Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 In the Matter of ) ) Competition, Rate Deregulation and ) MM Docket No. 89-600 the Commission's Policies Relating ) to the Provision of Cable Television ) Service ) 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 Inquiry ("Notice") in the above- captioned proceeding.[1] I. INTRODUCTION The Cable Communications Policy Act of 1984 ("Cable Act")[2] directs the Commission to report to Congress, no later than October 28, 1990, on the performance of the cable industry since passage of the Cable Act. The Notice starts a comprehensive examination of the industry as a first step toward preparing that report by requesting information on many issues concerning the cable industry and its competitive position in the video marketplace. A pervasive issue in the Notice is whether the cable industry has acquired sufficient market power in the video services marketplace to warrant changes in the Cable Act. Before considering changes in the Cable Act, it is important to recognize the extent to which the Act has produced benefits for television viewers -- its ultimate objective. A principal goal of the Cable Act is to "assure that cable communications provide and are encouraged to provide the widest possible diversity of information sources and services to the public."[3] Even cable industry critics acknowledge that the Cable Act has given the cable industry "a shot at competing with its powerful older broadcasting rival," and that "there would have been far less diversity of programming" had the Cable Act not been passed.[4] These benefits are readily apparent. At the end of 1983, roughly 60 percent of all U.S. television households had access to cable television service.[5] By 1989, that figure exceeded 80 percent, according to some estimates.[6] As the Notice points out, moreover, nearly 87 percent of all subscribers are served by cable systems with more than 30 channels, as opposed to only 57 percent in 1984.[7] This expansion in reach and channel capacity has been matched by a sharp increase in the programming available to cable subscribers. In July 1984, three months before passage of the Cable Act, there were 40 national cable networks and 24 regional networks.[8] In January 1990, there were 64 national networks and 30 regional networks.[9] Some contend, however, that these benefits have come at too great a cost -- in the form of substantially higher basic cable rates, as well as increased horizontal concentration and vertical integration, which allegedly raise both competitive and "diversity" concerns.[10] As a result, such parties call for the reregulation of cable television. In response to concerns about basic cable rate increases, the Commission recently instituted a separate rulemaking to examine rate regulation issues in detail, including when regulation is appropriate, how it should be exercised, and by whom.[11] Accordingly, NTIA intends to address cable rate regulation issues in that rulemaking. As the Commission well knows, however, regulation is a cumbersome, imperfect process that seldom produces market results, including rates and types of services, equivalent to those that would prevail under competitive conditions. As a result, regulation of basic cable rates (or any facet of the cable industry), while a possible stop-gap measure, would not be the best long-term response to perceived market abuses by cable firms. NTIA's preferred approach is to pursue policies that will foster a more competitive structure in local video markets. Accordingly, NTIA strongly supports the Notice's "structural" thrust -- its examination of ways to promote greater competition in the local markets served by cable systems. For the reasons discussed below, NTIA believes that achievement of this objective can be promoted by facilitating telephone company provision of distribution facilities to unaffiliated programmers on a common carrier basis and by encouraging greater use of commercial leased access channels under Section 612(b) of the Cable Act. The Commission also should carefully consider recommending that Congress amend the franchise provisions of the Cable Act to limit the conditions that localities may impose on cable franchisees. NTIA does not believe, however, that reimposition of some form of "must carry" rules would be desirable. Finally, the record in this proceeding should be examined carefully with regard to ownership concentration and vertical integration in the cable industry. II. WAYS TO INCREASE COMPETITION IN LOCAL VIDEO MARKETS One of the fundamental predicates for the deregulatory initiatives in the Cable Act was the view that cable systems faced competition from a host of existing and emerging rivals[12] -- traditional television broadcast stations, satellite master antenna systems ("SMATV"), subscription television stations ("STV"), direct broadcast satellite ("DBS") operators, multichannel multipoint distribution service ("MMDS") systems, and video cassette recorders ("VCRs").[13] Congress determined that these alternative distribution media would limit cable systems' ability to charge excessive rates. Moreover, the fact that many of cable's putative competitors were not subject to significant federal or state regulation prompted Congress to remove or moderate the regulatory burdens imposed on cable systems, principally by state and local authorities. The intervening years have shown these assumptions about the competitiveness of alternative media to be optimistic. To be sure, television broadcast stations provide credible competition to cable service in many markets. The proliferation of VCRs[14] and pre- recorded video cassettes appears to have given viewers an alternative to the pay services offered by cable systems. However, in many communities, other forms of television transmission do not appear to have furnished an effective substitute for the core of cable systems' businesses -- basic cable service.[15] While MMDS operations have emerged in scattered markets, limited, in part, by licensing delays and problems in integrating frequencies from three different radio services,[16] STV has not developed significantly, and SMATV serves limited groups of customers, such as hotels and apartment buildings. Large scale deployment of DBS remains on the horizon.[17] As a result, cable is, for the most part, the only multichannel television service available in most communities. Consequently, like the Commission, NTIA believes it necessary to explore ways to increase competition in local video markets. We discuss some possible approaches below. A. To Promote Competition, the Commission Should Adopt Policies That Facilitate Telephone Company Provision of Video Distribution Facilities on a Common Carrier Basis. In discussing ways to encourage competitive alternatives to existing cable systems, the Notice requests comment on the "video common carriage" or "video dial tone" concept that NTIA proposed in its 1988 Video Study.[18] Under this approach, a telephone company would be able to construct, operate, and maintain a transport facility within its local service area, the channel capacity of which would be leased to unaffiliated video programmers on a common carrier basis. Rates for channel capacity would be regulated to ensure that they were reasonable and nondiscriminatory. Potential customers might include traditional cable operators, broadcasters, networks, sports organizations, production studios and syndicators. However, under the Video Study proposal, telephone companies would not be allowed to select, own, or control the programming carried over their facilities.[19] NTIA is currently reexamining the benefits and costs of telephone company provision of video programming, in addition to video common carriage, in its recently-released Notice of Inquiry on the domestic telecommunications infrastructure.[20] Accordingly, we will not address the programming issue here, but urge the Commission to act to implement video common carriage effectively. 1. Implementation of Video Common Carriage Would Benefit Subscribers. In the Video Study, NTIA concluded that implementation of video common carriage would have several important public benefits, including nondiscriminatory treatment of all video program suppliers, realization of potential economies of scope in the provision of distribution facilities for voice, data, and video services (which would promote efficiency and produce lower cable rates), and "spill-over" benefits to other communications users from development of network equipment and software needed to provide video distribution facilities.[21] As the Commission points out, most communities are served by a single cable system.[22] On the one hand, this may be the result of government regulation -- i.e., the common practice of local governments of awarding a single cable franchise in each community. On the other hand, the prevalence of single-system communities may also reflect underlying economic realities of the cable industry. Some economists have concluded that the construction and operation of cable distribution facilities entail significant economies of scale, which means that costs decline with each increase in subscribers served.[23] If that is true, it may be most efficient for a single firm to provide such facilities. Indeed, the existence of significant economies of scale may mean that a particular community cannot support more than one facilities provider, although no definitive conclusions can be drawn based on currently available evidence.[24] It is important to recognize, however, that provision of programming, as opposed to facilities, does not appear to exhibit these economic characteristics. Consequently, it is likely that programming can be furnished on a highly competitive basis. Significant inefficiencies may result when, as is the case today, the owner of video distribution facilities can determine which programs will be carried over the facilities and what prices will be charged for the programs. In such cases, the owner will be able to charge subscriber rates above those that would prevail if the distribution facilities were readily available to competing program suppliers. Video common carriage would overcome this problem. Most importantly, by separating what may be the less competitive part of the cable business -- construction and operation of the underlying transmission facilities -- from the more competitive part -- provision of programming -- it would be possible both to exploit the economies of scale in providing facilities and to gain the benefits of competition in providing programming.[25] Moreover, if there are economies of scope in construction of distribution facilities for voice, data, and video services, telephone companies may be able to provide video distribution facilities at a lower cost than firms with facilities suitable only for delivery of video programming.[26] In virtually all instances, at least some of these cost savings will be passed through to subscribers, even if there is only one provider of programming.[27] However, an important benefit of video common carriage could be an increase in the number of firms seeking to provide programming to households. Telephone companies, as common carriers, would be required to provide service upon reasonable request to programmers that wished to use telephone company transmission facilities. Moreover, regulation would seek to ensure that rates for channel access would be sufficient to cover telephone companies' costs, yet would be low enough to stimulate demand for such access by multiple programmers. In these circumstances telephone companies would have the incentives top expand facilities to maximize use of their networks. This would facilitate competition among programmers, which would drive subscriber rates to levels reflecting the costs of producing and distributing programming to subscriber homes.[28] 2. Video Common Carriage Can Be Implemented Under the Current Statutory Scheme, Although Some Clarifying Changes Are Desirable. The Video Study identified current franchising requirements as the principal impediment both to increasing competition in local markets and to implementation of video common carriage.[29] As discussed below, it may be desirable to modify certain franchising provisions of the Cable Act in order more fully to encourage competitive entry into local video markets. However, NTIA believes that some relief can be obtained without having to modify the Act. In particular, we believe that the Commission may have overstated the case when it suggested that the Cable Act "requires firms to obtain local franchises before . . . providing video programming through a common carrier."[30] NTIA believes it reasonable to conclude that the Act neither compels common carriers to lease facilities only to franchised programmers, nor requires all providers of video programming to obtain franchises. Indeed, a reasonable argument can be made that neither the telephone company providing video common carriage nor the programmers that offer cable service over telephone company facilities requires a franchise. Given the importance of these issues to the potential implementation of video common carriage, NTIA recommends that the Commission address them directly in its report to Congress on cable matters. We recommend that the Commission, as the expert agency charged with administering the Cable Act, either make clear its interpretation of the Cable Act in this regard or request clarification from Congress. a. Neither the Cable Act nor the Commission's Rules Appear to Prohibit Telephone Companies from Leasing Distribution Facilities to Unfranchised Programmers. In the Video Study, NTIA concluded that the Cable Act and Commission practice preclude a telephone company from leasing distribution facilities to unfranchised video programmers. However, further reexamination of this issue suggests a different conclusion. Section 613(b) of the Cable Act only prohibits telephone companies from providing "video programming" in their local service areas.