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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************** Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of ) ) Annual Assessment of the Status of ) CS Docket No. 98-102 Competition in Markets for the ) Delivery of Video Programming ) FIFTH ANNUAL REPORT Adopted: December 17, 1998 Released: December 23, 1998 By the Commission: Chairman Kennard and Commissioners Ness, Powell and Tristani issuing separate statements; Commissioner Furchtgott-Roth dissenting and issuing a statement. Table of Contents Paragraph I. Introduction . . . . . . . . . . . . . . . . . . .1 A. Scope of this Report . . . . . . . . . . . . . .. . .2 B. Summary of Findings . . . . . . . . . . . . . .5 II. Competitors in Markets for the Delivery of Video Programming. . .. . .. . .. . .14 A. Cable Industry . . . . . . . . . . . . . . 14 B. Direct Broadcast Satellite Service . . . . . . . .. . .61 C. Home Satellite Dishes. . . . . . . . . . . . . .80 D. Wireless Cable Systems . . . . . . . . . . . . .81 1. Multichannel Multipoint Distribution Service . .. . .81 2. Local Multipoint Distribution Service . . . . .. . .87 E. Satellite Master Antenna Television Systems. . . . .. . .88 F. Broadcast Television Service. . . . . . . . . . .95 G. Other Entrants . . . . . . . . . . . . . . 102 1. Internet Video . . . . . . . . . . . . 102 2. Home Video Sales and Rentals. . . . . . . . .106 H. Local Exchange Carriers . . . . . . . . . . . .110 I. Electric and Gas Utilities. . . . . . . . . . . .. . .120 III. Market Structure and Conditions Affecting Competition. . .. . .. . .122 A. Horizontal Issues in Markets for the Delivery of Video Programming . .. . .122 1. Market Definition . . . . . . . . . . . . .123 2. Concentration in Local Markets . . . . . . . .. . .126 3. Competitors Serving Multiple Dwelling Units. . .. . .129 4. Regional Concentration of Cable Systems . . . .. . .144 5. Concentration in the National Market. . . . . .. . .152 B. Vertical Integration and Other Programming Issues . .. . .158 1. Status of Vertical Integration . . . . . . . .. . .158 2. Other Programming Issues . . . . . . . . . .170 C. Technical Advances. . . . . . . . . . . . . . .195 1. Deployment of Digital Technology . . . . . . .. . .196 2. Navigation Devices. . . . . . . . . . . . .199 IV. Competitive Responses. . . . . . . . . . . . . . . .207 A. New Case Studies. . . . . . . . . . . . . . . .208 B. Preliminary Findings . . . . . . . . . . . . . .. . .232 V. Administrative Matters . . . . . . . . . . . . . . .236 Appendices A. List of Commenters B. Cable Industry Tables C. Horizontal Issues Tables D. Vertical Integration Tables E. Program Access Matters Resolved F. Inquiry Conerning Cable Television Programming Costs -- Report of the Cable Services Bureau I. INTRODUCTION 1. This is the Commission's fifth annual report ("1998 Report") to Congress submitted pursuant to Section 628(g) of the Communications Act of 1934, as amended ("Communications Act"). Section 628(g) requires the Commission to report annually to Congress on the status of competition in markets for the delivery of video programming. Congress imposed this annual reporting requirement in the Cable Television Consumer Protection and Competition Act of 1992 ("1992 Cable Act") as a means of obtaining information on the competitive status of markets for the delivery of video programming. A. Scope of this Report 2. In this 1998 Report, we update the information in our previous reports and provide data and information that summarizes the status of competition in markets for the delivery of video programming. The information and analysis provided in this report is based on publicly available data, filings in various Commission rulemaking proceedings, and information submitted by commenters in response to a Notice of Inquiry ("Notice") in this docket. To the extent that information included in previous reports is still relevant, we do not repeat that information in this report other than in an abbreviated fashion, and provide references to the discussions in prior reports. 3. In Section II we examine the cable television industry, existing multichannel video programming distributors ("MVPDs") and other program distribution technologies, and potential competitors to cable television. Among the MVPD systems or techniques discussed are direct broadcast satellite ("DBS") services and home satellite dishes ("HSDs"), wireless cable systems using frequencies in the multichannel multipoint distribution service ("MMDS") or local multipoint distribution service ("LMDS"), satellite master antenna television ("SMATV") systems and broadcast television service. We also consider several other existing and potential distribution technologies for video programming, including the Internet, home video sales and rentals, local exchange telephone carriers ("LECs"), and electric and gas utilities. We include these services and providers of service because they offer, or are expected to offer, video programming in conjunction with non-video service. 