THE PITFALLS OF A LA CARTE: FEWER CHOICES, LESS DIVERSITY, HIGHER PRICES. An NCTA Policy Paper

Transcription

1 THE PITFALLS OF A LA CARTE: FEWER CHOICES, LESS DIVERSITY, HIGHER PRICES An NCTA Policy Paper May 2004

2 INTRODUCTION AND SUMMARY Not that long ago, when American consumers sat down for the evening to watch television, they had three principal program choices ABC, CBS, and NBC. The idea that consumers should be able to choose among hundreds of diverse programming channels was only a dream. Today, cable has made that diversity a reality, offering an abundance of high-quality programming that educates, informs, and entertains consumers. Cable offers something for nearly everyone, with networks devoted to children and families, women s issues, news and public affairs, minorities and foreign languages, sports, science, history, religion, music, technology, and more. This unprecedented diversity has been made possible by virtue of program packages, or tiers. Tiers combine new networks with well-established networks, thereby allowing new networks to be sampled by consumers so they can find and build an audience. By allowing new networks to share the large subscriber base created by the more established networks, tiers provide a critical financial base for new networks to reach the potential audience necessary for survival. And this dynamic creates the investment incentives that produce the rich diversity of programming consumers enjoy today. Under the tiering model, program growth has been spectacular. There are 339 national and 84 regional cable networks today, and creative ideas for new networks continue to be developed. Likewise, consumer enthusiasm for cable networks, both new and established, has been enormous. Cable network viewership continues to increase as the broadcast audience declines, and critical acclaim for cable s programming is growing sharply as well. There is more program diversity today than at any point in history, and the tiering model developed by the cable industry is responsible for this success. 1

3 Notwithstanding the clear pro-consumer benefits of tiers, some policymakers have suggested that basic cable program networks should be sold on an unbundled, a la carte basis, instead of, or in addition to, program tiers. While this suggestion may offer superficial appeal, on further examination, it is evident that a la carte is neither feasible nor desirable and, in fact, would cause significant harm to programmers, cable operators, and consumers alike. An a la carte pricing model would require a fundamental restructuring of the cable and programming businesses. It would change the way programming is distributed and marketed by the cable and satellite industries. It would destroy the economic underpinnings upon which companies have invested billions of dollars to build new infrastructure and develop new programming. It would require a complete overhaul of customer service operations to handle the vastly more complicated processes involved in offering hundreds of channels on a stand-alone basis. A government policy to require a la carte is not simply tinkering with the cable and satellite industries business model. It forsakes a highly successful, market-driven business model, to substitute an entirely new model with no empirical evidence as to its long-term viability, and turns back the clock on the extraordinarily diverse programming business that has developed over the last 30 years. A la carte, whether in place of, or as an add-on to the current tiering model, would harm consumers in several specific ways: A la carte will reduce program diversity. Basic cable program networks generate revenues from two sources, subscription fees and advertising fees. Both depend on the number of subscribers the network reaches. Many networks, particularly niche networks that target small, underserved audiences, would not be able to attract enough subscribers standing alone to generate the license fees or advertising revenues to cover the costs of the network. As a result, many existing niche networks will die and many new networks will not be created. 2

4 A la carte will increase prices for consumers. A cable network cannot recoup lost revenues by charging more for advertising since it will have fewer potential viewers in an a la carte world. The network s only option is to raise its subscription fees, and this means higher prices for consumers. The Government Accounting Office recently confirmed this conclusion, finding that a la carte could result in higher per-channel rates for consumers. 1 Moreover, because an addressable set-top box would be needed for each television set in a home to receive a la carte services, there would be significant additional equipment costs for millions of consumers. The technical problems with providing a la carte in today s predominantly analog cable environment are overwhelming and cost prohibitive. Cable is still a largely analog delivery system. Notwithstanding the industry s substantial investment in, and marketing of digital service, only about 30% of its customers today take digital services. That means about 50 million cable homes are still analog. And even in a typical digital cable home, not every TV is equipped with a digital settop box. There is no practicable way to provide analog channels on an a la carte basis. Instead, a cable operator would have to duplicate all analog signals in digital. In order to receive the digital programming, however, every customer would need an addressable set-top box for every television in his or her home. The cost of this approach could be billions of dollars. Moreover, duplication would be a vast waste of limited bandwidth. The cable industry has invested billions of dollars upgrading and expanding its plant so that it can offer consumers new digital programming, HDTV, video-on-demand, high-speed cable Internet, and telephony service. It makes no sense to delay deployment of these services in order to duplicate analog programming that consumers can already get today. There are serious and costly customer service problems with a la carte that would leave consumers frustrated and confused. Cable s customer service systems would have to be completely revamped to accommodate a la carte. For example, new and more complex order-taking and billing systems would be necessary to handle the hundreds, if not thousands of program options available in an a la carte world. Most importantly, consumers would require much lengthier and more complicated calls with cable representatives, leaving them exasperated at a time when the industry s efforts over the last several years to improve customer service have begun to bear fruit. There is no evidence that a la carte is a viable business model or one that consumers prefer. Some parties have suggested that the experience of Canadian cable operators supports imposition of an a la carte requirement in the U.S. But 1 U.S. Gen. Accounting Office: Telecommunications: Issues Related to Competition and Subscriber Rates in the Cable Television Industry 30, 36 (Oct. 2003) ( GAO Report ), available at 3