[31] It does not address whether telephone companies may lease capacity to others, or restrict the classes of potential customers that may use such capacity. The legislative history of Section 613(b) does not preclude telephone companies from providing distribution facilities to unaffiliated programmers that lack a local franchise. Although the legislative history specifies that telephone companies may lease facilities "to a franchising authority or to a cable operator who has received a franchise,"[32] there is no indication that this was intended to be an exhaustive listing of permissible customers.[33] Indeed, the preceding sentence states that "nothing in section 613(b) is intended" to prevent a cable company from constructing video distribution facilities within a community. One sure impediment to such construction would be a ban against telephone company provision of facilities to all programmers who lack a cable franchise.[34] Given this uncertainty about Congress' intent, the Commission can adopt the reasonable interpretation that the Act does not preclude telephone companies from leasing distribution facilities to all unfranchised video programmers. In the Video Study, NTIA suggested that the Commission, as well as the Cable Act, also limits telephone companies to leasing facilities to franchised programmers.[35] This conclusion was based upon our reading of two decisions in which the Commission declined to grant Section 214 authorization for telephone companies to construct video distribution facilities in their local service areas.[36] The Commission has since indicated that authorization was denied in those cases because the telephone companies had no customers at all for their proposed facilities, not that the potential customers lacked a cable franchise.[37] In light of this clarification, it is reasonable to conclude that the Commission does not bar a telephone company from leasing distribution facilities to unfranchised video programmers. We ask that the Commission clarify how its rules apply to this situation. b. The Cable Act Does Not Appear to Require All Providers of Cable Service To Obtain a Franchise. Although Section 621(b)(1) of the Cable Act provides generally that "a cable operator may not provide cable service without a franchise,"[38] a close reading of the Act suggests that providers of programming under a video common carriage arrangement are not necessarily "cable operators," and thus may not require franchises under the Act. Section 602(4) defines a "cable operator" as any person that (1) provides cable service[39] over a cable system in which it owns a "significant interest,"[40] or (2) controls or is responsible for the management and operation of a cable system.[41] Section 602(6) defines a cable system as "a facility, consisting of a set of closed transmission paths and associated signal generation, reception, and control equipment that is designed to provide cable service which includes video programming and which is provided to multiple subscribers within a community."[42] The term includes transmission facilities provided by common carriers, to the extent they are used to provide video programming, but excludes a facility used only to retransmit broadcast signals.[43] Thus, by its terms, Section 621 of the Act requires a franchise when a firm (1) provides cable service and (2) controls, manages, or has a significant ownership interest in a cable system (i.e., is a cable operator).[44] In contrast, when a telephone company constructs, owns, and maintains a distribution facility, and leases capacity to unaffiliated programmers, it seems clear that Section 621 would not impose a franchise obligation on the programmers because they are not "cable operators."[45] It is a close question, however, whether a telephone company that provides distribution facilities to unaffiliated programmers would be required to have a cable franchise in addition to whatever regulatory authorization it already holds to provide other telecommunications services. As the Commission has previously recognized, although such a company would clearly own a "cable system," it arguably does not provide cable service;[46] instead, it merely is supplying the underlying transmission facilities that enable its customers to provide cable service.[47] Thus, the Commission could reasonably interpret Section 621 as not requiring such a telephone company to obtain a cable franchise. Because NTIA recognizes that this construction of the Act is not free from question, we request the Commission to address this issue in its report and, if necessary, seek clarification from Congress. We note, however, that a contrary interpretation (i.e., requiring telephone companies to obtain a cable franchise when they merely provide distribution facilities to unaffiliated programmers) would add another layer of regulation to telephone company-provision of such facilities, and thus likely reduce the companies' incentives to provide them. B. As Noted in the Video Study, Current Local Franchise Practices May Raise Barriers to Competitive Entry. The Notice solicits comments on whether certain facets of the local franchising process bar or discourage the establishment of competition on the local level.[48] NTIA reiterates its conclusions from the Video Study in this regard and encourages the Commission to consider recommending to Congress that it modify the Cable Act to limit the restrictions that a locality may impose on potential franchisees as one means of promoting competition. In the Video Study, NTIA found that franchising authorities' common practice of issuing de facto exclusive franchises provides localities with the leverage to induce prospective applicants to agree to a variety of franchise concessions.[49] NTIA also discussed in depth how the franchise process, as currently structured, can impose substantial costs on franchisees, cable subscribers, and the public, without producing countervailing benefits. Among other things, the Video Study noted that the franchise process can be both lengthy and highly politicized, with significant delays between the original issuance of requests for proposals and the ultimate initiation of service.[50] NTIA also noted that localities have the ability to extract costly concessions from prospective franchisees (for example, requiring "state-of-the-art" cable systems with facilities, channel capacities, and equipment far in excess of what the community might actually desire, or donations of channel capacity and production equipment for "public access" programming).[51] The imposition of such requirements can raise the cost of operations for cable operators and, ultimately, the rates that subscribers pay.[52] As NTIA recognized in the Video Study,[53] localities have a legitimate interest in regulating the use by cable systems of public rights-of-way in a manner consistent with the public safety and welfare. Franchising authorities thus may properly require cable companies to comply with certain safety standards to minimize the risk of harm to the public during construction, and require compliance with specific construction schedules to reduce disruption to the public in the use of those rights-of-way. Similarly, franchisors should be able to ensure that cable operators pay the full costs of any disruption to the community, such as the expense of digging up and repairing streets and of stringing cables on telephone or electric poles. In addition, we recognize that localities may properly impose a reasonable fee as compensation for a cable operator's use of public property in its private business, and that they may have a legitimate interest in ensuring that all businesses within their jurisdiction comply with appropriate, minimally intrusive consumer protection requirements. Particularly in small communities in areas not served by other forms of television service, the franchising process may serve as a way of ensuring that consumers receive television programming through a cable operator of adequate quality and reliability. However, as the Video Study recognized, many of the requirements that franchising authorities impose go beyond protecting the foregoing interests.[54] The most significant barriers to competitive entry are requirements that there be only one cable operator per franchise area,[55] that each franchisee provide universal service, and that franchisees construct and operate "state-of-the-art" cable systems. Aside from the disputed constitutionality of such requirements,[56] NTIA questions whether the fact that the provision of cable involves a use of public rights-of-way warrants municipal regulation unrelated to that use. The Notice also states that Section 621(a)(1) of the Cable Act allows franchising authorities to grant more than one franchise to serve the same community,[57] but in practice, most franchising authorities grant a franchise to serve a particular area to only one firm (even though that franchise typically is not expressly exclusive).[58] The Notice asks a series of questions to determine whether amending the Cable Act to require the award of two or more local cable franchises would be an effective way to encourage greater competition on the local level.[59] While the Commission's suggestion might be a salutary reform of the franchising process where necessary, it may not be the case that simply requiring the award of multiple franchises would itself have a significant impact on promoting competition. There may be factors altogether separate from municipal franchising practices that impede head-to-head competition on the local level.[60] Even in those communities where there are multiple franchised cable companies, there are very few cases in which those franchisees engage in head-to-head competition. The more common practice has been for franchisees essentially to divide the franchise territory into separate markets. Furthermore, when the courts have ordered a municipality to permit an overbuild, the would-be challenger often has failed to build its proposed system.[61] Franchisees and franchise applicants thus may share responsibility for the lack of competition in local cable markets. In any event, it may be the case that alternative delivery media -- whether through telephone company provision of video common carriage, MMDS, or DBS -- may well be more promising avenues for competition in video services in the long run. NTIA believes that the preferable approach is to create a regulatory structure that does not prejudge the issue of what technologies may prove to be the most efficient means of delivering video programming in the future. C. The Cable Act Should Be Modified to Make Leased Access A More Viable Avenue for Potential Competitors. Another method of encouraging competition on the local level that the Notice mentions is leased access.[62] While Section 612 of the Cable Act currently requires larger cable operators to set aside up to 15 percent of their channels for lease to unaffiliated entities,[63] relatively few firms have taken advantage of this provision. Section 612(c)(1) gives cable operators relatively broad discretion in setting the terms under which commercial leased access will occur.[64] In practice, it may be that cable operators have been able to restrict the demand for leased access by setting high rates or other commercially infeasible terms. NTIA supports measures that would strengthen the viability of leased access. If a cable operator were to make leased access channels more readily available to alternative sources of programming, those firms might well be able to offer their programming directly to subscribers at a lower price than if marketed through the franchised cable operator. This, in turn, should exert competitive pressure on the operator to lower its rates or provide improved service. Moreover, greater use of leased access channels should result in greater diversity of programming. Commission adoption of policies to encourage telephone companies to provide video distribution facilities on a common carrier basis could well change the incentives of cable operators to provide leased access channels. Telephone companies could then compete with traditional cable operators to sell distribution facilities to programmers. If, as we have discussed above,[65] telephone companies are eventually able to provide such facilities at a relatively low cost due to economies of scope associated with the construction of an integrated voice, data, and video network, traditional cable firms may make leased access channels available to outside programmers on more competitive terms in order to compete more effectively with telephone company-provided facilities. D. "Must Carry" Rules Should Not Be Reimposed. The Notice also raises as a way to increase competition the reimposition of "must carry" rules, which would be designed to limit or eliminate the ability of cable companies to deny their subscribers access to local broadcast stations. The Notice asks whether some form of "must carry" relief would diminish the ability of cable operators to exercise market power in setting basic subscriber rates or providing access to local broadcast stations. It also solicits comment on the interplay between "must carry" rules and the cable compulsory license.