4. In Section III of this report, we examine market structure and competition. We evaluate horizontal concentration of the multichannel video marketplace and vertical integration between cable television systems and programming services. We also discuss competitors serving multiple dwelling unit ("MDU") buildings. We further discuss programming issues and technological advances. In Section IV, we examine a limited number of cases where consumers have a choice between an incumbent cable operator and another MVPD provider in a particular market and report on the effects of this entry. B. Summary of Findings 5. In the 1998 Report, we address the status of competition in markets for the delivery of video programming, discuss how the regulatory changes enacted in the 1996 Act have affected the competitive environment, and describe barriers to competition that continue to exist. The information gathered in this report provides the last comprehensive picture of the state of cable competition prior to March 31, 1999, the date on which the Commission's authority under Section 623(c)(3) to review complaints submitted by local franchising authorities concerning increases in rates for cable programming service ("CPS") tiers sunsets. 6. The Report finds that competitive alternatives and consumer choices are still developing. We find that cable television continues to be the primary delivery technology for the distribution of multichannel video programming and continues to occupy a dominant position in the MVPD marketplace. As of June 1998, 85% of all MVPD subscribers received video programming service from local franchised cable operators compared to 87% a year earlier. 7. There has been an increase in the total number of subscribers to noncable MVPDs. Much of this increase is attributable to the continued growth of DBS, which is attracting former cable subscribers and consumers not previously subscribing to an MVPD. Between June 1997 and June 1998, the DBS grew from approximately 5 million subscribers to 7.2 million subscribers. DBS subscribers now represent 9.40% of all MVPD subscribers compared to 6.85% a year earlier. In addition, new open video systems ("OVS") have launched in a few areas. However, there have been declines in the number of subscribers and market shares of HSD, MMDS, and SMATV over the last year and the one existing LMDS system recently terminated service. There also has been a limited number of additional cable overbuilds in the last year. In communities where the incumbent cable operators face such competition, they respond in a variety of ways, including lowering prices, adding channels at the same monthly rate, improving customer service, or adding new services such as interactive programming. 8. A total of 76.6 million households subscribed to multichannel video programming services as of June 1998, up 4.1% over the 73.6 million households subscribing to MVPDs in June 1997. This subscriber growth accompanied a 2.3 percentage point increase in multichannel video programming distributors' penetration of television households to 78.2% in June 1998. During this period, the number of cable subscribers continued to grow, reaching 65.4 million as of June 1998 up about 2% over the 64.2 million cable subscribers in June 1997. The total number of noncable MVPD subscribers grew from 9.5 million as of June 1997 to 11.2 million as of June 1998, an increase of over 18% since the 1997 Report. 9. During the period under review, cable rates rose more than four times the rate of inflation. According to the Bureau of Labor Statistics, between June 1997 and June 1998, cable prices rose 7.3% compared to a 1.7% increase in the Consumer Price Index ("CPI"), which is used to measure general price changes. A portion of these rate increases is attributable to capital expenditures for the upgrading of cable facilities (up 21% over 1996), an increase number of video and nonvideo services offered, and increased programming costs (license fees increased by 18.4% and programming expenses increased by 20.9%). In addition, we note that there is evidence indicating that where direct competition exists it affects cable operators' pricing decisions. 10. As a general matter, significant competition from telephone companies has not developed even though the Telecommunications Act of 1996 ("1996 Act") removed the barriers to LEC entry into the video marketplace. The 1996 Act repealed a statutory prohibition against an entity holding attributable interests in a cable system and a LEC with overlapping service areas. At the time of the 1996 Act's passage, it was expected that local exchange telephone carriers would begin to compete in video delivery markets, and cable television operators would begin providing local telephone exchange service. With the exception of Ameritech, which has acquired 87 cable franchises and reports that it serves 200,000 subscribers, telephone entry into video markets has been slow to develop. The Bell Atlantic video distribution system in Dover Township, New Jersey, which seemed likely at one time to be the prototype for telephone entry into the video business, will be terminated by the end of 1998 or very early in 1999. Pursuant to its joint marketing agreement with DirecTV, however, Bell Atlantic will give its Dover subscribers the opportunity to switch to DirecTV. In addition, Congress developed the OVS framework as another means to encourage telephone company entry into the video marketplace. Thus far, however, few telephone companies have sought certification to provide video through OVS. Further, the technological convergence that would permit use of the telephone facilities for provision of video service has not yet occurred. 