20-.30 range), despite the large number of explanatory variables in those models.[51] Finally, some of the models produce counter-intuitive results. For example, the model with respect to price per basic channel shows that rates in markets receiving five broadcast signals are significantly different (i.e., lower) from prices in markets receiving only one signal. However, that same model shows that prices in six signal markets are not significantly different from one signal markets.[52] Although the introduction of each additional signal may have a diminishing competitive effect on price, it should not cause prices to increase, as the Dertouzos- Wildman model suggests. The Jaffe and Kanter study cited above is also flawed in an important respect. In NCTA's criticism of the usefulness of the q- statistic (the numerator of which can be derived from cable sales prices) in measuring market power, it argues that the "market value of a company [e.g., its sales price], . . . often fluctuates for reasons completely unrelated to market power."[53] If cable system sales prices are of limited use in calculating the q-statistic, they should also be of limited use in calculating cable market power in other contexts. Thus, the two studies that NCTA relies upon do not provide a sufficient basis for establishing a new "effective competition" standard. To attempt to place a new standard on a sounder econometric footing, staff in NTIA's Office of Policy Analysis and Development conducted its own econometric analysis of the relationship between the availability of off-the-air broadcast signals and basic cable rates, attached as Appendix A.[54] Like any such analysis, the NTIA staff study necessarily is based on certain simplifying assumptions that may not be precisely met in practice, and is constrained somewhat by limits on the availability of data on potential relevant factors. Nevertheless, the study appears to be an improvement, in certain respects, over some of the existing studies[55] and a useful addition to the current debate on reregulation of basic cable rates. The NTIA staff study, like the Dertouzos-Wildman analysis, supports the notion that the availability of broadcast signals can exert downward pressure on basic cable rates.[56] The study, however, does not support the Dertouzos-Wildman conclusion that, once a critical number has been reached (in their analysis, five signals), "[a]dditional signals . . . have no discernable effect on the behavior of cable operators." In fact, additional signals appear to have a continuing, though diminishing (at the margin), negative effect on basic rates. Nonetheless, the NTIA staff study does not demonstrate that a specific "effective competition" standard is the "right" one, because this statistical study does not attempt to state what the "right" number of signals may be. Given the state of the analysis, the Commission's selection of the appropriate "effective competition" standard will necessarily be imprecise. NTIA therefore believes that any new standard should be selected conservatively -- that is, in the direction of minimizing regulation. Because regulation tends to be a costly, inefficient process, it should be employed only when clearly necessary. In making this decision, the Commission should keep in mind a few important factors. First, if Congress and the Commission move aggressively to introduce more competition in local video markets, a new "effective competition" standard may quickly become obsolete. Second, once a standard (and accompanying regulatory regime) is in place, history suggests that it will be difficult to change. Third, even if change can be accomplished, the process of re- regulating a substantial portion of the cable industry now, only to "re-deregulate" a few years later, could be very disruptive. Fourth, while there are a number of steps the Commission can take to attempt to ensure that increased regulation does not undermine incentives for competitive entry (see infra at Section IV), there is always the risk that this will be the result. NTIA believes that the public would be ill-served if in seeking to achieve certain short-term benefits through increased regulation, the Commission adopted a regulatory regime that jeopardized the greater long-term rewards of competition. These factors suggest that the better course would be for the Commission to adopt a less stringent "effective competition" standard that can be tightened in the future, if necessary, rather than a more expansive standard that may soon cause more harm than good. NTIA therefore recommends that the new standard be set at no more than six signals. We believe that such a standard, coupled with the monitoring procedures discussed below, will strike the best balance between protecting subscribers and minimizing the costs of regulation.