[66] 1. "Must Carry" Rules Are Not Necessary to Limit Cable Operator Market Power. As we have stated in the past,[67] NTIA believes that "must carry" rules are contrary to the public interest. NTIA believes that, in the absence of market imperfections, markets should generally be free of government intervention because the interplay of supply and demand will lead to an optimal allocation of society's resources in such circumstances. Moreover, if there are market imperfections in the local video market in which cable operators offer service to subscribers, there is no reasonable assurance that "must carry" rules would be the appropriate solution. One form of market imperfection that some have offered as a justification for the reimposition of "must carry" rules is excessive market power of cable operators in the setting of basic service rates. Because the off-air availability of television broadcast signals limits to some degree a cable operator's ability to set excessive rates for subscribers, some argue that the cable operator has incentives to refuse to carry broadcast stations, thus potentially reducing their viewership and advertising revenues. This reduction in revenues would, in turn, affect the quality of programming on local broadcast stations, ultimately reducing the amount of competitive pressure that broadcasters could exert on cable operators. However, a cable operator's incentive to engage in this form of anticompetitive behavior appears to be quite limited. Local broadcast signals are an important element of the viewing fare that cable operators offer their subscribers.[68] Indeed, households often subscribe to cable in part to obtain superior signal quality from local broadcasters or, in some areas of the country, access in the first instance to a variety of local broadcast signals. As a result, a cable operator's carriage of local broadcast signals significantly raises a household's willingness to subscribe to cable service. This increase in demand, combined with the effects of the compulsory license,[69] translates into an increase in the cable operator's profits.[70] Therefore, cable operators appear to have a strong incentive to carry, in general, local broadcast signals,[71] and "must carry" rules are unnecessary to constrain cable operator market power.[72] Some might argue that a cable operator still has an incentive to deny access to local broadcast stations because such carriage dilutes the local advertising revenues that the cable operator otherwise might earn. Given that subscriber fees are a much larger source of revenues to cable operators than advertising revenues,[73] however, cable operators are more likely to carry those local broadcast signals that are highly valued by cable households.[74] Aside from the policy concerns raised above, NTIA is sympathetic to the Commission's concerns about promoting adequate diversity of viewpoint,[75] which were a major factor in originally adopting "must carry" rules. However, NTIA notes that it may be difficult to craft "must carry" rules to address such a goal that could withstand constitutional scrutiny. Twice the Commission has adopted "must carry" rules, and twice the Court of Appeals for the District of Columbia Circuit has struck those rules down on First Amendment grounds.[76] The Commission therefore should carefully evaluate whether any such rules it might adopt would likely survive court challenge. 2. For Many Cable Systems, the Cable Compulsory License Cannot Be Justified as a Matter of Public Policy. As we have stated in the past,[77] NTIA strongly believes that the cable compulsory license is a needless regulatory intrusion in the economic relationship between cable operators and those who hold the copyrights to programs transmitted by broadcast stations. The considerations that convinced Congress to adopt the cable compulsory license are no longer valid. For example, in view of the increased concentration of ownership in the cable industry,[78] it should not be too burdensome for many MSOs to negotiate directly with copyright holders for the right to retransmit the programming that the MSOs carry.[79] Moreover, there is little reason to fear that producers of programming transmitted by broadcast stations will refrain from providing cable operators with needed programming because programmers are becoming increasingly dependent on cable operators for additional revenues. The cable compulsory license also creates substantial distortions in the market for video programming. For a number of reasons, the payments to copyright holders set by the compulsory license are not likely to equal the payments that would be made in an unregulated market. First, under a regime of full copyright liability, the actual price at which a program supplier would license its programming to a cable operator would reflect not only the net effect of cable retransmission on the value of a program to broadcasters,[80] but also numerous other factors that affect the relative bargaining power of the parties, such as the uniqueness of the product and whether the cable operator possesses significant monopsony power in the market for video programming. Second, the Copyright Royalty Tribunal's ("CRT") distinction in rates for different types of distant signals[81] would not necessarily occur in an unregulated marketplace. Third, the copyright rate that the owners of broadcast rights would demand in a regime of full copyright liability would depend upon the number and nature of the television stations operating in the importing cable system's franchise, which the current system does not take into account. For these reasons, rates that would be established in a free market for cable programming would likely be different from the rates set by the compulsory license. As a result, the compulsory license creates distorted incentives for program suppliers. On the one hand, resources will be misallocated if the rates are too low because such suppliers will produce less programming than is economically justified. On the other hand, if the rates are too high, resources will be misallocated because suppliers will produce more programming than is economically justified. Accordingly, we recommend that the Commission urge Congress to repeal the compulsory license while refraining from adopting "must carry" rules. III. CONCENTRATION OF CABLE OWNERSHIP As noted in the Video Study, the last decade has witnessed steadily increasing concentration of ownership within the cable industry.[82] This trend has raised the potential that concentration may give the larger MSOs excessive market power in certain markets. If so, the result could be both higher prices and reduced diversity of programming choices for subscribers. These concerns have prompted some to propose ownership limits for cable television systems.[83] It is important to recognize, however, that concentration may produce economic and social benefits for cable subscribers.[84] For example, increases in ownership concentration within the cable industry appear to stem largely from the efforts of MSOs to add systems and subscribers in order to capture economies of scale, which may enable MSOs to realize significant cost reductions. Similarly, to the extent that ownership concentration permits firms to manage better the risks of acting in ways that maximize their long term returns, such concentration may permit a real savings. As demonstrated above, in virtually all cases, at least a portion of those savings will be passed on to subscribers, even if the MSOs face no competition in their local communities.[85] The critical issue is whether the increased efficiencies from concentration are outweighed by unacceptable use of "market power" by MSOs in ways that harm cable subscribers. NTIA cannot offer a definitive answer to this question at this time. There is a dearth of solid evidence on the adverse effects of cable concentration. Common complaints about concentration seem based largely upon anecdotes. While these allegations give cause for concern, they are not enough to enable NTIA to determine with confidence whether a particular level of concentration within the cable industry will adversely affect consumers. We note, however, that the Notice requests extensive information on the level of ownership concentration within the cable industry and its potential effects on competition. We recommend that the Commission examine the record carefully to determine whether it supports further conclusions on the issue of cable concentration and competitive concerns. In the following sections we attempt to describe an analytical framework that will be useful to the Commission in addressing these issues. A. Cable Concentration Would Have Adverse Effects, If at All, Only in the Market for Cable Network Programming. To assess the competitive implications of cable concentration, one must first define the product and geographic markets that could be affected. Generally speaking, cable systems participate in three principal markets: as buyers of programming, as sellers of programming to subscribers, and as sellers of advertising time. Although the latter two markets, especially the subscriber market, are very important, NTIA does not believe that concentration, standing by itself, can give MSOs significant market power vis-a- vis either subscribers[86] or advertisers.[87] We will therefore focus on the potential effects of ownership concentration in programming markets. As the Commission suggests, there are at least two types of programming "products" -- individual programs and "cable network programming channels" ("cable networks").[88] As a practical matter, however, cable systems do not generally acquire individual programs.[89] Rather, programs are generally purchased by "middlemen" and packaged as cable networks for resale to cable systems. Thus, as with national advertising,[90] cable systems, regardless of size, typically do not appear to have an impact on the market for single programs.[91] Cable network programming encompasses the various 24-hour-a- day, satellite delivered program packages that have been assembled from individual programs. Because many of these channels are rather specialized (e.g., all-news, all-sports, all-music, all- movies), NTIA believes that they rarely could attract the audience necessary to make them attractive fare for advertising-driven broadcast networks and stations. Accordingly, such networks rely instead on carriage by "pay" media, such as cable television. Although the Commission states that the relevant geographic market for these cable networks is nationwide,[92] we note that there are now at least 30 regional cable networks.[93] An MSO could be sufficiently concentrated to cause great harm to these regional channels, without having a large enough market share to disrupt the nationwide market for cable program channels.[94] Thus, NTIA believes it appropriate for the Commission to consider the effects of cable concentration on both national and regional markets for cable program channels. B. Cable Ownership Concentration Does Not Appear To Have Given MSOs Market Power Vis-a-Vis Cable Networks. Having identified the relevant market, we now consider whether concentration of cable ownership can be said to harm participants in that market, to the detriment of cable subscribers. The principal concern in this regard is whether concentration gives MSOs monopsony power as buyers of programming.[95] We therefore review the possible adverse affects of cable market power on cable networks, and then consider whether these potential effects have actually occurred. Cable networks generate revenues through a combination of advertising and subscription fees.[96] However, both revenue streams are determined by the number of subscribers each network attracts.[97] Because a cable network's revenues are so closely tied to the number of its subscribers, the network must garner a "critical mass" of subscribers in order to generate sufficient revenues to cover operating expenses.[98] In a concentrated market, a cable network could have difficulty reaching and maintaining that critical mass if it is not carried by the largest MSOs. In that case, the MSOs would have substantial market power vis-a-vis the network programmer. In extreme cases, they could determine whether the service would succeed, thus directly affecting the diversity of programming available to cable subscribers, whether served by the MSOs or not. MSOs also could agree to carry the cable network only if they received substantial discounts in license fees or an equity interest in the network itself.[99] By so doing, the MSOs could appropriate some or all of the profits the network programmer would expect to receive in return for creating a desirable new program service. Even if this forced transfer of profits did not endanger the network's viability, it could limit the network's ability to acquire or develop new programming, thus making it less able to compete with other networks. Moreover, the MSOs' ability to extract profits from cable networks could deter other entrepreneurs from attempting new program ventures, again lessening the supply and quality of programming available to subscribers. Finally, large MSOs in a concentrated industry might also use their market leverage to dissuade cable programming networks from dealing with alternative distribution media, such as MMDS and home satellite dishes. In this way, the MSOs could attempt to insulate their systems from competition in providing service to subscribers. Although these potential adverse effects of excessive cable concentration are of concern, there is no conclusive evidence that they have occurred in practice. NTIA recognizes that large MSOs typically receive substantial rate discounts from cable program networks.[100] However, the available evidence is too sketchy to indicate whether these discounts reflect good faith negotiations between parties of roughly equivalent bargaining strength or the exercise of market power by concentrated MSOs. In order to make such a determination, the Commission would need detailed and systematic data on the size of those rate discounts, which cable firms receive them, and why they are given. NTIA hopes that the comments in this proceeding will begin to bring this data to light. If not, we recommend that the FCC consider ways to obtain it. Whatever the cause and extent of such discounts, there is little evidence that they have harmed existing cable networks, or deterred new entrants. For example, many cable networks appear to be profitable, some of them handsomely so.