5 that is not the case. In fact, the vast majority of Canadian cable subscribers receive programming in analog tiers, precisely the same way U.S. subscribers receive cable service. While some Canadian cable operators recently began to offer newer and less popular digital program channels on an a la carte basis, there is no proof that it is a sustainable business model. The government should approach regulation of cable pricing and packaging cautiously given that past attempts have been counterproductive. In 1992, the government regulated cable s pricing and packaging. The regulations hobbled program networks, eroded investment, and set back broadband deployment at least five years. The regulations were so disruptive that only four years later, Congress voted to repeal them. Today, cable contributes hundreds of thousands of jobs and billions of dollars in investment, franchise fees, and state and local taxes to the U.S. economy. Just like the 1992 regulations, a la carte would disrupt the industry s business model and undermine its ability to acquire funds for investment, growth, and job creation. Each of these problems is an independent reason not to impose an a la carte requirement. Taken together, they far outweigh any theoretical benefits of a la carte. The current tiering model has worked well. Over 90 million U.S. cable and satellite customers have benefited because, by providing consumers with a wide choice of diverse, high-quality programming at a reasonable price, basic and expanded basic packages offer one of the greatest entertainment values available anywhere. For less than $1.50 per day, including equipment costs, cable and satellite customers can enjoy packages offering 60 or more different basic cable and broadcast channels. The average TV household uses this diverse choice of programming nearly five hours per day. The government should not reconfigure this proven model in favor of a la carte, particularly where the outcome is at best uncertain and at worst harmful to consumers. As GAO has warned, it is difficult to ascertain how many consumers would be better off and how many would be made worse off under an a la carte approach. 2 2 GAO Report at 6. 4

6 I. A LA CARTE WOULD REDUCE THE PROGRAM DIVERSITY AND CONSUMER CHOICE CONSUMERS ENJOY TODAY. Cable operators have always given customers multiple options for purchasing programming, never more so than today. Among the options are the following: Basic tier: includes broadcast channels, public, educational and governmental channels, and leased access channels; typically channels; Expanded basic tier: includes many popular and niche program networks and typically has channels; Premium networks: a la carte channels such as HBO or Showtime, which offer uncut theatrical and original movies, events, or series programming; cable systems typically offer several premium service options; Digital tiers: includes a wide variety of general and niche programming not included in the expanded basic tier; many cable systems offer multiple digital tiers; Pay-per-view: includes movies, events, and other programming offered on a perprogram basis; Sports packages: includes packages of baseball, basketball, hockey, and college football games offered on a season or partial season basis; Video-on-demand: includes a wide selection of movies and other programming that consumers can purchase on a per-program basis from a library of such programming; Subscription video-on-demand: allows subscribers to a program network to select and view particular programming from a library created by the network; and Free video-on-demand: an evolving form of video-on-demand in which cable operators make a large selection of programming, including local and regional programming, available to their customers without charge. The only one of these options that a consumer must purchase is the basic tier, and that is because Congress requires cable operators (unlike DBS providers) to provide this tier to all customers. 3 All of the other program choices are optional at the discretion of the customer. 4 3 See 47 U.S.C. 543(b)(7)(A). 5

7 A. A La Carte Would Cause the Demise of Basic Program Networks. The most popular option, of course, is the expanded basic tier, which typically includes many channels that consumers highly value and regularly watch. One of the great benefits of this tier has been the creation of a huge array of diverse, high-quality program networks. One of the truly unfortunate effects of a la carte would be to destroy that model and thereby reduce the diversity of programming available to consumers today. There are two basic truths about a la carte: First, a la carte would reduce a program network s revenues. Most basic cable networks have two revenue sources: subscription fees and advertising fees. A la carte would undermine this dual revenue stream model. Notably, it would substantially reduce audience reach and viewership, resulting in significant reductions in advertising revenue. GAO confirmed that any movement of networks from the most widely distributed tiers to an a la carte format could result in a reduced amount that advertisers are willing to pay for advertising time. 5 Second, a la carte pricing would not reduce the costs of producing programming. A programmer incurs certain fixed costs to create a network, including purchasing and developing programming, and marketing and distributing the network. These costs are not reduced in any way based on the number of subscribers the network ultimately attracts. In fact, a network s marketing costs are likely to increase substantially in an environment where it must market itself to every consumer. As a result, a la carte would actually reduce consumer choice. While some of the most popular networks may be able to survive a switch to a la carte by raising their prices, other networks would not be able to do so. In particular, niche networks that have relatively small audiences, even if they could raise their prices, would not be able to attract enough subscribers in an a la carte world to generate the subscription fees and advertising revenues to cover the cost of 4 While all cable systems offer their customers multiple programming options, not every system offers all of the options described above. However, because the cable industry has been rapidly upgrading its plant over the last several years, more and more systems are providing these choices, and the trend is strongly and irreversibly in that direction. 5 GAO Report at 35. 6