[57] D. The Commission Should Monitor Rates Charged by Cable Systems and Should Commit To Reexamine its "Effective Competition" Standard in Three Years. As the current debate over "effective competition" demonstrates, a standard deemed reasonable in theory may prove to be inadequate under evolving market conditions. For this reason, the Commission should carefully monitor the rates charged by cable systems, and thus the performance of any new "effective competition" standard, in order to evaluate the costs and benefits of regulation. By so doing, the Commission can avoid one of the most frustrating aspects of the debate over cable rate regulation: the lack of reliable, industry-wide data on changes in basic cable service rates since deregulation. Accordingly, NTIA recommends that the Commission require cable systems to file, on an annual basis, information on basic service rate levels and the changes in rates over the previous twelve months.[58] To permit assessment of possible effects of "quality" increases on basic rates, the Commission should also require cable systems to report changes in the number of services offered on their "basic cable service" tiers subject to regulation under the Cable Act. This type of report should be brief and not burdensome for cable companies to prepare.[59] Among other things, systematic information on rates and services will help the Commission determine whether its "effective competition" standard remains appropriate under changing market conditions. Accordingly, NTIA recommends that the Commission use the information gathered to reexamine any new standard within three years to ensure that it is consistent with prevailing market conditions. IV. THE COMMISSION SHOULD PRESCRIBE A MODIFIED "PRICE CAP" SCHEME TO GUIDE NON-FEDERAL REGULATION OF BASIC CABLE SERVICE RATES WHERE EFFECTIVE COMPETITION DOES NOT EXIST. In 1985 the Commission adopted several procedural rules that non-federal agencies must follow in regulating basic cable rates.[60] The Notice requests comments on whether the Commission should adopt additional regulations, such as a specific ratemaking methodology.[61] For several reasons, NTIA believes that the Commission should adopt such a methodology, but should do so in a way that does not discourage entry into cable markets by alternative video suppliers. One way to do this would be through a simplified form of price cap regulation. With the growing popularity of cable television and the many complaints about basic rate increases, regulators will face intense political pressure from subscribers to restrain basic rates, even in markets where existing rates may be reasonable. One tempting way for regulators to keep basic rates low could be to ignore the costs associated with the cable distribution plant, which are fixed in the short run and which, in many cases, may already be fully recovered through depreciation. However, any regulatory scheme that permits setting basic rates below long run economic costs will have two unfortunate consequences. First, it could deter entry by efficient competing distribution media, such as MMDS or telephone company-constructed distribution facilities. Second, such rates would sharply reduce cable systems' incentives to make the capital investments necessary to expand and upgrade their distribution facilities. In either event, television viewers would suffer in the long run. NTIA therefore believes that the Commission should prescribe a specific methodology to guide non-federal regulation of basic cable rates. NTIA also concurs with the Notice's tentative conclusion that the methodology adopted should not be rate of return regulation.[62] The weaknesses of such a scheme are well- documented.[63] Although it is both costly and cumbersome to apply, the principal difficulty with rate of return regulation is that it does not create incentives for regulated firms to operate efficiently.[64] On the other hand, price cap regulation does not exhibit these same fundamental flaws. NTIA therefore recommends that the Commission require that non-federal authorities employ a price cap scheme in regulating basic cable rates. Under this approach, cable systems would be able to adjust regulated basic rates annually in accordance with changes in an index (the "cost index") that reflects the cost of providing service. As the Commission is aware from its price cap proposals for AT&T and the local exchange carriers in the telephone industry, such plans can become quite complicated. We believe that any such plan adopted for cable systems should be as flexible as possible. Indeed, the Court of Appeals decision in American Civil Liberties Union v. FCC[65] appears to limit the specificity with which the Commission can define any regulatory scheme to be adopted by state or local regulators. Section 623(b)(2)(B) of the Cable Act authorizes the Commission to "establish standards for . . . rate regulation."