11. Noncable MVPDs that provide competitive pressure on incumbent cable operators and provide consumers with real choice still find regulatory and other barriers to entry in to markets for the delivery of video programming. MVPDs with the potential to compete with incumbent cable operators continue to experience some difficulties in obtaining programming, both from vertically integrated satellite cable programmers and from unaffiliated program vendors who continue to make exclusive agreements with cable operators. In multiple dwelling unit ("MDU") markets, while landlords may have a choice of more than one distributor, potential entry may be discouraged or limited by incumbent video programming distributors that have negotiated long-term exclusive contracts. In addition, consumers report that the inability to provide local broadcast signals, pursuant to current copyright law, is a major drawback of DBS service, which affects their decisions to subscribe to this alternative MVPD. 12. Our findings as to particular distribution mechanisms operating in markets for the delivery of video programming include the following: þ Cable Systems: The cable industry has continued to grow in terms of subscriber penetration, channel capacity, the number of programming services available, revenues, audience ratings, and expenditures on programming. The cable industry remains healthy financially, which has enabled it to invest in improved facilities, either through upgrades or rebuilding. As a result, there have been increases in channel capacity, the deployment of digital transmissions that provide better picture quality than can be offered through analog service, and the initiation of nonvideo services, such as Internet access. Cable operators also are beginning to offer telephony, although the use of integrated facilities remains primarily experimental with limited exceptions. Since the 1997 Report, the cable television industry has continued to grow in terms of subscribership (up to 65.4 million subscribers as of June 1998, a 2% increase from June 1997), channel capacity (some systems, such as Comcast's Orange County, California system, now offer over 120 video channels), number of national satellite-delivered video programming services (up to 245 services by June 1998 from 172 in June 1997, a 41% increase, most of which can be attributed to new digital programming packages such as HBO, HBO 2, HBO 3, HBO Family), revenues (an approximate 8% increase between June 1997 and June 1998), audience ratings (non-premium cable viewership rose from a 38 share at the end of June 1997 to a 41 share at the end of June 1998), and expenditures on programming (an approximate 20% increase in program license fees paid by cable system operators). þ Direct-to-Home ("DTH") Satellite Service (DBS and HSD): Video service is available from high power DBS satellites that transmit signals to small DBS dish antennas installed at subscribers' premises, and from medium and low power satellites requiring larger satellite dish antennas. It is estimated that there are 7.2 million DBS (DirecTV/USSB and Echostar) and medium power (Primestar) subscribers, an increase of almost 43% since the 1997 Report. Industry reports state that 2.2 million of the 3.6 million net new MVPD subscribers in 1998, or almost two thirds, are choosing DBS. Between 3.8 and 4.0 million households are HSD users, although only about 2.0 million HSD subscribers actually purchase programming packages, a 7% decrease in the last year that is likely due to subscribers switching to DBS. DirecTV and Primestar (which is significantly owned by cable operators) have the largest number of DBS subscribers and are again among the 10 largest providers of multichannel video programming service. DBS represented a 9.4% share of the national MVPD market in June 1998 and HSD represented another 2.7% of that market. þ Wireless Cable Systems: Currently, the wireless cable industry ("MMDS") provides competition to the cable industry in only limited areas. MMDS subscribership fell from 1.1 million subscribers to 1.0 million subscribers between June 1997 and June 1998, a decrease of 9%. This drop in subscribership may be the result of a reduction of marketing of analog MMDS service in anticipation of deployment of digital services. The advent of digital MMDS and the recent authorization of two-way MMDS service that will make high-speed Internet and telephony possible have the potential to foster renewed MMDS growth. Wireless cable represented a 1.3% share of the national MVPD market in June 1998. þ SMATV Systems: SMATV systems use some of the same technology as cable systems, but do not use public rights-of-way, and focus principally on serving subscribers living in multiple dwelling units ("MDUs"). SMATV subscribership has declined 19.1% since the last report, with the industry representing a 1.2% share of the national MVPD subscribership as of June 1998. Certain technological advents, such as upgraded facilities, implementation of digital transmission and microwave headend technologies, and expanded service offerings to include DBS programming, Internet access, telephone service, and security services, have the potential to foster SMATV growth. þ Broadcast TV: Broadcast networks and stations are competitors to MVPDs in the advertising and program acquisition markets. Additionally, broadcast networks and stations are suppliers