8 producing their services. GAO has confirmed that a la carte would threaten the viability of niche networks, concluding that some cable networks, especially small and independent networks, would not be able to gain enough subscribers to support the network. 6 Of course, it is not possible to predict precisely which networks would fail in an a la carte environment, but the list of networks at risk is daunting. For example, would children s networks like Discovery Kids, Noggin, and WAM! survive in an a la carte world? Would family-oriented services like ABC Family, Hallmark Channel, and National Geographic Channel survive? One leading family-friendly network has expressed concern that it would not. 7 Would networks devoted to women s issues like Lifetime Real Women, Oxygen, and WE: Women s Entertainment survive? Would local news programming like Central Florida News, News 10 Bronx, and News 14 Carolina survive? Would networks devoted to minorities and foreign language programming like the Asia Channel, BET, and La Familia Network survive? Would programming devoted to the arts like Ovation and the Independent Film Channel survive? These questions are not academic. They reflect real and serious concerns within the programming community: 6 Id. at 36; see also id. (citing multiple programmers and financial analysts as saying that smaller networks or those providing specialty programming would be hurt the most by an a la carte system ) (emphasis in original); Escalating Cable Rates: Causes and Potential Solutions. Hearing Before the Senate Comm. on Commerce, Science, and Transportation, 108 th Cong. (Mar. 25, 2004) ( Senate Commerce Committee Hearing ) ( One of the concerns we had, frankly, in talking to people was that you would actually be losing some channels and some networks, and its based on a lack of viewership... They [programmers] couldn t get enough subscribers, couldn t get enough advertisers. ) (statement of Mark L. Goldstein, Director, Physical Infrastructure Issues, General Accounting Office), available at Raymond Lee Katz, et al., Bear Stearns, A La Smart? 5 (Mar. 29, 2004) ( Bear Stearns ) ( We believe many of the smaller, nascent networks would find it difficult to survive in an a la carte environment, reducing consumer choice. ). 7 Letter from Judith McHale, President and Chief Operating Officer, Discovery Communications, Inc., to Members of the Senate Committee on Commerce, Science, and Transportation (Mar. 8, 2004) ( McHale Letter ) ( Discovery s award-winning networks will not exist in an a la carte environment and consumers will have lost the channels they regard as the pre-eminent source of high-quality, family-friendly programming. ). 7

9 ESPN President George Bodenheimer recently testified that a la carte schemes, whether for all services or just directed at a particular genre, will only produce... less choice and the extinction of many channels that serve specific but important audiences. 8 Discovery Communications President Judith McHale told members of the Senate Commerce Committee that a la carte would result in the demise of exactly the type of family-friendly programming the Committee seeks to foster. 9 TV One 10 Chairman Alfred Liggins cautioned that a la carte would have a chilling effect on programming diversity in America, and could put us and many other innovative cable networks out of business. 11 B. Marketplace Evidence Demonstrates That A La Carte Reduces Programming Diversity. There is marketplace evidence to support these concerns. For example, The Golf Channel originally launched as an a la carte network in January Because the network was unable to attract a large number of subscribers, it could not generate a significant amount of advertising. Instead, it had to rely predominantly on subscription fees to generate revenues. The Golf Channel struggled as an a la carte network and likely would have failed had it not been able to move to the expanded basic tier in Once it was on the tier, it could reduce its price to cable operators (and thus, ultimately, consumers) and begin to attract advertising revenue. The 8 Senate Commerce Committee Hearing (statement of George Bodenheimer, President, ESPN Inc. and ABC Sports) (emphasis added). Ironically, the services that may be hurt the most by a la carte are new digital and highdefinition services, adversely affecting the cable industry s efforts (and the government s policy) to advance the digital transition. 9 McHale Letter (emphasis added); see also id. (explaining that in an a la carte world, it would be untenable for Discovery to produce the kind of high-quality, informative and educational programming the American public deserves ). 10 TV One, which launched in January 2004, is devoted to providing programming tailored for African- American adults. 11 Alfred Liggins, Editorial, Destroying Diversity, Wash. Times, Apr. 12, 2004, at A21 ( Liggins Editorial ) (emphasis added); see also GAO Report at 36 (stating that, without tiering, launching a new network... would be very difficult ). 8

10 Golf Channel thrived. Prior to moving to the tier, the network had less than three million subscribers. Today, it has about 60 million subscribers in the U.S., plus another five million in Canada and Japan (and it recently launched an affiliated channel in England). Like many other niche networks, the success of The Golf Channel is directly linked to the economics of the expanded basic tier. * * * * * In short, the market has shown that the expanded basic tier is an efficient way to promote consumer choice by delivering a wide variety of high-quality programming at reasonable prices. 12 By contrast, cable operators, programmers, economists, financial analysts, and government agencies have repeatedly warned that a la carte would restrict consumer choice and reduce the program diversity that consumers enjoy today. II. A LA CARTE PRICING WOULD INCREASE PRICES FOR CONSUMERS. The theory of a la carte is that consumers would be able to reduce their cable bills by selecting and paying only for those program networks they wish to view. However, this theory is based on a false premise -- that the price of purchasing only a fraction of the networks on an expanded basic tier would be a corresponding fraction of what the tier currently costs. That is not how a la carte would work. Consider the following simple example: Assume it costs $100 to produce a program network and that the network is carried on a tier with 50 subscribers. To recover its costs, the network needs to 12 Tiering is not only an economically efficient way to offer cable programming, it is a commonplace and efficient method for delivering a wide range of products to consumers. Economists Inc., How Bundling Cable Networks Benefits Consumers at i (July 23, 1998), filed in CS Dkt. No (July 31, 1998) ( Economists Incorporated ). In fact, when a GAO representative was recently asked whether he could think of any other product or industry in which the government requires an a la carte pricing structure, he responded [n]ot off the top of my head, notwithstanding that GAO had just concluded an exhaustive study of a la carte pricing. Senate Commerce Committee Hearing (statement of Mark Goldstein). 9