[101] Moreover, the increase in cable concentration over the past five years has been accompanied by the appearance of numerous new regional and national cable networks.[102] This growth is difficult to square with the notion that cable ownership concentration has reduced the variety of cable programming networks available to subscribers. Similarly, increased concentration within the cable industry apparently has not impaired cable networks' incentives or abilities to invest in new programming. The major pay cable networks, HBO and Showtime, have waged a vigorous battle for rights to the latest motion pictures.[103] Recently, ESPN paid some $400 million for the rights to telecast major league baseball,[104] and $450 million to telecast National Football League games.[105] Additionally, two other basic cable channels, USA Network and Lifetime, invested heavily to improve their programming. Again, these actions are not consistent with the notion that increased cable concentration has given MSOs excessive leverage over cable network programmers. Although NTIA is aware of anecdotal evidence that MSOs have been able to pressure cable networks not to deal with alternative distribution media,[106] many of these claims have not been substantiated. We have also heard complaints that alternative distribution media must pay substantially higher rates than MSOs in order to acquire cable network programming.[107] The Commission has announced its intent to begin a inquiry into this issue, at least with respect to delivery of broadcast signals.[108] NTIA encourages the Commission to expand that investigation to include cable networks. Until more detailed evidence is available, however, it is premature to suggest that such rate disparities are attributable to pressure from concentrated MSOs on program suppliers. C. The Cable Industry Is Not Excessively Concentrated Under Prevailing Antitrust Standards. DOJ evaluates concentration within an industry by first calculating a Herfindahl-Hirschman Index ("H-index") and then applying rules of thumb for determining when the H-index indicates that concentration begins to raise competitive concerns.[109] We have undertaken an evaluation of cable concentration under these guidelines.[110] Briefly, the H-index is derived by squaring the percentile market share of each firm in an industry, then adding the squares together.[111] As a rule of thumb, DOJ considers an industry with an H-index below 1000 to be relatively unconcentrated. Accordingly, it will not challenge mergers that result in an H-index below that level, except in extraordinary circumstances.[112] On the other hand, DOJ is likely to challenge a merger if it both produces an H-index above 1000 and increases the pre-merger index more than 100 points, unless DOJ determines, after considering several mitigating factors, that the merger will not substantially lessen competition.[113] Table 1 lists recent market shares[114] for the ten largest cable MSOs, as well as the H-index for the industry.[115] TABLE 1 Subscribers Market MSO (millions) Share (%) 1. TCI 12.439 24.0 2. ATC/Warner 6.848 13.2 3. Continental 2.525 4.9 4. Comcast 2.300 4.4 5. Cox 1.528 3.0 6. Cablevision Systems 1.388 2.7 7. Jones Intercable 1.291 2.7 8. Newhouse 1.200 2.3 9. Times Mirror 1.071 2.1 10. Cablevision Industries .998 1.9 H-Index = 852.4 Total Cable Subscribers = 51,794,510 Table 1 indicates that, at this point, the cable industry remains relatively unconcentrated. However, it can readily be shown that if the largest firm should attempt to increase its market share by slightly over 3 percent, the resulting merger would produce an H-index of over 1000, and would also increase the index by well over 100 points. As a result, the merger could well be subject to challenge by DOJ. In short, although the cable industry may be deemed unconcentrated today, it is nonetheless close to the point at which any significant increase in concentration will likely attract antitrust scrutiny. Any future mergers involving the larger MSOs should be carefully scrutinized for another reason. As noted above, DOJ generally will not challenge a merger that triggers the critical threshold (i.e., post-merger H-index above 1000, an increase in the index of more than 100 points) if it determines, after considering several factors, that the merger will not substantially lessen competition. One of the factors to be considered is ease of entry. As DOJ points out, if barriers to entry in the industry are low, "existing competitors could not succeed in raising price for any significant period of time."[116] As the Commission is aware, there are substantial barriers to competitive entry in areas currently served by cable systems. Economic factors may preclude entry into a given area by a second cable system. Restrictive franchising practices commonly impede competing programmers, even if facilities are available to deliver that programming to subscribers. Introduction or expansion of MMDS systems is limited in several respects.[117] Although these barriers may recede in time, for now it would not be prudent to assume that additional market power created by increased cable concentration will be dissipated quickly by new entry. Accordingly, NTIA recommends that ease of entry should be used sparingly as a reason for approving a cable merger that otherwise exceeds the critical H-index thresholds. Thus, at least under prevailing antitrust guidelines, the cable industry is not excessively concentrated, although substantial further merger activity could be of concern. Moreover, although excessive concentration can cause market dislocations, there is only limited evidence that such dislocations have actually occurred. NTIA urges the Commission to evaluate carefully the record compiled in this proceeding for additional evidence, because we believe that governmental action in this area, if necessary, should not be delayed. Until such evidence is found, however, current levels of cable concentration do not appear to warrant regulatory or legislative intervention. IV. VERTICAL INTEGRATION The increase in concentration within the cable industry has been paralleled by an expansion in vertical integration -- instances in which a firm that owns cable systems also holds an equity interest in a cable programing network.[118] Although vertical integration has been common within the cable industry,[119] the pace of integration has accelerated in the past several years, particularly with respect to basic cable channels. As a result, cable systems have now secured equity interests in 4 of the 6 national pay cable networks, and 24 of the 58 national basic cable networks, including 14 of the top-20.[120] Various parties have expressed concern that the increase of vertical integration within the cable industry may have given cable systems the ability to impair competition in certain markets. The Notice therefore asks a series of detailed questions about the benefits and potential adverse consequences of cable vertical integration. For the reasons set forth below, NTIA tentatively reaffirms its finding in the Video Study that vertical integration does not appear to cause significant competitive problems within the cable industry itself. However, we are concerned about allegations that vertical integration has enabled cable systems to deny programming to competing distribution media. We hope that the comments in this proceeding will furnish enough facts and statistics to permit a thorough examination of this issue. A. Vertical Integration Can Produce Significant Benefits for Cable Subscribers. As the Notice points out, common ownership of cable systems and cable programming can produce significant benefits for cable subscribers.[121] Vertical integration can ease the introduction of new cable programming services or help sustain existing services, thus expanding the diversity of viewing choices for subscribers.[122] As noted in the Video Study, "the cable industry's $550 million investment in Turner Broadcasting provided a much-needed infusion of capital to the latter firm, solidifying, among other things, the financial health of WTBS and CNN, two of the three largest cable networks."[123] C-SPAN, which provides extensive coverage of congressional proceedings, probably would not exist without support from the cable industry. Finally, MSO investments in the Discovery Channel are thought to have improved dramatically that service's chances of survival.[124] Vertical integration can also promote the introduction of new program services by giving producers "better information about viewer tastes, their reactions to programs and their desire for new programs."[125] Producers that are vertically integrated with MSOs can easily gain information from the MSOs on "what cable viewers want and what niches are being missed in current programming schedules, thereby facilitating the development of programming better tailored to their viewers."[126] Finally, vertical integration can enable a cable firm to avoid "transaction costs"[127] normally incurred in acquiring programming. Such costs include not only time, human resources, and money expended in negotiating and enforcing program contracts, but also costs caused by the uncertainties of completing agreements in an adversarial setting. Vertical integration can eliminate or substantially reduce these transaction costs by bringing programming "contract negotiations" or decisions within the confines of a single firm.[128] In the end, the cable firm's subscribers should share at least a portion of these cost savings in the form of lower rates.[129] B. It Is Not Clear That Vertical Integration Has Reduced Diversity or Limited Competition. As a theoretical matter, vertical integration could cause market dislocations in two major respects.[130] First, it could induce a cable operator not to carry unaffiliated program services. That decision would probably not jeopardize the viability of the excluded service and, thus, reduce the supply of programming unless the cable operator's market share (in terms of subscribers served) is relatively large.[131] Nonetheless, discrimination against unaffiliated programming services is important from the consumer's point of view, because it may deny subscribers the opportunity to view services that they would prefer to receive, thereby artificially and inefficiently limiting diversity of viewing choices for those subscribers. Second, vertical integration could enable a cable system to deny affiliated programming to alternative distribution media (e.g., MMDS or home satellite dishes) in an effort to deter entry, thereby preserving the operator's dominant position in its franchise area.[132] Not having ready access to their most abundant source of programming -- existing cable networks -- these competitors might be forced to enter simultaneously both the programming and distribution markets, substantially increasing their costs and risks.[133] If these elevated costs do not preclude entry entirely, they may nonetheless delay it. In the meantime, the cable operator involved would be insulated from market forces that could limit its ability to charge excessive rates to subscribers. 1. The Commission Should Examine the Record Carefully For Evidence of Whether Vertical Integration Has Led to Discrimination Against Unaffiliated Programming Services. NTIA is aware of only limited examples that suggest discriminatory conduct by vertically integrated MSOs against unaffiliated cable networks. For example, MSOs with equity interests in CNN allegedly required NBC to reformulate its proposed cable news network so that it would not compete directly with CNN.[134] We encourage the Commission to explore this and similar instances of possible discriminatory conduct to determine if vertical integration presents significant competitive problems. NTIA's Video Study examined cable systems' carriage of basic cable networks in some detail, and found no compelling evidence of discrimination.[135] To be sure, common ownership significantly improved a network's chances of being carried by a particular cable system. However, increased carriage of affiliated basic networks did not appear to lead to the exclusion of unaffiliated networks.[136] The evidence was more ambiguous with respect to pay services. Common ownership significantly increased the probability that a pay service would be carried by a particular cable system.[137] In most cases, increased carriage of affiliated services was not to the detriment of unaffiliated services. In at least one case, however, we expressed concern about potential discriminatory conduct,[138] but concluded that the problems were not so pervasive as to warrant regulatory action. NTIA urges the Commission to examine carefully the record in this proceeding on this matter. At present, however, the benefits to consumers of vertical integration in this regard seem most significant. Although there is some cause for concern with respect to pay services, the available evidence is not sufficient to support regulation at this time. 2. The Commission Should Examine The Record Carefully for Evidence that Vertical Integration Has Led To Denial of Cable Network Programming to Alternative Distribution Media. The record that the Commission compiles in this proceeding will be important in determining whether vertical integration has resulted in the denial of cable network programming to alternative distribution media. The Video Study found that vertical integration did not appear to have led to such denial to MMDS, although we acknowledged that the answer was not clear-cut. That study found that, although many vertically-integrated cable networks were not available to MMDS, a number of them were. Moreover, several non-vertically integrated cable networks were also not available to MMDS. The lack of a pattern led NTIA to question whether the source of the MMDS industry's problems in acquiring cable programming was due to vertical integration.