of content for distribution by MVPDs. Since the 1997 Report, the broadcast industry has continued to grow in the number of operating stations (from 1561 in 1997 to 1583 in 1998) and in advertising revenues ($32.5 billion in 1997, a 4% increase over 1996). While audience levels have declined in the last year, the four major television broadcast networks still account for a 55% share of prime time television viewing for all television households. In the last year, the Commission took several actions on digital television and the first DTV television stations started offering service in November 1998. þ LEC Entry: The 1996 Act expands opportunities for LECs to enter markets for the delivery of multichannel video programming. As noted in previous reports, LECs do not yet represent a national presence in the MVPD market. The competitive presence of LECs in specific video markets, however, is growing. In certain areas, especially in the midwest, LECs are already or are becoming significant regional competitors. Particularly notable are the efforts of Ameritech as a cable overbuilder and BellSouth as an overbuilder and MMDS operator. Ameritech has acquired 87 cable franchises, potentially passing more than 1.5 million homes. Seventy-two of these cable franchises are operational, in whole or in part, and it is reported that they serve at least 200,000 subscribers. Bell South has acquired cable franchises in 18 areas, with the potential to pass 1.2 million homes, and is launching digital MMDS service in a number of areas. The growth of the LEC competitive presence in the MVPD market will probably continue in the same manner as it has until now: deliberately, and by a number of different delivery mechanisms. Whether LECs will become nation-wide competitors to the cable industry is less clear. þ Open Video Systems: In the 1996 Act, Congress established a new framework for the delivery of video programming -- the open video system ("OVS"). Under these rules, a LEC or other entrant may provide video programming to subscribers, although the OVS operator must provide non-discriminatory access to unaffiliated programmers on a portion of its channel capacity. The Commission has certified 11 OVS operators to serve 17 areas. Most of the firms receiving OVS certification are not LECs. Bell Atlantic in Dover Township, New Jersey, and RCN in New York City and Boston are the only operating open video systems, no change over the last year. Bell Atlantic, however, is transitioning away from its Dover system and plans to ask customers to switch to its joint venture with DirecTV. Starpower, a joint venture of RCN and Potomac Electric Power Company ("PEPCO") in Washington, D.C. is currently serving 20,000 subscribers with Internet access, local telephone or long distance telephone service, or all three. It expects to begin video service by the end of the year. Between June 1997 and June 1998, the number of OVS subscribers grew from 3,000 to 66,000. þ Internet Video: At the end of 1997, 44% of all households owned a personal computer and 60 million adults and 20 million children were Internet users. Previously, we reported on the availability of software technologies that make real-time and downloadable audio and video from the Internet accessible through a personal computer. We also noted that there are technologies available for the provision of Internet video over a television using set-top box Internet access and through the WebTV and Worldgate service packages. As of June 1998, investment and development of Internet video services was continuing, though video pictures offered by Internet video still remain of less than broadcast quality. Media companies, however, continue to offer increasing amounts of video over their websites in the expectation that the pictures will be acceptable for the intended use or eventually improve to broadcasting or VCR quality. However, the medium is not a direct competitor to providers of traditional video services at this time. þ Home Video Sales and Rentals: Video cassettes and laser discs provide feature films similar to those distributed by cable operators on premium channels and others involved in the distribution of video programming. The most significant development in the home video market in the last year was the increased availability of Digital Versatile Discs ("DVDs") that were first introduced in 1997. DVD technology provides picture and audio quality that is superior to that of video cassettes. As of September 1998, 700,000 DVD players had been purchased, with over 1000 movies, documentaries and concerts available for sale or rental in the DVD format. þ Electric Utilities: Utilities have the potential to become major competitors in the telecommunications industry generally, and in the video marketplace in particular, since they already possess fiber-optic networks throughout the public rights-of-way in the areas they serve. In the last year, several utilities have announced, commenced, or moved forward with ventures involving multichannel video programming distribution. In particular, Tacoma City Light began offering cable service in Tacoma, Washington. PEPCO has formed a joint venture with RCN, named Starpower, that is beginning to offer video, telephone, and Internet services in the Washington, D.C. area. PEPCO is mainly providing its fiber optic backbone to this joint venture. Other utilities, including Black Hills Corporation serving the Rapid City, North Dakota, area and the municipal utility in Coldwater, Michigan, have announced plans to offer video services. 