[66] In invalidating a Commission rule providing for basic rate increases based on an "automatic pass through" of costs by cable systems, the ACLU court stated that the Commission would seem to be exceeding its authority if it were to use the general direction to establish "standards for rate regulation" to justify direct regulation of the permissible amount of a rate increase.[67] Without a change in the law, a highly detailed price cap system outlined by the Commission for implementation by state and local regulators could be legally suspect. However, general Commission standards requiring state and local authorities to implement a reasonable price cap methodology, rather than rate of return regulation, would seem to avoid the "direct regulation" proscribed in ACLU. The Commission should weigh whether changes in Section 623(b)(2)(B) of the Cable Act are necessary for it to satisfy its policy concerns in this area.[68] V. THE COMMISSION SHOULD ADDRESS POTENTIAL STRATEGIC BEHAVIOR BY CABLE SYSTEMS NEWLY SUBJECT TO REGULATION. An important element in developing a simple cable price cap plan would be to determine the initial, or baseline, rate to which subsequent increases will be applied. The Commission is concerned that, if regulation is expanded beyond current levels, cable systems subject to such regulation will have incentives to raise basic rates before the effective date of a new regulatory scheme to mitigate the impact of rate regulation.[69] To avoid such strategic behavior, NTIA recommends that regulated rates generally be set at levels no higher than those prevailing on January 22, 1990, the release date of the Notice.[70] The Commission should make an exception from this general rule, however, in cases where cable systems engage in "retiering" after the effective date of a new "effective competition" standard, by changing their basic cable service packages from those offered on January 22, 1990. As the Commission notes, the Cable Act gives cable systems broad flexibility to retier, or repackage, their basic service offerings.[71] Consequently, a newly regulated system could readily remove popular cable network programming from its regulated basic service tier to minimize the impact of regulation.[72] If it did so, and if the rate for the regulated tier were set at levels prevailing in January 1990 (before the retiering occurred), subscribers would be paying the same price for a reduced number of services. Because the Commission apparently has little legal authority to prevent retiering,[73] it should seek to protect subscribers by expressly permitting non-federal regulators to set the initial rate for the regulated basic cable service tier when a cable system subject to regulation under a new "effective competition" standard has restructured that tier after January 22, 1990. VI. CONCLUSION For the foregoing reasons, NTIA respectfully requests that the Commission adopt the recommendations contained herein. Respectfully submitted, Janice Obuchowski Assistant Secretary for Jean M. Prewitt Communications & Information Chief Counsel William F. Maher, Jr. Jana S. Patterson Associate Administrator Attorney Office of Policy Analysis and Development National Telecommunications and Information Administration U.S. Department of Commerce Room 4717 14th Street and Constitution Ave., N.W. Washington, D.C. 20230 (202) 377-1816 April 6, 1990 Project managers for this filing were Mark Bykowsky and Tim Sloan, NTIA, Office of Policy Analysis and Development, Suite 4725, U.S. Department of Commerce, Washington, D.C., 20230, (202) 377-1880. Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 In the Matter of ) ) Reexamination of the Effective ) MM Docket No. 90-4 Competition Standard for the ) Regulation of Cable Television ) Basic Service Rates ) COMMENTS OF THE NATIONAL TELECOMMUNICATIONS AND INFORMATION ADMINISTRATION Janice Obuchowski Jean M. Prewitt Assistant Secretary for Chief Counsel Communications & Information William F. Maher, Jr. Jana S. Patterson Associate Administrator Attorney Office of Policy Analysis and Development National Telecommunications and Information Administration U.S. Department of Commerce Room 4717 14th Street and Constitution Ave., N.W. Washington, D.C. 20230 (202) 377-1816 April 6, 1990 SUMMARY Cable television has provided many benefits to the American public since passage of the Cable Communications Policy Act of 1984. More than 80 percent of the nation's television households now have an opportunity to purchase cable service. Moreover, cable systems give their customers access to more than 90 high quality national and regional programming services, many of which are unavailable from any other source. This expansion in services has attracted increasing numbers of subscribers. In fact, more than one-half of all American homes receive television service from their local cable