[139] NTIA is aware, however, of instances in which exclusive dealing arrangements between cable systems and cable program networks have been used selectively. The Video Study noted that the Black Entertainment Network ("BET") was generally available to MMDS operators, except (at the time) in Washington, D.C., where the principal owner of BET held the cable system franchise.[140] We also understand that Viacom's pay service, Showtime, is available to some MMDS systems, but its availability is severely restricted in Cleveland, where Viacom owns or manages two cable systems.[141] We believe that the Commission should examine carefully the factual circumstances of these examples, which concern us. In addition, the Commission has recently noted substantial disparities in the rates that satellite carriers charge cable systems and distributors of programming to home satellite dishes for the right to retransmit broadcast signals.[142] We are also aware of complaints by alternative distribution media that they pay several times more than cable systems for cable network programming.[143] The difficult problem in addressing this problem is a lack of data. Anecdotal evidence is, of course, available, but that alone does not permit systematic analysis of the issue. For example, it would be important to know what the rate disparities are, how the rates that alternative media compare with those paid by cable systems of similar size, and to what extent the price differentials reflect differences in cost in serving the respective buyers. If commenting parties do not provide sufficient information on these matters, NTIA urges the Commission to do what is necessary to obtain it. Although we continue to believe that vertical integration within the cable industry does not raise substantial competitive problems, we are prepared to reassess that conclusion should the weight of the evidence in the record suggest otherwise. V. 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 March 1, 1990 Project managers for this filing were Carol Mattey and Tim Sloan, NTIA, Office of Policy Analysis and Development, Suite 4725, U.S. Department of Commerce, Washington, D.C., 20230, (202) 377-1880. ATTACHMENT 1 Top-20 Cable MSOs -- 1990 Company[144] Subscribers Market share (%) 1. TCI 6,792,535 24.0 United/UA 2,530,000 (9/89) Heritage 1,131,343 (11/89) Storer 765,000 Cooke Cablevision 730,800 (5/89) TKR Cable 289,300 Bresnan Communications 129,780 K.C. Cable Partners 70,000 (1/89) TOTAL 12,438,758 2. ATC 4,300,000 (12/89) 13.2 Warner Cable 1,713,000 Paragon 764,734 K.C. Cable Partners 70,000 (1/89) TOTAL 6.847,734 3. Continental 2,525,000 4.9 4. Comcast 1,535,000 4.4 Storer 765,000 TOTAL 2,300,000 5. Cox 1,5283907 3.0 6. Cablevision Systems 1,387,771 2.7 7. Jones Intercable 1,291,162 2.7 8. Newhouse 1,200,000 (11/89) 2.3 9. Times-Mirror 1,071,282 2.1 10. Cablevision Indust. 988,544 1.9 11. Viacom 994,889 (11/89) 1.9 12. Sammons 873,590 1.7 13. Century Communications 825,000 (10/89) 1.6 14. Adelphia Comm. 766,000 1.5 15. Falcon Cable TV 700,000 (10/89) 1.4 16. Telecable 584,552 1.1 17. KBLCOM 560,000 1.1 18. Scripps-Howard 540,000 1.0 19. Multivision Cable TV 499,491 1.0 20. Tele-Media 475,163 0.9 TOTAL 74.4 Source: Cablevision, Jan. 29, 1990, at 81 (subscriber figures are for January 1990, except as noted). Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 In the Matter of ) ) Competition, Rate Deregulation and ) MM Docket No. 89-600 the Commission's Policies Relating ) to the Provision of Cable Television ) Service ) 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 March 1, 1990 SUMMARY NTIA supports the Commission in exploring ways to foster a more competitive structure in the local markets served by cable systems. We believe that this "structural" approach is preferable, as a long-term response to current problems in the cable industry, to reregulation of cable television. The regulation of rates and services is a cumbersome process that seldom produces the efficiencies and innovation possible through competitive markets. NTIA urges the Commission to facilitate telephone company provision of distribution facilities to unaffiliated programmers on a common carrier basis. NTIA believes that video common carriage would benefit subscribers by enabling telephone companies to exploit potential economies of scale in the provision of distribution facilities for voice, data, and video services, while at the same time stimulating greater competition in the provision of programming. We believe that a reasonable argument can be made that video common carriage can be implemented under the current statutory scheme, because the Cable Act neither compels common carriers to lease facilities only to franchised programmers nor requires all providers of video programming to obtain franchises. Moreover, a reasonable argument can be made that common carriers that lease distribution facilities to programmers may not be required to obtain franchises in certain circumstances. We urge the Commission to address these issues in its upcoming report to Congress and, if necessary, seek legislative clarification in this area. NTIA also believes that Commission should consider recommending that Congress amend the franchise provisions of the Cable Act to limit the conditions that localities may impose on cable franchisees as an additional means of promoting competition on the local level. We do not believe, however, that requiring the award of multiple franchises in a community would necessarily be an effective solution because there may be factors separate from municipal franchising practices that impede head-to-head competition on the local level. NTIA supports measures that would encourage greater use of commercial leased access channels under Section 612(b) of the Cable Act. We note that Commission adoption of policies to facilitate telephone company provision of video common carriage could well encourage traditional cable operators to provide leased access channels to unaffiliated programmers on more competitive terms. NTIA opposes the reimposition of "must carry" rules. We believe that cable operators generally appear to have strong incentives to carry local broadcast signals and that "must carry" rules accordingly are unnecessary. NTIA also opposes continuation of the cable compulsory license for most cable systems. Available evidence indicates that current levels of ownership concentration in the cable industry do not warrant regulatory or legislative intervention at this time. It does not appear that such concentration has adversely affected the national or regional markets for cable programming. Nor does the cable industry appear, at present, to be excessively concentrated under prevailing antitrust standards, although substantial further merger activity could be of concern. Nonetheless, given the importance of this issue, NTIA recommends that the Commission carefully examine the record in this regard. Finally, while vertical integration does not appear to cause significant competitive problems, NTIA urges the Commission to examine the record compiled in this proceeding for evidence that vertical integration has led to discrimination against unaffiliated programming services or alternative distribution media. ---------------------------------------------------------------------------- ENDNOTES [1] MM Docket No. 89-600, FCC 89-345 (released Dec. 29, 1989). [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.  521(4) (Supp. III 1985). [4] See, e.g., Stein, The nexus between deregulation and improved cable programming, CableVision, Jan. 1, 1990, at 46. [5] See National Cable Television Ass'n, Cable Television Developments, at 2-3 (Dec. 1989). [6] See Notice at para. 41 (cable passes 81.7 percent of all U.S. television households); Paul Kagan Assoc., Inc., Marketing New Media, Nov. 20, 1989, at 6 (cable is estimated to pass 89 percent of all U.S. television households). [7] Notice at para. 3. [8] CableVision, July 16, 1984, at 62. [9] Id., Jan. 15, 1990, at 74. [10] See Hearings on the Cable Television Industry Before the Subcomm. on Communications of the Senate Comm. on Commerce, Science, and Transportation, 101st Cong., 1st Sess. (1989) (statement of Robert A. Alm, Hawaii State Dept. of Commerce and Consumer Affairs, at 2-4); id. (statement of Dorothy E. Harrington, Bayonne, N.J. City Council, at 3-4); id. (statement of Gene Kimmelman, Consumer Federation of America, at 7-11). [11] Reexamination of the Effective Competition Standard for the Regulation of Cable Television Basic Service Rates, MM Docket No. 90-4, FCC 90-12 (released Jan. 22, 1990). [12] See, e.g., H.R. Rep. No. 934, 98th Cong., 2d Sess. 22 (1984), reprinted in 1984 U.S. Code Cong. & Admin. News 4655, 4659 [hereinafter cited as "House Report"]. [13] SMATV is essentially a cable system that serves a single building or building complex. "Receive" antennas are installed on the roof of a multi-occupant building, and the signals are then distributed by wire throughout the building or complex. DBS systems transmit multiple channels of programming by satellite directly to antennas located at homes and multi- occupant buildings. MMDS, or "wireless cable," is a microwave-based system that transmits multiple channels of programming over-the-air to homes and multi-occupant buildings. MMDS systems can offer as many as 34 video channels. [14] Currently, 68 percent of all U.S. households own VCRs. Farhi, Viewers Put Video Rentals on Pause, Wash. Post, Feb. 14, 1990, at D1. As noted above, roughly 56 percent of American homes subscribe to cable television. [15] In 1990, basic services are projected to generate about 57 percent of the cable industry's $15.65 billion in annual revenues. Pay service revenues are predicted to comprise about 30.5 percent of those revenues. The remaining 13 percent of revenues are predicted to be generated from advertising, installation charges, pay-per-view, and miscellaneous services. See Paul Kagan Assoc., Inc., Cable TV Investor, Nov. 30, 1989, at 5. By way of contrast, in 1984, the figures for basic and pay service revenues were 46 percent and 43 percent, respectively. See Paul Kagan Assoc., Inc., The Kagan Cable TV Financial DataBook 70 (June 1987). [16] See Notice at para. 30. The Commission has instituted a rulemaking "to pinpoint and attempt to resolve the precise problems encountered by [MMDS] under the current regulatory regime." Id. 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). NTIA strongly encourages the Commission to reexamine and, if warranted, modify or eliminate regulations that may impede the growth of alternative media, such as MMDS. [17] Four firms recently announced a $1 billion plan to launch a 108 channel DBS system in the U.S. beginning in 1993. See Burgess, Satellite Partnership Plans Pay-TV System, Wash. Post, Feb. 22, 1990, at E1. It will take some time, however, for U.S. DBS deployment to approach that taking place in Europe and the Far East. See id. at E5. A form of DBS arose unexpectedly in the early 1980s when households with home satellite earth stations began intercepting the unscrambled satellite transmissions of most cable program networks. Growth of this "service" slowed considerably after cable programmers began scrambling their satellite feeds. Unauthorized reception of unscrambled satellite signals was not the service the Commission intended when it authorized DBS in 1982. [18] Video Program Distribution and Cable Television: Current Policy Issues and Recommendations, NTIA Report 88-233, at 32- 60 (June 1988). The Commission instituted a comprehensive inquiry into the general issue of telephone company provision of cable services in 1988, although the matter is still pending. See Telephone Company-Cable Television Cross- Ownership Rules, 3 FCC Rcd 5849 (1988). [19] This is essentially the situation under existing rules, which generally prohibit telephone companies from providing video programming in their local service areas. See 47 U.S.C.  533(b)(1) (Supp. III 1985); 47 C.F.R.  63.54(a) (1988). However, the prohibition does not apply where a telephone company seeks to furnish video programming in "rural" areas, which have been defined by the Commission to include places, outside urbanized areas, with fewer than 2,500 residents. See id.  63.58. NTIA has recently suggested that this definition be expanded in order to permit telephone companies to provide cable service to additional rural areas. Cable Television in Rural Areas: Hearings Before the Subcomm. on Government Information, Justice, and Agriculture of the House Comm. on Government Operations, 101st Cong., 2d Sess. (1990) (statement of William F. Maher, NTIA, at 4). [20] Comprehensive Study of the Domestic Telecommunications Infrastructure, 55 Fed. Reg. 800 (1990) [hereinafter cited as "Infrastructure Study"]. [21] See Video Study at 37-38. [22] See Notice at para. 22. [23] See, e.g., G. Webb, The Economics of Cable Television 41-63, 101 (1970); Besen and Johnson, An Economic Analysis of Mandatory Leased Access for Cable Television, R-2989-MF, at 21-22 (Rand Corp. 1982) [hereinafter cited as "Besen and Johnson"]. [24] Introduction of video common carriage into an incumbent cable system's territory would result in immediate competition between the telephone company's distribution operations and those of the incumbent cable system. Although the more efficient provider could conceivably drive its competitor out of the market in the long-term, it is difficult to predict whether that would occur in all circumstances, and, even if it did, which provider would prevail, or how long the process might take. We note that the bulk of cable plant represents a "sunk" investment, which cannot be removed economically should the owner go