11 earn $100 from subscription fees and advertising fees. To do that, it charges the distributor $1 per subscriber in subscription fees ($1 x 50 subscribers = $50) and generates $50 in advertising fees. Now assume the network is carried a la carte and is selected by 20% of the total 50 subscribers, or 10 subscribers. 13 The cost of producing the network remains $100. Only now the network has to recover the $100 from 10 subscribers instead of 50. Plainly, an advertiser will not pay the same to reach 10 subscribers as it paid to reach 50 subscribers. So, assume the advertising revenue is reduced to 20% of the previous total, or $10 (20% of $50). The network has to make up the remaining $90 of its cost with subscription fees. In other words, it has to charge $9 per subscriber ($90 divided by 10 subscribers). The effect of a la carte in this example is to raise the subscriber s monthly price for this network from $1 to $9. A. Independent Experts Find A La Carte Would Cause Consumer Prices to Increase. As GAO found, [b]ecause increased [subscription] fees... are likely to be passed on to subscribers, it appears that subscribers monthly cable bills would not necessarily decline under an a la carte system. 14 Other observers have reached the same conclusion. For example, financial analyst Bear Stearns modeled the effects of a la carte on a subscriber that selects five popular services -- the Disney Channel, ESPN, MTV, Fox News, and TBS. Bear Stearns estimated that the subscriber could actually pay more to purchase only five services a la carte than the cost of a larger tier which included the same five services and many more services as well. According to Bear Stearns, assuming a 25% take rate for each of the five services, the total price would be approximately $ When the price of broadcast basic service, equipment, 13 A 20% take-rate in an a la carte environment is a reasonable assumption given the historical performance of stand-alone networks. Bear Stearns at 4. Of course, many services, particularly niche services, could achieve takerates well below even 20%. 14 GAO Report at 36. Theoretically, a program network facing a decline in revenue could take steps to reduce production costs. Id. at 36. However, doing so would inevitably reduce the quality of the network and its attractiveness to consumers. This is not a strategy that either program networks or cable operators wish to pursue and, surely, not an approach the government would want to encourage. 10

12 and franchise fees is included, the whole package is probably more expensive than today s basic + expanded basic package, with only five networks and the [broadcast basic] tier included. 15 Even more telling is the dramatic increase in fees for each individual program network: 16 Current Price A la Carte Price (with a 25% take rate) Disney Channel $1.48 $5.90 ESPN $3.78 $15.82 MTV $0.43 $2.32 Fox News $0.51 $2.17 TBS $0.47 $2.42 Cost to Consumer $6.67 $28.63 It is no surprise, then, that Bear Stearns characterized a la carte as a can of worms, 17 or that GAO concluded that cable rates could actually increase for some consumers under an a la carte model. 18 There are multiple real life examples to demonstrate that a la carte is associated with higher consumer prices. For example, the Disney Channel was previously offered on an a la 15 Bear Stearns at 4; see also Richard A. Bilotti, Morgan Stanley Equity Research, The Evolution of Programming Costs 4 (Dec. 15, 2003) ( Morgan Stanley ) (noting that consumers taking a la carte services could pay more than the price of a standard tier). The reality, of course, is that most households would take more than five a la carte services. The Director of Consumers Union recently testified that the average household watches 12 to 17 channels. Senate Commerce Committee Hearing (statement of Gene Kimmelman, Director, Consumers Union). Applying the Bear Stearns analysis to a subscriber taking channels, it is easy to see how the cost to the subscriber of taking a la carte channels could greatly exceed the price of a tier See Bear Stearns at 5. Id. at 1. 11