systems. At the same time, basic cable rate increases and perceived problems with cable service quality have triggered concern among policymakers and have focused attention on the Commission's "effective competition" standard for basic cable rate regulation. As NTIA stated in commenting on the Commission's parallel Notice of Inquiry on the cable television industry, the Commission would best serve television viewers in the long term by expanding competition in the provision of video services to the home. As a short term measure, however, NTIA supports reexamination of the existing "effective competition" standard, but emphasizes that any increased regulation of cable systems resulting from this reexamination must not be designed or implemented in ways that discourage new competitive entry. NTIA believes that the current "three signal" standard for determining when regulation should occur should be modified. Among other things, the current standard has been undermined by the changing nature of basic cable service. Available studies suggest that somewhat more than three signals must be "available" within a community in order to ensure basic cable rates remain at reasonable, if not fully competitive, levels. Given the imprecision inherent in the available studies, as well as the costs and burdens associated with rate regulation, NTIA believes that the Commission should act conservatively and redefine "effective competition" to require the availability of six off-the- air broadcast signals. We think such a standard will provide cable subscribers adequate protection from excessive basic cable rates. Moreover, a conservative standard will minimize the possibility that regulation will inadvertently curtail the many benefits the cable industry has produced since 1984, or will reduce the prospect of competitive entry. We also suggest that the Commission adopt a program to monitor the rates charged by cable systems, and reexamine any new "effective competition" standard within three years to ensure that it remains consistent with market conditions. Additionally, where the "effective competition" standard is not met, the Commission should require state and local authorities that elect to regulate basic cable service rates to do so pursuant to a modified "price cap" plan. If a cable system should restructure (or "retier") "basic cable service," the Commission should expressly allow state and local authorities to determine the initial rate for the tier or tiers that may continue to be regulated consistent with the Cable Act. ---------------------------------------------------------------------------- ENDNOTES [1] 5 FCC Rcd 259 (1990). [2] Pub. L. No. 98-549, 98 Stat. 2780, codified at 47 U.S.C.  521-559 (Supp. III 1985). [3] 47 U.S.C.  543 (Supp. III 1985). "Basic cable service" means "any service tier which includes the retransmission of local television broadcast signals." Id.  522(2). [4] Implementation of the Provisions of the Cable Communications Policy Act of 1984, 50 Fed. Reg. 18637, 18648-50 (1985), modified on recon., 104 FCC 2d 386 (1986), aff'd in part and rev'd in part sub nom. American Civil Liberties Union v. FCC, 823 F.2d 1554 (D.C. Cir. 1987), cert. denied, 108 S.Ct. 1220, modified on remand, 3 FCC Rcd 2617 (1988). Initially, the Commission deemed a broadcast signal to be "available" within a community if the signal's Grade B contour covered any portion of the community. See 50 Fed. Reg. at 18651. On remand after reversal by the court of appeals, the Commission amended its "signal availability" standard to require that the broadcast signal's Grade B contour encompass the entire community. See Amendment of Parts 1, 63, and 76 of the Commission's Rules to Implement the Provisions of the Cable Communications Policy Act of 1984, 3 FCC Rcd 2617, 2621- 22, paras. 31-33 (1988). [5] The Cable Act permitted continued state and local regulation of basic cable service rates for two years after the effective date of the Act. See 47 U.S.C.  543 (c) (Supp. III 1985). That two-year transition period ended on December 29, 1986. [6] See S. 1880: The Cable Consumer Protection Act of 1989,  2(1), 101st Cong., 1st Sess. (rates in 97 percent of all cable franchises have been deregulated); U.S. General Accounting Office, Telecommunications: National Survey of Cable Television Rates and Services at 4 (Aug. 1989) ("GAO Study") (97 percent of cable systems surveyed as of October 1988, were deregulated). [7] Compare 57 Television & Cable Factbook, Cable & Service Volume at C-375 (1989 ed.) ("1989 Television & Cable Factbook") with 54 Television & Cable Factbook, Cable & Service Volume at A-45 (1986 ed.) ("1986 Television & Cable Factbook"). [8] Comments of NTIA at 3, in MM Docket No. 89-600 (filed Mar. 1, 1990) ("NTIA NOI Comments"). [9] 1986 Television & Cable Factbook at C-33 - C-41. [10] See, e.g., Comments of the National