out of business. As a result, even if the availability of telephone company-provided distribution facilities were to drive a cable operator from the market, that would not immediately drive the underlying facilities from the market. Instead, the incumbent cable operator might sell its facilities to another provider at a price that could enable the new operator to compete with the telephone company facilities for a time. At some point, the cable plant would reach the end of its useful life, and the operator would have to decide whether to abandon service, or to incur costs to construct a facility that could compete with the telephone company distribution system. On the other hand, because of differences between the relatively simple network architectures of current cable operators and the more complex switched video, voice, and data networks that telephone companies could use to provide video common carriage, the cost/performance characteristics of the two systems could be different. Incumbent cable systems might be able to operate at relatively low cost, delivering one-way video services consisting of packages of entertainment programming, while the telephone companies could provide a broader mix of services, including video-on-demand and interactive video services, but perhaps at higher costs. In these circumstances, it is possible that the two systems could successfully serve the same area. Moreover, facilities costs are not necessarily determinative of the success of a cable business. Incumbent cable operators typically bundle the provision of video transmission service with the delivery of program packages, and many have further vertically integrated into the production of programming. To the extent there are efficiencies from such integration, cable systems may have significant advantages over telephone company entrants in the marketplace. Whether there are any such efficiencies is one issue being examined in our infrastructure proceeding. See Infrastructure Study, supra note 20, at 812. [25] Besen and Johnson, supra note 23, at 22. [26] Consumers could receive incidental benefits from the network upgrades that telephone companies might undertake in order to deliver video signals over their facilities. For example, telephone company provision of transport facilities for video service may ultimately accelerate deployment of advanced transmission technologies such as optical fiber, which would substantially increase the amount of voice, data and video information that could be delivered through the network. Such deployment could also make available sophisticated services, such as interactive video. However, NTIA recognizes that such advanced facilities would take time to build even if it were clear that telephone companies could start today. Although the cost of optical fiber is falling, it may not yet be less expensive than copper facilities. NTIA is exploring this issue. See Infrastructure Study, supra note 20, at 807-08. Moreover, telephone companies contend that they need to provide cable programming themselves in order to justify investment in such facilities from a business perspective. See id. at 812. If this claim is true, such advanced networks might not be built, even under a video common carriage regime. [27] See Notice at para. 59. To maximize profits, a video service provider, like all firms, will serve additional subscribers up to the point that the marginal revenues it receives are equal to the marginal costs of serving those subscribers. If the provider's costs go down (in this case, as a result of a decrease in the cost of transmission facilities), all other things being equal, subscriber rates will decrease as well. The amount of the cost saving passed through to subscribers will depend upon the elasticity of demand for video programming. The provider will be able to retain all cost savings only if demand is perfectly inelastic. [28] The several national pay cable networks typically charge cable systems a wholesale price per subscriber per month for the right to retransmit those networks to subscribers. The cable systems then not only charge subscribers a substantial mark- up, but also generally require that subscribers purchase the systems' basic services in order to access any pay services. Both of these practices reduce demand for the pay networks. If those networks could market directly to subscribers, as video common carriage would enable them to do, they would not "tie" the availability of their services to the purchase of basic services. The pay networks likely would charge a lower rate than would a cable system. Competition among the pay networks would tend to drive the rates for each one towards cost. Moreover, when each network would set its subscriber rates, it would only be concerned about its own revenues and profits. When a cable system sets its pay service rates, it must consider the effect each individual rate will have on the revenues earned from all other pay services it offers. As a result, the subscriber rate that a cable operator sets for a particular pay network will likely exceed the rate that the network itself would set. See Besen and Johnson, supra note 23, at 17, 55. We note, however, that these higher rates may be offset to some degree by increased diversity (i.e., the number of different services offered) that might occur if the cable operator is free to choose which networks will be carried on its system. See id. at 55-57. [29] Video Study at 40. NTIA also found that implementation of video common carriage would be hampered by Note 1 to Section 63.54 of the Commission's cable-telephone crossownership rules, which severely limits the range of financial and business relationships that telephone companies and their channel lessees can enter into consistent with the restrictions. The Commission is addressing this issue in its pending cable-telephone crossownership proceeding. Telephone Company-Cable Television Cross-Ownership Rules, 3 FCC Rcd at 5865-5866, paras. 85-93. [30] Notice at para. 23. [31] Section 613(b) states: It shall be unlawful for any common carrier, subject in whole or in part to title II of this Act, to provide video programming directly to subscribers in its telephone service area, either directly or indirectly through an affiliate owned by, operated by, controlled by, or under common control with the common carrier. 47 U.S.C.  533(b)(1) (Supp. III 1985). [32] See House Report at 57, 1984 U.S. Code Cong. & Admin. News at 4694. [33] For example, a restrictive reading of this language would prevent a telephone company from leasing transmission facilities to entities that the Act expressly does not require to obtain a franchise. See 47 U.S.C.  522(6)(A),(C) (retransmitter of broadcast signals only), 541(b)(2) (lawful provider of cable service without a franchise on July 1, 1984). [34] For example, the Commission requires telephone companies seeking permission to construct video distribution facilities to demonstrate that they have a customer for the facility. See Telephone Company-Cable Cross-Ownership Rules, 3 FCC Rcd at 5873 n.53. Telephone companies have entered into agreements to lease capacity in relatively few instances, however, and in each case only to franchised entities. As a practical matter, telephone companies may be reluctant to assume the risks of serving unfranchised entities unless they are sure that it is lawful to do so. [35] Video Study at 40, 44-46. [36] Id. at 40 (citing Application of General Tel. Co. of California, 3 FCC Rcd 2317 (1988); Letter from Chief, Domestic Facilities Division, Common Carrier Bureau, FCC, to Director, Federal Relations, Pacific Bell, Oct. 29, 1984). [37] See Telephone Company-Cable Cross-Ownership Rules, 3 FCC Rcd at 5873 n.53. [38] 47 U.S.C.  541(b)(1) (Supp. III 1985). As mentioned supra, note 33, the Cable Act provides for exceptions to this general requirement. [39] "Cable service" is defined in Section 602(5) as "(A) the one- way transmission to subscribers of (i) video programming, or (ii) other programming service, and (B) subscriber interaction, if any, which is required for the selection of such video programming or other programming service." Id.  522(5). [40] The existence of a "significant interest" is determined according to Commission rules for attributing ownership interests in broadcast, cable television, and newspaper properties for purposes of the Commission's various crossownership rules. See House Report at 41, 1984 U.S. Code Cong. & Admin. News at 4678. [41] 47 U.S.C.  522(4) (Supp. III 1985). [42] Id.  522(6). [43] Id.  522(6)(A),(C). [44] In the typical case -- when a firm constructs, owns, operates, and programs a video distribution facility -- the answer is clear; a franchise is required because the operator satisfies both prongs of the Section 621 test. A similar result obtains if a telephone company were allowed both to construct distribution facilities and to offer programming over those facilities, even if the company also leased additional capacity to unaffiliated programmers. See House Report at 56, 1984 U.S. Code Cong. & Admin. News at 4693 (telephone company that provides cable service under rural exemption required to obtain a franchise). In contrast, video program distributors that provide cable service through leased access or public channels are not required to obtain a franchise because they neither own nor manage the cable system. See Telephone Company-Cable Cross-Ownership Rules, 3 FCC Rcd at 5863, para. 73. [45] See Telephone Company-Cable Cross-Ownership Rules, 3 FCC Rcd at 5863, para. 73 ("Under these circumstances it is possible that the customer of channel service may not fall within the definition of cable operator in that he neither owns nor manages the cable system"). This might not be the case, however, if the unaffiliated programmers operate and control the headend, the place at which programming sources are received and prepared for transmission to subscribers over telephone company-controlled distribution facilities. One could argue that a headend, standing alone, is not a "cable system," because the definition encompasses both a headend and distribution facilities. See 47 U.S.C.  522(6) (Supp. III 1985). An equally construction, however, would be either that there are two cable systems, or that the "cable system" is the part that makes the entire system look like a traditional cable system (i.e., the headend). In either case, the programmers that operate the headend would likely be treated as "cable operators," and thus required to obtain franchises before offering service. [46] See Telephone Company-Cable Cross-Ownership Rules, 3 FCC Rcd at 5863, para. 74 ("Since, in a common carrier scheme, the carrier neither would be selecting the programming nor marketing or otherwise participating in a relationship with subscribers, we question whether the carrier could be considered to be providing cable service under Section 621(b)(1)") (emphasis in original). [47] As noted, the Cable Act defines cable service as the one-way transmission of video programming to subscribers. See 47 U.S.C.  522(5)(A) (Supp. III 1985). Under a literal reading of the Act, one could argue that a telephone company that offers only distribution facilities would need a cable franchise (separate from its telephone franchise) because it is providing transmission capabilities to video programmers, even without actually providing the programming itself. However, for a number of reasons, this restrictive reading leads to results that seem inconsistent with congressional intent. First, it does not comport with long-standing practice. Telephone companies have never been required to obtain a cable franchise before constructing video distribution facilities. Requiring them to do so now would seem to erect a substantial barrier to telephone company provision of such facilities on a common carrier basis, a situation Congress apparently wished to avoid. See House Report at 57, 1984 U.S. Code Cong. & Admin. News at 4694. Second, such a reading could have significant jurisdictional consequences. The Commission currently reviews telephone company construction of video distribution facilities exclusively, pursuant to Section 214 of the Communications Act. See General Tel. Co. of California, 13 FCC 2d 488 (1968), aff'd sub nom. General Tel. Co. of California v. FCC, 413 F.2d 390 (D.C. Cir. 1969). If provision of distribution facilities means that telephone companies must obtain a cable franchise (as "cable operators" providing "cable service"), the Cable Act would entitle state and local franchising authorities to play a role in this review process. There is no indication that Congress intended that there be such multiple levels of regulatory review for telephone company provision of video transmission facilities. [48] Notice at para. 23. [49] Video Study at 20. [50] Id. at 26-27, 29-30. [51] Id. at 27-29. [52] According to one study, such franchise requirements increase basic service rates by an average of 51 cents per month. See Zupan, Three Essays on the Efficacy of Cable Franchise Bidding Schemes, at 30 (unpublished Ph.D dissertation, MIT 1987). [53] Video Study at 23. [54] See id. at 23 (exclusive franchises are unrelated to regulating the use of public rights-of-way). See also id. at 27 (current franchising process imposes significant costs when it requires the provision of excessive facilities). [55] See id. at 20, 26-31. [56] In one pending case involving the City of Los Angeles, a would-be entrant has challenged a number of franchise requirements on First Amendment grounds, and the federal district court recently found many of the restrictions to be unconstitutional on cross-motions for summary judgment. Preferred Communications, Inc. v. City of Los Angeles, Case No. CV 83-5846 (C.D. Cal. Jan. 5, 1990). The constitutionality of such requirements has been drawn into question by several other courts as well. See Notice at para. 25 nn.42, 46. [57] 47 U.S.C.  541 (Supp. III 1985). The legislative history makes clear that this provision was intended to give localities the discretion to decide how many franchises should be granted within a given geographic area. House Report at 59, 1984 U.S. Code Cong. & Admin. News at 4696. [58] Notice at para. 22. [59] Id. at paras. 