13 carte basis for about $8-13 per month. When it was folded into the expanded basic tier, the price decreased significantly, to about $ Similarly, many regional sports channels, including the predecessor to Comcast SportsNet in the Washington, D.C. area, were offered a la carte for $8-15, but when moved to the expanded basic tier, the price for these services dropped substantially to about $1-2. This phenomenon can also be seen by simply observing the a la carte networks that are offered today, such as HBO and Showtime. Typically consumers pay about $10-15 per month for these networks, far more than the price of services offered in a tier. B. A La Carte Would Force Unnecessary Equipment on Consumers, Putting Additional Pressure on Consumer Prices. A la carte would also impose unnecessary equipment costs on millions of consumers. Analog programming tiers are generally transmitted into a subscriber s home unscrambled. Under an a la carte regime, cable operators would need to scramble all of the networks they transmit to ensure that subscribers are unable to view networks they are not paying to receive. 20 As explained below, this means that to receive a la carte channels a consumer would require an 18 GAO Report at 34; see also Morgan Stanley at 4-5 ( It is also unclear what the pricing would be for individual channels on an a la carte basis, so consumers taking many channels could end up paying more than the standard analog package. ). 19 See Examination of Cable Rates: Hearing Before the Subcomm. on Communications of the Senate Comm. on Commerce, 105th Cong. 38 (1998) (statement of Leo J. Hindery, Jr., President, Tele-Communications, Inc.) ( The addition of Disney to the widely subscribed regulated tier added less than a dollar to the price of the tier. As an a la carte service, with a much smaller subscribership, Disney cost about $10. ); see also Press Release, Time Warner Cable Nebraska, Time Warner Cable Adds Disney to Basic; Rearranges New Channel Lineup (Jan. 1, 2003) ( Beginning Dec. 31, The Disney Channel will be included in basic service in all of the Nebraska Time Warner Cable systems. Prior to this change, Disney was only offered as a premium service for $7.95 per month. ), available at Tim Gannon, Cablevision Rates on the Rise, The Suffolk Times (New York), Dec. 2, 1999 (indicating that a la carte subscriptions to The Disney Channel cost $12.95 per month), available at Nancy Cicco, Disney Still "Premium," Portsmouth Herald, July 5, 2001 (indicating that a la carte subscriptions to The Disney Channel cost $9.95), available at 20 GAO Report at

14 addressable set-top box for every television set in his or her home. The average monthly rental price for an addressable set-top box is $4.39, 21 and the average home has 2.5 television sets. So, a la carte would mean that the average family that chooses a la carte would have an additional equipment cost of $10.98 per month even before getting to the additional costs of the programming. III. SERIOUS TECHNICAL PROBLEMS WOULD MAKE A LA CARTE DIFFICULT, COSTLY, AND TIME-CONSUMING TO IMPLEMENT. Since 1996, the cable industry has invested over $85 billion in system upgrades roughly $1,200 for every cable customer. 22 Today, over 90 million homes are passed by upgraded cable plant capable of offering high-speed Internet, telephony, new digital tiers with up to 260 channels of video programming, CD-quality music, and video-on-demand. Approximately 22 million cable customers have voluntarily purchased digital services and have an addressable set-top box to enable them to view those services. Notwithstanding the industry s concerted efforts to deploy digital, however, analog is still the primary method of delivering cable service. Even subscribers in the 22 million homes that have opted to buy digital services still receive broadcast basic and expanded basic services in analog format (and they get all their services in analog on any television that does not have a set-top box). More than 50 million cable homes do not take digital cable services, so subscribers in those homes get all their services in analog. Analog will continue to be an important delivery method for cable services for many years to come. 21 See id. 22 National Cable & Telecommunications Association, 2003 Year-End Industry Overview (2004) ( NCTA 2003 Overview ), available at 13

15 A. There is No Practicable Way to Provide Analog Channels on an A La Carte Basis. There are two theoretical approaches to offering a la carte in today s predominantly analog cable world: (1) traps; and (2) hybrid set-top boxes. 23 However, each approach has serious technical or economic impediments and, as a practical matter, neither of them will work. Traps, or filters, are physical devices that can be attached to the cable plant outside a customer s residence to block channels. A separate trap is generally needed for each channel to be blocked. However, the use of more than two or three traps for any single cable customer creates serious degradation of the signals coming into the customer s home. In an a la carte world, it would be necessary to block significantly more than two or three channels. Even if this were technically feasible, cable operators would be required to create a unique channel configuration for each of the millions of homes that chose a la carte. And each time a consumer wanted to add, subtract, or substitute services, the operator would have to send a technician to the consumer s home to reconfigure the channel lineup. These problems make the use of traps to provide channels on an a la carte basis unworkable. 24 Using hybrid set-top boxes, which support the distribution of both analog and digital channels, to provide a la carte would be equally infeasible. First, operators would need to scramble all the analog channels on the expanded basic tier. This is necessary because analog channels are generally unscrambled and, as GAO found, the only way to ensure that consumers 23 Hybrid set-top boxes have the capability to receive both analog and digital channels. At some point, cable systems may transition to an all-digital environment with no analog services. Theoretically, all-digital systems would eliminate some of the technical impediments to offering a la carte. But, we are many years away from that time. 24 Traps pose other problems as well. Over time the performance of traps deteriorates (for example, because they are exposed to harsh weather conditions) and this, too, results in poor video signals being delivered to the consumers homes. Defective traps also may leak RF energy and cause interference to other telecommunications systems in the area. 14