Cable Television Ass'n, Inc. at 17-18, in MM Docket No. 89-600 (filed Mar. 1, 1990) ("NCTA NOI Comments"). [11] See Cabletelevision Advertising Bureau, Inc., Cable TV Facts 90, at 4 ("Cable TV Facts 90"). [12] Competition, Rate Deregulation and the Commission's Policies Relating to the Provision of Cable Television Service, 5 FCC Rcd 362 (1989) ("Notice of Inquiry"). [13] NTIA NOI Comments at 3. [14] See, e.g., GAO Study at 4 (rates for the lowest price tier of basic service increased 29 percent between December 1986 and October 1988). The increase in the inflation during this period was apparently less than 8 percent. See Comments of the United States Telephone Ass'n at 23, in MM Docket No. 89- 600 (filed Mar. 1, 1990) (average annual inflation rate between 1986 and 1988 was 4 percent or less). In comments filed in the Commission's cable Notice of Inquiry, the National Cable Television Association, Inc. ("NCTA") has argued that the post-deregulation rate increases are no cause for Commission concern. See NCTA NOI Comments at 13-24. While the factors NCTA points to (such as increased programming options and increased subscribership) may be indicia of benefits to consumers, such factors do not, by themselves, establish that many, if not more, of these same benefits would not have been produced in a more competitive market environment without the same level of rate increases. [15] See NCTA NOI Comments at 15. [16] See, e.g., Barron, How Cable TV Is Like Con Ed and the Post Office, N.Y. Times, Mar. 25, 1990, at E20. [17] See, e.g., S. 1880, supra note 6,  4(a) (proposing to redefine "effective competition"); S. 833: The Cable Television Subscriber Protection Act of 1989,  3, 101st Cong., 1st Sess. (same). [18] See 47 U.S.C.  543(b)(3) (Supp. III 1985). [19] NTIA NOI Comments at 4. See also Reply Comments of NTIA at 2, in MM Docket No. 89-600 (filed Apr. 2, 1990) ("NTIA NOI Reply Comments"). [20] See Notice, 5 FCC Rcd at 262, paras. 25-28. See also the legislative proposals cited supra note 17. Although the availability of a second multichannel provider is not necessary to provide effective competition to an existing cable system, NTIA nevertheless believes that, where a second such provider exists, the Commission should conclude that "effective competition" does exist. See infra at 14. [21] See NTIA NOI Comments at 9-14; NTIA NOI Reply Comments at 2. [22] See Amendment of Parts 21, 43, 74, 78 and 94 of the Commission's Rules, Pertaining to Rules Governing Use of the Frequencies in the 2.1 and 2.5 GHz Bands Affecting: Private Operational-Fixed Microwave Service, Multipoint Distribution Service, Multichannel Multipoint Distribution Service, Instructional Television Fixed Service, and Cable Television Relay Service, Gen. Docket No. 90-54, FCC 90-60 (released Feb. 22, 1990). [23] NTIA strongly supports development of such "incentive regulation" schemes for telecommunications generally. See, e.g., NTIA Regulatory Alternatives Report, Rep. No. 87-222 (July 1987). [24] For example, to alleviate concerns about possible errors in the price cap plan adopted for AT&T and proposed for local exchange carriers, the Commission has proposed periodic reviews of regulated firm profits. However, such reviews could limit the beneficial incentives associated with price cap regulation. [25] This again argues strongly for relying on the increased introduction of competition, rather than regulation, as a long-term solution to cable rate and service problems. [26] Section 623 of the Act states that franchising authorities may only "regulate rates for the provision of basic cable service." 47 U.S.C.  543(b)(1) (Supp. III 1985). As noted above, "basic cable service" is "any service tier which includes the retransmission of local television broadcast signals." See supra note 3. [27] See Notice, 5 FCC Rcd at 265, para. 44 (citing 47 U.S.C.  545(a), (d) (Supp. III 1985)). See also infra note 71 and accompanying text. Before passage of the Cable Act, Commission decisions also gave cable operators broad discretion to retier their basic service offerings. See Community Cable TV, Inc., 98 FCC 2d 1180, 1188-89 (1984). [28] See 47 U.S.C.  543(e)(1) (Supp. III 1985) ("any rate subject to regulation pursuant to this section may be increased . . . at the discretion of the cable operator by an amount not to exceed 5 percent per year if the franchise (as in effect on the effective date of this title) does not specify a fixed rate or rates for basic cable service for a specified period or periods which would be exceeded if such increase took effect"). [29] See NTIA NOI Comments at 12 n.26. [30] H.R. Rep. No. 934, 98th Cong., 2d Sess. 66 (1984), reprinted in 1984 U.S. Code Cong. & Admin. News 4655, 4703. [31] See, e.g., Television & Cable Factbook, Cable & Station Coverage Atlas. [32] The notion that broadcast signals can be competitive substitutes