13. We also find: þ Nationally, concentration among the top MVPDs has declined since last year. DBS operators DirecTV and Primestar rank among the ten largest MVPDs in terms of nationwide subscribership along with eight cable multiple system operators ("MSOs"). As a result of acquisitions and trades, cable MSOs have continued to increase the extent to which their systems form regional clusters. The number of clusters of systems serving at least 100,000 subscribers is currently 117, down from the 139 reported last year. Although the number of clusters declined, the trend for clusters to increase in subscribership or size appears to be continuing, and these clustered systems now account for service to approximately 52% of the nation's cable subscribers. By clustering their systems, cable operators may be able to achieve efficiencies that facilitate the provision of cable and other services, such as telephony. þ The number of satellite-delivered programming networks has increased from 172 in 1997 to 245 in 1998. Vertical integration of national programming services between cable operators and programmers, measured in terms of the total number services in operation, declined from last year's total of 44% to just 39% this year, the continuation of a four year trend. However, in 1998, cable MSOs, either individually or collectively, owned 50% or more of 78 national programming services. A year earlier, cable MSOs owned 50% or more of 50 national networks. Sports programming warrants special attention because of its widespread appeal and strategic significance for MVPDs. The Report identifies 29 regional sports networks, many owned at least in part by MSOs. The number of regional and local news networks continue to grow, with 25 news services currently competing with local broadcast stations and national cable networks (e.g., CNN). þ The program access rules adopted pursuant to the provisions of the 1992 Cable Act were designed to ensure that alternative MVPDs can acquire, on non-discriminatory terms, vertically-integrated satellite delivered programming. We recently strengthened our enforcement procedures for these rules. We observe that some former vertically integrated satellite-delivered programming service is now being distributed terrestrially. We recognize that the issue of terrestrial distribution of programming, including in particular regional sports programming, could eventually have a substantial impact on the ability of alternative MVPDs to compete in the video marketplace. We will continue to monitor this issue and the impact on the competitive marketplace. þ Technological advances are occurring that will permit MVPDs to increase both quantity of service (i.e., an increased number of channels using the same amount of bandwidth or spectrum space) and types of offerings (e.g., interactive services). In particular, cable operators and other MVPDs continue to develop and deploy advanced technologies, especially digital compression, in order to deliver additional video options and other services (e.g., data access, telephony) to their customers. To access these wide ranging services, consumers use "navigation devices." In the last year, the Commission adopted rules and policies to implement Section 629 of the Communications Act, which is intended to ensure commercial availability of these navigation devices. The cable industry, through CableLabs, is developing standards for the interoperability of digital set-top boxes and cable modems. II. COMPETITORS IN MARKETS FOR THE DELIVERY OF VIDEO PROGRAMMING A. Cable Industry 14. This section addresses the performance of franchised cable system operators in five major areas: (1) general performance -- both the quantitative and qualitative measures of basic services provided, subscriber levels, and viewership; (2) financial performance -- revenue, cash flow status, and stock valuations; (3) capital acquisition and disposition -- the amount of funds raised and used to improve existing physical plant and acquire new systems; (4) other performance indicators -- system transactions, cable overbuilds, and rates charged by cable operators; and (5) provision of advanced broadband services -- the growth of cable data access, digital broadband services, and broadband telephony. 1. General Performance 15. Since our last report, the cable industry has continued to grow in basic cable subscribership, homes passed, basic cable penetration, premium service subscriptions, basic cable viewership, and channel capacity. In addition, during 1997 and the first half of 1998, the industry began to implement some of its previously announced plans to offer expanded broadband services including digital video, Internet access through cable, interactive cable, and broadband telephony. 16. Cable's Capacity to Serve Television Households The number of U.S. homes with at least one television ("TV households") was reported as 97 million at the end of 1996 and 98 million at the end of 1997 and June 1998. According to one source, the number of homes passed by cable was 93.7 million at the end of 1996 and 94.6 million at the end of 1997, an increase of 1%. The same source indicates that by the end of June 1998, the number of homes passed by cable was 95.1 million. As such, the number of homes passed as a proportion of the number of TV households decreased one tenth of one percent from 96.6% in January 1997, to 96.5% in December 1997, and in the first half of 1998, increased one half of one percent to 97% of TV households. 