16 get only the services they purchase is to scramble the signals. 25 Second, the hybrid set-top boxes deployed today do not include analog descrambling circuitry; rather, they only receive analog channels that are in-the-clear or unscrambled. In other words, even if operators could get the analog signals scrambled, today s hybrid boxes would not be able to descramble them and pass them along to consumers televisions. B. Duplicating Analog Channels in Digital to Provide A La Carte Would be an Enormous Waste of Bandwidth. If cable operators attempted to avoid this problem by duplicating the analog channels in digital, a la carte subscribers would still need a hybrid set-top box for every television in their home to view the duplicated signals. 26 The cost of providing these boxes, at about $200 per box, could be in the billions of dollars. 27 Moreover, duplication would be an enormous waste of bandwidth. Consistent with the government s policy of promoting the digital transition, the cable industry has spent billions upgrading and expanding its plant. The pro-consumer benefits of that investment innovative digital programming, HDTV, video-on-demand, high-speed cable Internet, circuit-switched telephony, and VOIP are undeniable. It would harm consumers to delay further deployment of 25 See GAO Report at 32. However, the equipment necessary to scramble analog signals is no longer manufactured, including the chips and integrated circuits used within the equipment. 26 Digital cable-ready televisions would not require a hybrid set-top box. However, less than one-tenth of one percent of the televisions in U.S. homes today are cable-ready digital. 27 In addition, if cable operators were required to duplicate their analog channels on a digital tier, there are significant equipment upgrades that would be necessary at cable headends. Every channel moved from the expanded analog basic tier to the digital tier would need its own digital encoder to digitize or convert the signal. Additional multiplexers and QAM modulators could also be needed to ensure that the services can be distributed over the cable system. The amount of additional equipment would be considerable, requiring additional floor space and electrical power. Also, a typical headend could possibly need to construct additional building space, electrical power, and heating and air conditioning to accommodate this new equipment. 15

17 these services in order to duplicate analog program services that consumers can already get today. IV. SERIOUS AND COSTLY CUSTOMER SERVICE PROBLEMS CAUSED BY A LA CARTE WOULD LEAVE CONSUMERS FRUSTRATED AND CONFUSED. Over the last two decades, the cable industry has developed order-taking, billing, and customer service systems designed to support existing business models, including tiers. If that business model is significantly altered by substituting a la carte for the expanded basic tier, or even by adding a la carte as another purchase option, these customer service systems will have to be redesigned and upgraded. That process will be extremely time-consuming and costly, and ultimately leave consumers frustrated and confused. Today, cable customers have a relatively finite set of service options and cable operators order-taking systems are designed to allow customer service representatives ( CSRs ) to handle them quickly and efficiently. A CSR may be able to process a customer s order (or change of order) by simply touching a computer screen that displays the dozen or so options available to the customer. In an a la carte environment, this order-taking system will not work. A la carte entails hundreds, if not thousands, of different service options and the order-taking systems are not currently capable of handling that volume or complexity. Moreover, because of the vast number of options presented by a la carte, a typical customer s call to order or change service would be considerably more complicated than a comparable call today. Most restaurant-goers have a hard time remembering the three or four specials described to them by a waiter. Imagine if the waiter had to describe hundreds of specials and the consumer had to remember all the options, sort through them, and then make a 16

18 decision about which to choose. That would be the consumer s experience with ordering programming in an a la carte world. This process would not only complicate a cable customer s typical call, it would increase the duration of the call, as well. Even if the typical call were only a few minutes longer, a la carte would require vastly more CSRs to handle the calls. 28 The cable industry has worked hard over the last several years to improve its customer service and those efforts have begun to bear fruit. A la carte threatens to reverse that success. 29 Likewise, cable s current billing systems were designed for cable s traditional multi-tier model, not an a la carte model. The combinations of billing possibilities in an a la carte format are virtually limitless and would impose significant new costs while the industry and customers adjust to an exceptionally complex set of offers. V. THERE IS NO EVIDENCE THAT THE CANADIAN A LA CARTE EXPERIENCE SUPPORTS A LA CARTE IN THE UNITED STATES. Some parties have suggested that the experience of Canadian cable operators supports the imposition of an a la carte requirement in the U.S. But this is not the case. The vast majority of Canadian consumers buy their cable programming in analog tiers, the same as most U.S. cable customers. In terms of price, total number of channels, and networks offered, most of those Canadian analog offerings are roughly the equivalent of U.S. 28 Cable operators are subject to federal customer service regulations that require cable operators, for example, to answer customers telephone calls within 30 seconds. See 47 C.F.R The complexities of a la carte would certainly make it more difficult for operators to satisfy these customer service regulations. 29 A la carte would also complicate and lengthen the duration of visits to customers homes by cable technicians. 17