for cable service illustrates the complexities of competition in local video markets. Cable systems offer a range of specialized programming packages (all-news, all- sports, all-music) that are highly valued by many viewers and are unavailable from broadcasters. On the other hand, similar, if not perfectly substitutable, types of programming are also available from broadcast stations. Cable's advantage is that its greater capacity enables a cable operator to offer far more of each type of programming than its broadcast rivals. The advantage of broadcasters is that they offer programming that is at least partially substitutable for cable programming at no direct cost to viewers. Thus, although broadcast programming may not be an adequate alternative for some viewers, it is likely to be viewed as a reasonable substitute for others. Because cable operators cannot readily charge different prices to each group of prospective subscribers, in setting rates they will have to take account of some viewers' more elastic demand for cable service. In this way, the availability of broadcast signals can constrain the rates cable operators charge for basic service. [33] See, e.g., Pacey, Cable Television in a Less Regulated Market, 24 J. Ind. Econ. 81 (1985). [34] See NCTA NOI Comments at 24-25 (citing Comments of National Cable Television Ass'n, Inc. in MM Docket No. 84-1296 (filed Jan. 28, 1985)). [35] Dertouzos and Wildman, Competitive Effects of Broadcast Signals on Cable, at 2 (Feb. 22, 1990) ("Dertouzos and Wildman") (submitted as an attachment to NCTA NOI Comments). [36] See Notice, 5 FCC Rcd at 261, paras. 14-15. [37] Id. at 261, para. 15. [38] It is important to recognize that some of this increase may reflect a shift of some cable networks from expanded basic tiers to the lowest priced basic tiers. For example, of the 178 systems reflected in Table 1, 21 (11.8 percent) offered expanded basic service tiers in 1989, as opposed to 34 (19.1 percent) in 1986. [39] The increase in the number of "cable exclusive" programming carried by most systems may have reduced the degree of substitutability between broadcast and cable programming. See Notice, 5 FCC Rcd at 261, para. 17. See also the discussion supra note 32. [40] Id. at 261, para. 14. [41] See id. [42] See Implementation of the Provisions of the Cable Communications Policy Act of 1984, 50 Fed. Reg. 18637, 18650, para. 102 (1985). The Commission suggested briefly that differentiating among signals would raise First Amendment concerns. It also stated that differentiating among types of signals would not be consistent with its past efforts to foster alternative program sources. The Commission did not, however, discuss further its reasoning on either of these points. [43] That the three types of broadcast signals are valued differently by viewers is readily apparent from several sources. Even in cable homes, for example, network affiliates capture the largest audience shares. See Cable TV Facts 90, supra note 11, at 6. Moreover, the audience share for each network affiliate is more than 150 percent greater than the viewing shares for all local independents combined. Id. Each network's share is also more than five times larger than the shares for public stations. Id. [44] The need for an "effective competition" standard to specify network affiliates diminishes as the number of signals within the standard increases. As a practical matter, communities that receive a relatively large number of broadcast signals (e.g., five or more signals) will likely receive a full complement of network affiliates. For example, in our sample of 216 cable systems, every community that received at least five broadcast signals off-the-air also received three unduplicated network affiliates. [45] Dertouzos and Wildman, supra note 35, at 2. [46] Id. [47] Jaffe and Kanter, "Market Power of Local Television Franchises: Evidence from the Effects of Deregulation," Discussion Paper 1445, Harvard Institute of Economic Research (1989). [48] Dertouzos and Wildman, supra note 35, at 24. [49] Id. at 25. [50] Id. at 9. [51] See id. at 20, 22. A regression model's R-squared value indicates the proportion of the total variation in the dependent variable that is explained by the independent variables. In simple terms, it measures the "goodness of fit" of a model, and generally its explanatory power. R-squared values range between 0 and 1.0, with a model's explanatory power increasing as its R-squared value increases. See J. Pindyck and D. Rubinfeld, Econometric Models and Economic Forecasts 35 (1976). [52] See Dertouzos and Wildman, supra note 35, at 23. [53] NCTA NOI Comments at 39, quoting Grossman, On the Misuse of Tobin's q to Measure Monopoly Power, at 1 (1990) (submitted as an attachment to NCTA's NOI Comments). [54] Bykowsky and Sloan, Competitive Effects of Broadcast Signals on the Price of