22-24. [60] See supra notes 23-24 and accompanying text. [61] NTIA understands that the would-be challenger ultimately accepted a cash settlement from the incumbent in the Palo Alto overbuild case, Century Federal, Inc. v. City of Palo Alto, No. C-85-2168 EFL (N.D. Cal.). See also Nor-West Cable Communications Partnership v. City of Saint Paul, No. 3-83 Civ. 1228 (D. Minn. Sept. 1, 1988) (jury finding that would-be challenger lacked financial ability, technical capability, and intent necessary to design, construct and operate cable system in competition with incumbent). [62] Notice at paras. 40-41. [63] 47 U.S.C.  532 (Supp. III 1985). [64] Id.  532(c)(1). In particular, cable operators have the freedom to establish "the price, terms, and conditions of such use which are at least sufficient to assure that such use will not adversely affect the operation, financial condition, or market development of the cable system." Section 612(f) of the Cable Act, id.  532(f), provides that the price, terms and conditions set by cable operators are presumed reasonable, unless proven otherwise by clear and convincing evidence. [65] See supra notes 24-28 and accompanying text. [66] Notice at paras. 31-36. [67] See Comments of NTIA in Amendment of Part 76 of the Commission's Rules Concerning Carriage of Television Broadcast Signals by Cable Television Signals, MM Docket No. 85-349 (filed Jan. 26, 1986 and Apr. 25, 1986). [68] See Notice at para. 37; Compulsory Copyright License for Cable Retransmission, 4 FCC Rcd 6562, 6582 & n.194 (1989) (citing Cabletelevision Advertising Bureau, Cable TV Facts at 11 (1988)). [69] Under the compulsory license, the marginal cost to a cable operator of carrying local broadcast signals is effectively near-zero. Smaller cable systems (commonly referred to as "Form 1" and "Form 2" systems) pay a flat fee for the first broadcast signal they carry (whether it is distant or local) and incur no additional liability for the carriage of additional signals; the larger "Form 3" systems (i.e., those with semi-annual basic service revenues greater than $292,000) pay royalties based on the number and type of distant signals carried, and effectively pay nothing for the retransmission of local signals (so long as they carry one or more "distant signal equivalents"). See 17 U.S.C.  111(d)(1)(B)-(D) (1982 and Supp. V 1987); 37 C.F.R.  201.17(d)(2), 308.2(b) (1988). [70] Cable operators decide which signals to carry based upon both the additional revenue that the carried signal will generate and the incremental cost of carrying that signal; the operator will carry those signals that generate the highest incremental profits. Assuming that the incremental cost of carrying a signal is uniform across all signals, the cable operator is most likely to carry the signal that its subscribers value the highest because that signal will generate the greatest additional revenue. [71] The Notice does not make a specific proposal for "must carry" rules. However, Congress is considering legislation that would condition the availability of the compulsory license on making a certain percentage of channels available for the carriage of local commercial and public stations, with the cable operator retaining some discretion to decide which signals to carry when the number of stations seeking carriage exceeded the number of "must carry" channels. See S. 1880: The Cable Television Consumer Protection Act of 1989, 101st Cong., 1st Sess. (1989). Under such legislation, the broadcast stations that would receive carriage are those most likely to be carried by the cable system regardless of any "must carry" rules because, as noted above, the cable operator would generally have strong economic incentives to carry the most popular local broadcast stations. [72] Another possibility is that market imperfections exist in basic service "quality" -- meaning the mix of services and programming available to cable subscribers. Indeed, some argue that "must carry" rules are necessary to ensure a mix that provides a diversity of viewpoints or to promote entry of new broadcasting ventures in areas where most homes are served by cable. If it could be shown that cable operators lack incentives to carry the "right" mix of signals, there might be greater justification for the reimposition of "must carry" rules. However, the economic literature is inconclusive on whether this sort of market imperfection actually exists. See A.M. Spence, Monopoly, Quality, and Regulation, 6 Bell J. of Econ. 417-29 (1975). [73] Total cable television advertising revenues were projected to be $2.378 billion in 1989, of which $1.401 billion were from national network advertising; in contrast, total basic service revenues were projected to be $8.989 billion. Paul Kagan and Assoc., Inc., The Kagan Cable TV Financial DataBook, at 70 (June 1987). [74] NTIA also believes that "must carry" rules are undesirable as a matter of policy because such rules create, at least in the short run, economic distortions in the market for video programming. In the absence of "must carry" rules, those signals (whether broadcast station or cable network) that are of most value to cable operators will most likely be the ones that they carry. Such stations or program services should earn greater revenues by virtue of their expanded viewership on cable and thus will be able to bid up the price of programming, which, in turn, will give incentives to program suppliers to produce similar programs in the future. In contrast, under "must carry" rules, a cable operator would be required to carry a certain number of local broadcast signals regardless of actual subscriber preferences. Specific local broadcast signals that must be carried under the rules may not necessarily contain the programming that subscribers value most highly. Moreover, even if a cable operator has the discretion to decide which broadcast signals to carry when the number of stations seeking carriage exceeds the number of "must carry" channels, subscribers may actually prefer non- broadcast signals (namely, cable networks) that cannot be carried due to limited channel capacity. As a consequence, program suppliers will receive incorrect messages regarding viewer program preferences, and viewers will be harmed. [75] In particular, NTIA is concerned whether cable operators have adequate incentives to carry noncommercial educational stations, which generally provide alternative programming to the standard commercial broadcast fare and thereby increase the diversity of programming available to the public. But see supra notes 68-72 and accompanying text. [76] See Century Communications Corp. v. FCC, 835 F.2d 293 (D.C. Cir.), clarified, 837 F.2d 517 (D.C. Cir. 1987), cert. denied, 108 S. Ct. 2014 (1988); Quincy Cable TV, Inc. v. FCC, 768 F.2d 1434 (D.C. Cir. 1985), cert. denied, 476 U.S. 1169 (1986). [77] See Comments of NTIA in Compulsory License for Cable Retransmission, Gen. Docket No. 87-25 (filed Aug. 6, 1987). [78] See infra note 82-83 and accompanying text. [79] We note, however, that direct negotiations could be burdensome for smaller MSOs and individual cable systems. One way to alleviate this problem might be to repeal the compulsory license only for "Form 3" systems. See 37 C.F.R.  308.2(b) (1988). [80] In adopting the compulsory license, Congress was concerned that retransmission of a distant signal by a cable operator would injure the copyright holder's ability to exploit the program in the distant market. See H.R. Rep. No. 1476, 94th Cong., 2d Sess. 90 (1976), reprinted in 1976 U.S. Code Cong. & Admin. News 5659, 5704-05. [81] After the FCC dropped its rules in June 1981 limiting the number of distant signals that a cable system could carry, many cable systems started carrying additional distant signals at the compulsory license fees then in effect. The CRT subsequently increased the rates for "nonpermitted signals" (namely, those in excess of the number permitted under the prior rules) to 3.75 percent of relevant gross revenue for each signal. [82] Video Study at 77 and Attachment 2. [83] See, e.g., S. 1880, The Cable TV Consumer Protection Act, 101st Cong., 1st Sess. (1989) (no cable firm may serve more than 15 percent of all cable subscribers). [84] For a discussion of the benefits of concentration, see Scherer, Economies of Scale and Industrial Concentration, in H. Goldschmid, H. Mann, and J. Weston, Industrial Concentration: The New Learning 16-54 (1974); Office of Plans and Policy, Federal Communications Commission, FCC Policy on Cable Ownership 103 (Nov. 1981). [85] See supra note 27. [86] It does not appear that levels of ownership concentration have a direct impact on the prices charged cable subscribers. Cable rates are determined by the level of competition within the local market served. If, for example, a cable operator faces no competition in the community it serves, it will be able to set excessive rates, regardless of whether that operator owns numerous systems elsewhere or none at all. [87] In comments on proposed revisions to the Commission's broadcast multiple ownership rules, the Department of Justice ("DOJ") suggested that the relevant advertising "product" market for broadcast stations was television advertising. Amendment of Section 73.3555 of the Commission's Rules Relating to Multiple Ownership of AM, FM, and Television Broadcast Stations, 100 FCC 2d 17, 39 (1984). This market was divided into two discrete "submarkets" -- network advertising and spot advertising. Id. at 40. Geographically, the former market is nationwide in scope, and the latter is local in scope. Id. NTIA believes that this same market definition is appropriate for cable television. Even very high levels of concentration would probably not give cable MSOs market power in the network advertising market. Generally speaking, national advertising time is sold, not by cable operators, but by the various cable networks that the operators carry. Consequently, cable operators, whether concentrated or not, can have no direct impact on national advertising rates. Moreover, even if operators did sell national advertising time, they still could not significantly influence national advertising rates. An MSO that controlled all cable subscribers could give national advertisers access only to the 56 percent of U.S. television households that subscribe to cable. On the other hand, the MSO's principal competitors, the television broadcast networks and their competitors, could allow those same advertisers to reach more than 90 percent of all television households. The advertisers would have ready substitutes should an MSO fix excessive advertising rates. Nor would concentration appear to present competitive problems in local spot advertising markets. As with the case of subscriber rates, see supra note 86, a cable operator's power over local advertisers will depend upon competitive conditions in its local community. If there are no, or few, alternative television outlets in the community, a cable operator may be able to set excessive advertising rates even if it owns no other systems. [88] Notice at para. 50. [89] This situation may change in the future, however. NTIA is aware, for example, that a cable system in Rochester, New York, has acquired individual programs to occupy its local origination channel. See Broadcasting, Oct. 2, 1989, at 52. [90] See supra note 87. [91] Even if cable systems did acquire individual programs, they would be competing with a host of potential buyers, including the major broadcast networks, unaffiliated cable network programmers, and local broadcast stations. See Notice at para. 50. In this highly competitive arena, it seems unlikely that even a very large MSO could exert much influence over the prices charged and paid for those programs. [92] Id. at para. 49. [93] See supra note 9 and accompanying text. Many of these are sports channels, such as the New England Sports Network or the New England Sports Channel. [94] For example, roughly 7 percent of all U.S. cable households are located in the six New England states. Thus, a single MSO could control all cable subscribers in New England and still not have sufficient market power to impact significantly competition in national program markets. On the other hand, that MSO would have substantial market power in its dealings with regional cable networks. [95] See Notice at para. 52. "Pure" monopsony exists when there is a single buyer for a good or service produced by a number of sellers. Where there is a single buyer and a single seller, the market is commonly referred to as a bilateral monopoly. [96] There are, of course, counterexamples. Pay cable networks, such as HBO and Showtime, rely exclusively on subscription fees. In the main, however, cable networks can obtain as much as 50 percent of their revenues from subscription fees. See Inquiry into the Scrambling of Satellite Television Signals and Access to those Signals by Owners of Home Satellite Dishes, 2 FCC Rcd 1669, 1678-79 (1987). [97] Subscription revenues vary directly with the number of subscribers because subscription fees are usually based on a monthly charge for every subscriber receiving the service. An increase in subscribers may also provide additional viewers that may persuade advertisers to buy time on a cable network or to pay more for that time, thus enhancing the network's advertising revenues. [98] Cf. Notice at para. 52 (a certain subscriber threshold is "needed to launch and sustain a cable programming service"). It is difficult to know what this critical mass is for any particular cable network. [99] Increases