19 expanded basic packages. 30 As in the U.S., many of the most popular cable networks are offered on a tiered basis and include A&E, CNBC, CNN, HGTV, The Family Channel, Discovery Channel, Food Network, Country Music Television and The Golf Channel, as well as Canada s own most popular networks like MuchMusic and TSN-The Sports Network. 31 Some, but not all, operators offer these analog channels in two or three smaller tiers rather than one large tier. This arrangement developed largely due to the fact that the Canadian government sequentially authorized cable carriage of different networks. A few systems in French-speaking Quebec Province offer an all digital service, so some popular English-language networks are part of an a la carte menu. But even in those systems, the operator requires the purchase of a digital tier of service as well as digital receiving equipment these customers cannot just pick and pay for five or six cable services. A. Only Digital Cable Customers Have Access to A La Carte and Several Purchases Are Required Before A La Carte is Available. A la carte always requires specialized set-top equipment, so Canada s a la carte offerings are only available to digital cable customers. Most Canadian cable operators offer digital tiers, including themed packages of digital programming, and also allow customers to pick and pay for individual digital channels from some of the dozens of digital program networks. Under 30 For prices ranging from $43 to $45 (Canadian) subscribers receive 63 to 68 channels of programming. There are no analog boxes on Canadian systems; adding the cost of an analog box to a U.S. cable subscription accounts for somewhat higher expanded basic costs on some systems in the U.S. 31 It was stated in recent testimony before the Senate Commerce Committee that ESPN was offered a la carte in Canada. See Senate Commerce Committee Hearing (statement of Gene Kimmelman, Director, Consumers Union). That statement is incorrect. 18

20 pick and pay on many systems, customers can choose one channel for $ $ ; five channels for $ $9.95 and ten channels for $ $14.95 (all Canadian dollars, prices vary by operator). However, whether in the special circumstances of French-speaking Quebec or elsewhere, Canadian cable customers must make several other purchases before they can exercise any a la carte options. For example, on many if not most systems, Canadian cable customers must purchase a package of about analog channels before they can buy services a la carte. This basic tier is typically comprised of broadcast stations and government and educational channels, and costs about $23 (Canadian) per month. In addition, each TV set requires a digital converter to receive a la carte. Cable customers can purchase a digital set-top box for $200+ or lease it for about $9 - $14 per month. For Quebec systems, the customer s minimum purchase would include a digital basic package, plus a digital tier, plus the digital box, resulting in a monthly fee of about $40 for 54 channels. 33 Only after those purchases can a customer pick and pay for a single channel. So, while an a la carte option is available to digital cable customers, there is no evidence that this option has reduced cable bills. A customer wishing to purchase just two a la carte channels would have to spend about $36 - $42 per month. And this customer would not get the most popular analog channels for this price. Thus, it is not surprising that a relatively small percentage of Canadian cable subscribers have availed themselves of this option. 32 Other a la carte purchases involve multicultural channels, with much higher prices ranging from $12 - $25 for Arab, Korean, Chinese and Polish language channels. 33 The digital tier on Quebec-like systems can include channels of the customer s choosing instead of a themed package, but that digital tier requires a minimum of 20 channel selections and costs more than the themed digital packages. Again, this somewhat unique arrangement reflects the lesser demand for English-language services among French-speaking viewers. 19

21 Customers more commonly choose to buy digital theme packages, such as More Movies (six movie channels for $7.99) or French language packages (4 to 9 channels for $ $6.99). Finally, as in the U.S., Canadian cable operators offer analog/digital packages including premium movies and a digital box rental for an all-in-one price. 34 B. Canada s Limited A La Carte is Significantly Different From Advocates Proposals for A La Carte in the U.S. While advocates cite Canada s a la carte option as precedent, it is important to recognize the significant differences between Canada s limited a la carte offerings and proposals to impose an a la carte regime in the U.S.: Canadian a la carte applies only where the technology supports a la carte, namely for digital cable services. There is no a la carte for analog-only customers. A la carte is not generally available for the most popular Canadian cable networks; these services are only offered on analog tiers. Moreover, channels can t be removed from analog and placed on digital without permission from the program network. Where the most popular English-language networks are offered a la carte, they typically are offered in that manner in French-language areas where by definition they have less appeal and where associated advertising revenues are minimal. For digital tier customers, themed packages are usually the better buy compared to a la carte; picking more than three or four of these channels on an a la carte basis costs more than the whole theme pack of 6 to 9 channels. 34 The Ultimate Digital Package as offered by Rogers, includes six English-language theme packages but not all 72 of its digital networks as the French-theme package is priced separately. 20

22 While digital a la carte in Canada does offer pricing options, digital cable penetration figures do not suggest that it leads to more customers being satisfied. Canada s digital cable penetration stands at 22% while U.S. digital cable penetration stands at 30%. This nearly 50% higher U.S. success rate with this new product may be, in part, the result of Canada s more complicated and confusing digital cable pricing structure. * * * * * If anything, the Canadian experience actually supports the conclusion that the U.S. cable operators have broadly reached there is significant reason to believe that consumers prefer tiers and scant evidence that consumers want their programming delivered on an a la carte basis. Even U.S. DBS operators, like DirecTV and EchoStar, which have all-digital platforms have chosen the same tiering model as cable. 35 Eddy Hartenstein, the former Chairman of DirecTV, expressed the view that DirecTV customers like to sit down and surf up and down the whole line-up. 36 In fact, he suggested that if cable went to an a la carte approach, DBS operators might use that as a marketing tool against cable. 37 For these reasons, it is not surprising that when asked, Why can t subscribers pay just for the channels they want? the Canadian Radio-television and Telecommunications Commission ( CRTC ) responded: By offering the programming services in packages, cable companies are able to ensure a wider audience base for each service and reduce individual fees. If cable customers were to select and receive only the channels they wanted, they might The same is true for Open Video System (OVS) providers, Multichannel Multipoint Distribution System (MMDS) providers, and Satellite Master Antenna Television (SMATV) providers. CableFAX Daily, May 21, 2003, at 1. See id. 21