17. Subscribership. Basic cable television subscribership grew from 63.5 million subscribers at the end of 1996 to 64.9 million subscribers at the end of 1997, an increase of 2.2%, and increased to an estimated 65.4 million subscribers by June 30, 1998, a six month increase of about 0.8%. Basic cable penetration also grew, increasing from 67.8% at the end of 1996 to 68.6% at the end of 1997 to 68.8% at the end of the first half of 1998. The percentage of TV households subscribing to cable continues to increase, rising to 66.2% of all TV households by the end of 1997, and to 66.7% by the end of June 1998. The number of basic cable subscribers as a percentage of the number of homes passed increased from 67.8% in 1996 to 68.6% in 1997 and to 68.8% by June 1998. The number of homes subscribing to premium cable services increased by 1.6% in 1997 to 31.5 million homes from 31 million homes at the end of 1996, and the number of premium services to which homes are subscribing (known as "premium units") increased 2.6%, with 56 million premium units subscribed to by the end of 1997, and an estimated 56.4 million units subscribed to by the end of the first half of 1998, a 0.7% increase. 18. Channel Capacity. Over the past year, cable operators have made significant capital expenditures to upgrade and rebuild cable infrastructure in order to increase channel capacity and provide additional services. Additionally, some operators have chosen to increase channel capacity through the deployment of digital platforms. Through upgrades and rebuilds, which are discussed later in this section, operators can increase the bandwidth of their networks, thus enabling them to offer additional channels of video service, as well as other services (i.e. Internet access, telephony). Through digital compression techniques, also discussed later, operators can have the option of offering their customers more video channels or a higher quality of resolution and reception. Changes to capital infrastructure and types of auxiliary services available are also discussed later in this report. 19. Some operators believe that a system will soon need to offer 150 or more channels to remain competitive. Many have made commitments for upgrades that will enable them to make this possible for their customers. For example, where available, Comcast's digital service offers customers over 175 digital and analog channels including 75 to 85 analog channels, 24 premium digital, 30 to 40 digital pay-per-view channels, and 40 audio music channels. MediaOne's digital service offers approximately 189 channels including up to 77 analog, 72 digital video channels, and 40 digital music channels. Cablevision Systems Corporation offers over 100 channels in some of its service areas, and other operators are preparing to make similar offerings to their subscribers. As such offerings by cable operators continue to be made, average channel capacity for cable systems continues to increase. In August 1997, analysts estimated that the year- end average cable system analog channel capacity would reach 78 channels by year-end 1997, and 90 channels by the end of 1998. 20. According to one source, cable systems with a capacity of 30 or more channels accounted for 83% of cable systems in October 1997. This represents 8,260 systems nationwide. The percentage of systems with channel capacities of 54 channels or more accounted for 19% of cable systems in October 1997, or 1,886 systems. In October 1998, cable systems with a capacity of 30 or more channels accounted for 84.6% of cable systems, or 8,328 systems. Cable systems with channel capacities of 54 channels or more accounted for 20.7% of cable systems in October 1998, or 2,040 systems. 21. In October 1997, 98.2% of all subscribers were served by systems with capacities of 30 channels or more. Moreover, 58.4% of all subscribers were served by systems with capacities of 54 or more channels in October 1997. In October 1998, 98.8% of all subscribers were served by systems with capacities of 30 channels or more and 61.51% of all subscribers were served by systems with capacities of 54 or more channels in October 1998. 22. Viewership. As noted in last year's report, viewership of non-premium cable networks has grown significantly over the past decade, while viewership of broadcast television stations has steadily declined. This trend continues. Twenty-four hour a day, seven day a week, non-premium cable viewership rose from a 38 share at the end of June 1997 to a 41 share at the end of June 1998. Twenty-four hour a day, seven day a week broadcast television viewership decreased from a 64 share at the end of June 1997 to a 61 share at the end of June 1998. 