Basic Cable Service (Apr. 6, 1990) ("App. A"). [55] First, the NTIA staff study was based on a random sample of cable systems that, although slightly skewed towards larger systems, is nonetheless more representative of the cable industry than the sample used by Dertouzos and Wildman. See id. at 5. Second, the "adjusted R-squared" values for the regression models estimated are all higher than the R-squared values for the comparable Dertouzos-Wildman models, suggesting that the staff's models more completely capture the relationship between availability of broadcast signals and basic cable rates. See id. at 14. [56] See id. at 16. [57] Based on NTIA's random sample of 216 cable systems, we estimate that this new standard would subject approximately 40 percent of all cable systems, serving roughly 9 percent of all cable subscribers, to regulation. [58] See Notice, 5 FCC Rcd at 263-64, paras. 37-38. [59] To minimize reporting burdens for small cable systems, the Commission may want to consider gathering rate information from a representative sample of smaller systems, rather than from all such systems. [60] See Implementation of the Provisions of the Cable Communications Policy Act of 1984, 50 Fed. Reg. at 18654. The Cable Act also limits the regulatory authority of such agencies in certain respects. See 47 U.S.C.  543(d), (e) (Supp. III 1985). [61] See Notice, 5 FCC Rcd at 263-46, paras. 36-40. [62] See id. at 264, para. 39. Because NTIA does not support imposition of rate of return regulation, we see no need for the Commission to collect from cable systems the sort of detailed financial information outlined in the Notice. See id. at 263-64, paras. 37-38. Instead, as noted above, NTIA recommends that the Commission establish an ongoing program to monitor changes in cable rates and services. See supra at 24. [63] See Policy and Rules Concerning Rates for Dominant Carriers, 4 FCC Rcd 2873, 2889-93, paras. 29-35 (1989); NTIA Regulatory Alternatives Report, Rep. No. 87-222, at 13-31 (July 1987). [64] See supra at 8-9. [65] 823 F.2d 1554 (D.C. Cir. 1987), cert. denied, 108 S. Ct. 1220 (1988) ("ACLU"). [66] 47 U.S.C.  543(b)(2)(B) (Supp. III 1985). [67] ACLU, 823 F.2d at 1571. The court also found the "automatic pass through" to be invalid because it had the effect of removing the 5 percent automatic increase permitted cable operators under the Cable Act. Id. [68] NTIA also notes that the Cable Act erects a potential barrier to consistent application of price cap regulation to basic cable rates. Section 623(e)(1) of the Act entitles cable systems, in most cases, to raise rates by 5 percent per year without regulatory approval. See 47 U.S.C.  543(e)(1) (Supp. III 1985). Thus, a price cap plan will not maintain basic cable rates in line with an underlying cost index unless the chosen index equals or exceeds 5 percent. While this may not be a significant problem in the short term (unless the rate of inflation is consistently well below 5 percent over the next few years), it could prove troublesome if this form of regulation remains in effect for an extended period of time. Consequently, the Commission should consider whether it should recommend to Congress that Section 623(e)(1) be modified in order for price cap regulation of basic cable rates to be fully effective. The Notice also suggests that any basic rate increases permitted under a price cap plan "would be in addition to the five percent increase" allowed by the Cable Act. Notice, 5 FCC Rcd at 264, para. 40. In our view, the Cable Act does not require that under a price cap form of regulation, five percent must be added to any changes in the selected cost index. [69] See Notice, 5 FCC Rcd at 264-65, para. 43. [70] Because this standard would give non-federal authorities substantial flexibility in implementing regulation, we believe that it would be acceptable under the ACLU decision, supra note 65. [71] See id. at 265, para. 44. Section 625(d) of the Act gives cable systems complete freedom to rearrange services among tiers if all tiers involved are not subject to regulation. 47 U.S.C.  545(d) (Supp. III 1985). Section 625(a) apparently gives cable operators broad flexibility to remove services from regulated basic service tiers unless the relevant franchise requires the operator to provide a certain type or mix of services on those tiers. Id.  545(a). [72] Although such retiering may well occur, NTIA is not convinced that all reregulated cable systems will adopt such a strategy. As a practical matter, the cable industry will be under intense political pressure to avoid retiering as a means of evading regulation. As importantly, retiering will likely entail significant costs, both in terms of new equipment and subscriber confusion and frustration. As a result, retiering will probably not be a worthwhile strategy for many cable systems. [73] See supra note 71.