in vertical integration within the cable industry could thus be explained by the exercise of market power by concentrated MSOs. [100] See, e.g., Video Study at 80-81. These discounts do not necessarily suggest a market failure or reduced overall economic welfare. As a rule, price discrimination (i.e., the charging of different rates for the same product) will not occur in a perfectly competitive market. This does not appear to be the case, however, when the product involved is a "public good," a good for which the cost of serving an additional customer is virtually zero. One economist has shown that price discrimination in the distribution of a public good will produce results similar to those that would occur in a perfectly competitive market. Indeed, the good might not be offered in the absence of discounts to firms who have different willingnesses to pay for it. See Demsetz, The Private Production of Public Goods, 13 J. Law & Econ. 293 (l970). Television programming, such as that offered by cable networks, is commonly thought of as a public good. See Spence & Owen, Television Programming, Monopolistic Competition, and Welfare, 91 Quarterly J. Econ. 103 (1977). [101] In 1987, ESPN's profits exceeded those of both ABC and CBS. See Communications Daily, July 26, 1988, at 4 (ESPN's 1987 profits were $60 million); NTIA Telecom 2000, at 495 (CBS and ABC profits in 1987 were $50 million). In 1988, the earnings of both ESPN and CNN exceeded those of CBS. See Maclean's, Aug. 7, 1989, at 42 (CNN's profits $100 million); Communications Daily, July 26, 1988, at 4 (ESPN's profits projected to be $100 million); Broadcasting, May 1, 1989, at 35 (CBS's profits $43 million). [102] See supra notes 8-9 and accompanying text. [103] See, e.g., Communications Daily, June 12, 1989, at 6; id., Mar. 7, 1989, at 1; id., May 20, 1988, at 7; id., July 16, 1987, at 7. [104] See id., Sept. 22, 1989, at 6. [105] ESPN, NFL Agree to Four-Year Deal, Wash. Post, Mar. 1, l990, at C2. [106] See Inquiry into the Scrambling of Satellite Television Signals and Access to those Signals by Owners of Home Satellite Dishes, 2 FCC Rcd 1669, 1705 n.89 (1987); Video Study at 87 & n.283. [107] See Inquiry into the Existence of Discrimination in the Provision of Superstation and Network Station Programming, Gen. Docket No. 89-88, FCC 89-365, at paras. 57-59 (released Dec. 29, 1989) (distributor of programming to home satellite dishes pays roughly $2.67 per subscriber more than cable systems for the same package of 5 network and superstation signals; same distributor pays nearly $.70 per subscriber more than cable systems for WTBS). See also Hearings on the Cable Television Industry Before the Subcomm. on Communications of the Senate Comm. on Commerce, Science, and Transportation, 101st Cong., 1st Sess. (1989) (statement of Robert L. Schmidt, Wireless Cable Ass'n, at 11) (rates charged MMDS operators for cable networks are "often several multiples higher" than those paid by cable systems); id. (statement of Bob Phillips, National Rural Telecommunications Cooperative, at 3) (NRTC's wholesale cost for a package of 17 cable networks is 444 percent higher than cable systems pay). [108] See Inquiry into the Existence of Discrimination in the Provision of Superstation and Network Station Programming, supra note 107, at para. 69. The Commission's order does not make clear whether or not this inquiry will be limited to discrimination with respect to broadcast signals. [109] See 1984 Merger Guidelines, 49 Fed. Reg. 26823 (1984). [110] There is a potential problem with subjecting the cable industry to traditional concentration analysis. Existing studies generally study the link between concentration and increases in monopoly power among sellers of goods and services. As noted above, in the cable context, the principal concern about concentration is that it will give cable systems monopsony power as buyers of programming, not monopoly power as suppliers of services. However, monopsony and monopoly are so closely related that "the formal analysis of monopoly power in buying [i.e. monopsony] is symmetrical with that of monopoly power in selling." G. Stigler, The Theory of Price 206 (3d ed. 1966). Accordingly, it seems reasonable to conclude that a level of concentration that permits the exercise of monopoly power would, in most cases, permit the exercise of monopsony power. [111] An industry with a single firm would produce an H-index of 10,000; an extremely competitive industry (i.e., one with a very large number of firms) would produce an index approaching 1. A major advantage of the H-index is that it captures the fact that the competitive performance of an industry is a function not only of the number of firms within the industry and their individual market shares, but also the relative size of each firm. The squaring process of the index introduces an explicit weighing mechanism that captures differences in market shares, particularly with respect to the largest firms. [112] 1984 Merger Guidelines, 49 Fed. Reg. at 26831. [113] For a discussion of these mitigating factors, see id. at 26831-26834. [114] We have expressed market shares as the percentage of total cable subscribers served by each MSO, rather than as a percentage of total industry revenues. We believe that this is appropriate because subscriber levels have a major effect on cable service revenues, the prices a cable system pays for programming, its ability to attract advertisers, and the value of its system to prospective purchasers. Additionally, because a cable network's success hinges on the number of viewers it reaches, the number of subscribers served by an MSO would seem to give a good indication of leverage that MSO might have over cable networks. Subscriber figures are also more accessible than revenue figures. Subscriber figures for each MSO were taken from CableVision, Jan. 29, 1990, at 80. For a description of how the subscriber counts were derived, see Attachment 1. In attempting to account for the different estimates of total cable subscribers, we took an average of two figures given for November 1989 -- 50.9 million (Notice at para. 3) and 52.5891 million (CableVision, Jan. 1, 1990, at 38). [115] Because of the difficulties in generating an H-index for an industry composed of hundreds of firms, we have calculated the cable industry index as follows: we first used market share data for the 20 largest MSOs, and then assumed that the remainder of the market is equally divided among 80 other companies. This process will produce an H-index somewhat, but not substantially, higher than would be obtained if we had calculated an index using market share data for all 9,000 firms within the industry. [116] 1984 Merger Guidelines, 49 Fed. Reg. at 26832. As a result, any increase in market power created by the merger will be quickly dissipated by the entry of new firms or expansion by existing rivals. [117] Notice at para. 30. [118] For a more formal definition of vertical integration, see P. Areeda & D. Turner, Antitrust Law para. 723, at 194-95 (1978). We consider a cable firm to be vertically integrated into programming if it holds any ownership interest in a cable network. However, the size of a firm's ownership interest may be of significance in certain circumstances. For example, to the extent that ownership of a cable network may give a cable operator the incentive to favor that network over a competing service, that incentive should exist even if the ownership interest is relatively small, although the magnitude of the incentive should vary in proportion to the size of the interest. On the other hand, to the extent that vertical integration gives a cable operator the incentive to withhold an affiliated program service from a competing distribution medium, the operator will be unable to act upon that incentive (in the absence of collusion) unless its ownership interest in the service confers control. [119] For example, popular pay cable services, such as HBO, Showtime, Cinemax, and the Movie Channel, have been affiliated from their inception in the 1970s with firms that also own cable systems. [120] For a complete listing of the programming services in which cable systems have an equity interest, see Klein, The Competitive Consequences of Vertical Integration in the Cable Industry 61-63 (June 1989) [hereinafter cited as "Klein"]; Paul Kagan Assoc., Inc., Cable TV Programming, Dec. 20, 1989, at 3. [121] Notice at para. 62. See also Office of Plans and Policy, Federal Communications Commission, FCC Policy on Cable Television 109-110 (1981); Network Inquiry Special Staff, Federal Communications Commission, New Television Networks: Entry, Jurisdiction, Ownership and Regulation, Vol. 1, at 374-76 (1980). [122] Starting a cable network is an risky process that entails a considerable amount of fixed, up-front costs. By underwriting some of these costs through vertical integration, a cable operator can share some of these risks with the program supplier, thereby increasing the probability that the service will make it to the marketplace. [123] Video Study at 91. [124] Broadcasting, June 30, 1986, at 32. [125] Klein, supra note 120, at 23. [126] Id. [127] Transaction costs refer to any expenditure of resources associated with the use of the market in transferring a good or service from one party to another. See O. Williamson, Markets and Hierarchies; Analysis and Antitrust Implications 8 (l975). [128] Because decision-makers within a firm will tend to share a common goal (i.e., to conclude a deal that benefits the firm), the internal "negotiations" or decision-making will likely be of shorter duration and less costly. Moreover, future contingencies can be resolved as they arise through normal administrative procedures within the firm. See Williamson, Transaction Costs in Antitrust Policy, 122 U. Pa. L. Rev. 1400, 1445 (l974). [129] See supra note 27. [130] NTIA does not believe that vertical integration has any direct impact on the rates that cable systems charge their subscribers. As noted above, a cable operator will set rates that maximize profits under the local market conditions it faces. See supra note 86. Vertical integration into programming cannot give a cable operator any greater ability to establish excessive subscriber rates than competitive conditions in its franchise area already permit. On this point, see Network Inquiry Special Staff, Federal Communications Commission, New Television Networks: Entry, Jurisdiction, Ownership and Regulation, Vol. 1, at 380-81. As we discuss below, however, to the extent that vertical integration can be used strategically by MSOs to restrict availability of programming to their competitors, there could be an indirect effect on prices charged to consumers resulting from the reduced level of competition in video delivery services. [131] However, as cable ownership concentration increases, there is a greater possibility that parallel (though, perhaps, non-collusive) decisions by large MSOs to favor their affiliated program services could jeopardize the viability of an unaffiliated service. [132] However, such inability to obtain programming may be due to exclusive dealing arrangements between cable systems and cable program networks. We noted in the Video Study the economic benefits of such arrangements to both parties, and stated that the benefits of exclusive dealing should not be denied without compelling evidence that they are being used to foreclose competition. Id. at 104-06. [133] See, e.g., Krattenmaker & Salop, Anticompetitive Exclusion: Raising Rivals' Costs To Achieve Power Over Price, 96 Yale L.J. 209 (1986). [134] See Hearings on the Cable Television Industry Before the Subcomm. on Communications of the Senate Comm. on Commerce, Science, and Transportation, 101st Cong., 1st Sess. (l989) (statement of Preston Padden, President, INTV, at 6). [135] Video Study at 94-95, 98-102. [136] A subsequent study conducted on behalf of the National Cable Television Association confirmed NTIA's conclusions in this regard. Klein, supra note 120, at 35-45. [137] Video Study at 94-95. [138] See id. at 98 n.302. See also Salinger, A Test of Successive Monopoly and Foreclosure Effects: Vertical Integration Between Cable Systems and Pay Services (Graduate School of Business, Columbia Univ. Sept. 1988). [139] We note that increasing amounts of cable programming are apparently now being made available to MMDS and other alternative distribution media. See Klein, supra note 120, at 65-71 (stating that many of the cable networks that the Video Study cited as being unavailable to MMDS are now available to at least some MMDS operations). [140] We understand that BET is now available to the Washington, D.C., MMDS system. See id. at 65. [141] The Cleveland MMDS operator obtained the right to carry Showtime only after filing an antitrust suit against Viacom. Even though the MMDS operator now offers Showtime on its system, it may not market the service in certain areas of Cleveland where Viacom wishes to extend cable service. Letter from Robert L. Schmidt, President, Wireless Cable Association, to Alfred C. Sikes, Administrator, NTIA, Dec. 27, 1988, at 2. [142] See Inquiry into the Existence of Discrimination in the Provision of Superstation and Network Station Programming, supra note 107, at paras. 57-59. The Video Study did not address the issue of the rates that alternative media pay when they are given access to cable programming. [143] See supra note 107. [144] NTIA used the Commission's cable ownership attribution rules, 47 C.F.R.  76.501, Note (a), (b) (1988), to determine the number of subscribers served by each MSO. An MSO was deemed to own or control another firm (and its subscribers) if that MSO (1) has a partnership interest in the second firm or (2) owns at least 5 percent of the voting stock of the second firm, unless the latter firm has a single majority stockholder. See Video Study, Attachment 2 at 9.