23. Cable Networks. In 1997, the number of basic cable networks increased by five, from 126 to 131 total basic cable networks, a 4% increase. During the first half of 1998, the number of basic cable networks increased by two to 133, a 1.5% half-year increase. The number of premium networks decreased by four networks, from 18 to 14, a 22.2% decrease between the end of 1996 and the end of 1997, but increased by six channels during the first half of 1998, to reach 20 total premium networks, a 42.9% half year increase. The number of pay-per-view networks decreased, from seven to six networks in 1997, a one network, 14.2% decline. The number of PPV networks, however, increased by three networks during the first half of 1998 to reach nine total PPV networks, a half-year increase of 50%. The number of networks classified as combined decreased by approximately 31% or by four networks in the first half of 1998 from 13 to nine. 24. Programming Costs. License fees paid by cable system operators to basic cable network programmers increased by 18.4%, from approximately $3.1 billion in 1996 to $3.7 billion in 1997. Analysts estimate that in 1998 fees will increase by an additional 20.5% to reach $4.4 billion. At the same time, programming expenses for the cable networks themselves have reportedly increased 20.9% in 1997 to $4.1 billion and an estimated 16.7% in 1998 to an estimated $4.8 billion. These increased programming costs for cable operators can be, and often are, passed along to cable subscribers as allowed for under the Commission's rules. 25. In June 1998, a voluntary questionnaire seeking information on the source of programming cost increases was distributed by the Commission to six multiple system operators ("MSOs"). The Cable Services Bureau analyzed the responses and prepared a Report. The responses of four of those questioned revealed that sports programming accounted for 26.7% of total expenditures for regulated programming in 1997 (or $127.6 million). Those four MSOs attributed 19.4% of rate increases to sports programming costs. Some cable operators note that distribution rights for NFL and NBA events have increased by 100% to 150%, while the NHL has increased its distribution rights fees 260%. Cox estimates that 27% of its total programming costs were attributable to sports programming in 1997. MediaOne indicates that its sports programming costs grew to 19.75% of all programming costs in 1997. Comcast notes that within the past few years, almost all regional sports networks have migrated from premium tiers (at $8 -$14 per month) to the basic cable package. Comcast further states that while this migration has likely contributed to the increase in the price of the basic cable package for subscribers, these tier migrations have generally met with customer approval. It also asserts that the shift of sports programming back to the basic cable tiers should address Congress' 1992 concerns regarding customers' lack of access to local sports programming when it is offered on premium channels. 26. The responses to the 1998 voluntary questionnaire also revealed that, according to the same four MSOs, news programming costs accounted for 11.2% (or $53.3 million) of total programming cost, children's programming accounted for 11.5% (or $55.2 million), and the general entertainment category labeled "all other," accounted for 50.6% (or $242.1 million) of the total programming. The MSOs attributed 11.9% of their rate increases to news programming, 4.5% to children's programming, and 64.2% to the "all other category." A&E Networks notes that the audience demand for higher quality programming content has been expanding, and thus programming networks must pay more for the same pool of talent, which consequently increases the price of that talent. This increase in the price for talent often results in an increase in fees charged to cable networks, which are often passed through to cable operators. The networks' strategy to increase original programming and investment in promotion for that original programming also contributes to the rising price of programming. 27. Other expenses incurred by cable operators are copyright fees for broadcast signal carriage. Fees collected for the first half of 1998, however, showed a noticeable decline over past half-years mostly due to the reclassification of WTBS from a distant broadcast superstation to a cable network. As of December 10, 1998, copyright fees paid by cable system operators for broadcast signal carriage under Section 111 of the Copyright Act for the period July 1 to December 31, 1996, were $88.98 million, and for the period January 1 to June 30, 1997 fees collected were $78.23 million. For the period July 1 to December 31, 1997, fees collected as of December 10, 1998 were $77.34 million, and for the period January 1 to June 31, 1998 fees collected were $51.87 million. 2. Financial Performance 28. Data concerning cable industry revenue and cash flow indicate that the cable industry remained financially strong in 1997 and the first half of 1998. Stock prices according to the Kagan MSO Index also show growth in the cable multichannel service operator sector. 29. Cable Industry Revenue. Annual cable industry total revenue grew 10.1% in 1997 to reach $30.784 billion. Analysts estimate 1998 year-end total revenue will reach $32.627 billion, an estimated 6% increase. By the end of 1997, revenue per subscriber grew 7.7% to $479.40 per subscriber per year, or $39.95 per subscriber per month. Analysts estimate that by 1998 year-end revenue per subscriber per year, will reach approximately $500, or $42 per subscriber per month. 