23 have to pay as much, or more, for one channel as they now pay for an entire package of programming. 38 VI. GOVERNMENT ATTEMPTS TO REGULATE CABLE OPERATORS PACKAGING AND PRICING HAVE BEEN COUNTERPRODUCTIVE. The government should be very cautious in its approach to a la carte. Its attempts to regulate the pricing and packaging of cable program services in the past have been counterproductive. In 1992, for example, Congress passed a law regulating the prices cable operators could charge for program packages. The FCC adopted implementing regulations the following year. Almost immediately, investment capital dried up, delaying cable system upgrades, and impeding the emergence of new programming networks. Moreover, the regulations did not control cable prices. 39 By 1994, the situation was so bad the FCC had to adopt a new set of regulations to counter-balance the negative effects of the prior rules. 40 And, by 1996, only four years after passing the original law, Congress decided to eliminate the entire regulatory scheme, recognizing that it had seriously harmed cable operators, programmers, and consumers alike. 38 Canadian Radio-television and Telecommunications Commission, Frequently Asked Questions (emphasis added), at (last visited Apr. 8, 2004). 39 The FCC s chief economist during this period has said that difficulties arose in regulating the supply of a product as complex as cable television services.... [E]ven under regulation, the prices of various tiers of service can and did increase. Michael L. Katz, An Economic Analysis of the Claims Made by Dr. Mark Cooper in Cable Mergers, Monopoly Power and Price Increases 20, 21 (July 28, 2003); see also Robert W. Crandall & Harold Furchtgott-Roth, Cable TV: Regulation or Competition 106 (1996) (recognizing the rate of technical progress in distributing video signals and the intangible nature of its highly differentiated service and urging regulators to rely more on competition than on regulation in this rapidly changing sector ). 40 These new rules, known as the going forward rules, allowed cable operators to increase the price of a tier when new programming was added. 22

24 A. The Cable Industry Makes A Substantial Contribution to the U.S. Economy. This story is important because the cable industry has become one of the primary providers of entertainment, information, broadband, and telecommunications services, and increasingly exerts a substantial positive impact on the U.S. economy. Consider the following contributions: Employment. In 2002, the cable industry directly employed 176,000 people. Compensation to these employees was nearly $9 billion. When cable-related employment by the industry s suppliers of goods and services is taken into account, the 2002 employment attributable to the cable industry was 1.1 million and the total earnings were $42 billion. 41 Infrastructure Investment. Since 1996, the cable industry has invested over $85 billion to upgrade its infrastructure. 42 From , three-quarters of the industry s cash flow was reinvested in its cable systems. 43 Programming Investment. In 2003, basic cable programmers invested $10.4 billion in programming, and the total investment in programming between 1996 and 2003 was more than $55 billion. 44 Cable Industry Suppliers. In 2002, the cable industry spent $42 billion with suppliers of goods and services. 45 These suppliers included companies in the following fields: utilities, construction, manufacturing, transportation/warehousing, wholesale and retail trade, finance/insurance, real estate administrative services, and arts and entertainment. Contributions to state and local government. In 2003, the cable industry paid over $2.4 billion in franchise fees to state and local governments See Bortz Media & Sports Group, Reinvesting in America: An Analysis of the Cable Industry s Impact on the U.S. Economy (July 2003) ( Reinvesting in America ) See NCTA 2003 Overview at 2. Reinvesting in America at 15. Kagan World Media, Economics of Basic Cable Networks 2004, at 17 (10 th ed.). Reinvesting in America at 6. NCTA 2003 Overview at

25 The cable industry s ability to sustain this level of contribution depends on its ability to generate cash flow. A predictable, sustainable cash flow allows the industry to borrow money, which in turn allows it to make investments in infrastructure, programming, and the introduction of new services, and to create new jobs. The effects of this activity are felt throughout the economy because a healthy, vibrant cable industry spurs investment, production, and job creation by other industries that supply cable hardware, programming, and support services. And, the vast bulk of these jobs will go to U.S. workers. Likewise, the majority of the programming the cable industry distributes is purchased from the creative community that also largely employs U.S. workers. B. A La Carte Would Impede Cable Industry Growth and Have a Negative Impact on the Economy. A la carte would disrupt the industry s cash flow and undermine its ability to continue to make the investments and create the jobs that have become so important to the U.S. economy. This is not just a theory. As noted, the government attempted in 1992 to regulate cable s packaging and pricing. The cable industry s capital expenditures during the period when those regulations were in effect ( ) averaged $4.6 billion per year. 47 In contrast, from 1999 to the present, the industry s capital expenditures averaged $13.3 billion per year. 48 History is clear: in addition to raising consumer prices and reducing program diversity, a la carte pricing would have a serious negative impact on investment, growth, and job creation for the U.S. economy Paul Kagan Associates, The Cable TV Financial Databook 1998, at 27. Kagan World Media, Broadband Cable Financial Databook 2003, at 147 (23 rd ed.). 24