30. When cable system revenue is indexed by source, the category with the greatest amount of growth in 1997 was the advanced video services (analog and digital) sector, increasing almost 130%, to reach $208 million, as subscribers began to take advantage of operators' new offerings. Analysts estimate that advanced services revenues will double by the end of 1998 to reach an estimated $424 million. In the more traditional revenue-generating sectors of cable, the greatest revenue generating segment was the pay- per-view sector, which had revenue increases of 27.2% from $647 million annual revenue in 1996 to $823 million annual revenue in 1997. Industry analysts predict total pay-per-view revenue will decrease 5.1% in 1998 to an estimated $781 million. Advertising revenues retained by MSOs increased almost 16% in 1997 from $1.7 billion in annual revenue in 1996 to $1.9 billion in 1997. Industry analysts predict this revenue sector will increase to an estimated $2.2 billion by year-end 1998. Premium tier revenues and home shopping revenues grew the least in 1997. Annual revenue from pay tiers decreased approximately 1% from $4.955 billion in 1996 to $4.952 billion in 1997, and are expected to decline to $4.913 billion by the end of 1998. Revenue from home shopping services grew from $145 million in 1996 to $152 million in 1997, a 4.8% increase, and is expected to increase to $160 million by year-end 1998. 31. Cable Industry Cash Flow. Cash flow may be used to value the financial position of cable firms. Analysts often report industry-wide cash flow in terms of operating cash flow. In the case of individual firms it may be expressed in terms of a proxy known as "EBITDA" (earnings before interest, taxes, depreciation, and amortization). Financial analysts report that industry-wide cash flow increased by 11.6% between the end of 1996 and the end of 1997, from $11.972 billion to $13.369 billion. Analysts estimate that by year-end 1998, cash flow will increase 8% to reach $14.440 billion. For 1997, the cable industry generated approximately $208.23 in annual cash flow per subscriber, about $18 higher than the $190.54 per subscriber generated in 1996. Analysts estimate that cash flow per subscriber per year will increase by approximately $13 to reach $220.80 in 1998. The ratio of cash flow to revenue ("cash flow margin") increased from 42.3% in 1996 to 43.4% in 1997, and is expected to increase to 44.2% in 1998. 32. Stock Prices. Between January 1997 and June 1998, stock market values of cable MSOs, as represented by the Kagan MSO Index, grew steadily, with growth accelerating between the fourth quarter of 1997 and the second quarter of 1998. By comparison, during the same period, both the Standard and Poor's Index of 500 widely-held stocks ("S&P 500") and the Dow Jones Industrial Average ("Dow Jones") grew more modestly. Indexed to a scale of January 1997 equalling 100, all three indices grew during the first quarter of 1998 and most of the second quarter of 1998, but by the end of the second quarter 1998, the Kagan MSO Index grew 59 percentage points more than the Dow Jones and 54 percentage points more than the S&P 500 indices. 33. A number of specific events contributed to the increase in MSO stock market values (i.e. "MSO valuations") in 1997 and the first half of 1998. As we reported in the 1997 Report, the collapse of the News Corporation's planned $1 billion acquisition of Echostar, and Microsoft's $1 billion investment in Comcast, contributed to the increase observed in MSO valuations in 1997. Also contributing to increased market valuations in 1997 were speculations of an AT&T-TCI merger, and Southwestern Bell's decision to exit the MVPD marketplace. AT&T's purchase of Teleport from a consortium of MSOs and purchases made by Microsoft co-founder Paul Allen contributed to increases in MSO valuations in late 1997 and the first half of 1998. The actual announcement of AT&T's proposed purchase of TCI led to increases in MSO market valuations after the second quarter of 1998. 34. Analysts indicate that specific cable operators are finding very high market acceptance to initial launches of cable-telephony service (up to 20% penetration in some areas), which is having a favorable impact on industry-wide stock values. Revenue gains of 6%-11%, and cash flow growth of 8%- 12%, with cash flow margins stable or increasing, also seems to be key to strong industry-wide market valuations. However, some analysts assert that several factors will limit revenue growth in 1998, including public pressure to restrict price increases. 3. Capital Acquisition and Disposition 35. Cable Industry Financing. The cable industry has typically relied on combinations of private and public financing, with the exact distribution of these combinations varying greatly from year to year. These year to year fluctuations in financing sources appear to be based on the availability of acceptable financing rates through private investors or capital lending institutions. Between July 1 and December 31, 1997, the cable industry acquired $865 million in private debt financing (i.e., financing received by MSOs from banks, insurance companies, and other institutional investors). In the second half of 1997, $2.775 billion of net new public debt was issued. The remaining industry financing was obtained through a mixture of private equity (i.e., equity received by MSOs from individuals, private corporations, venture capital firms, and investment banks) and public equity offerings (i.e., stock markets). Private markets yielded $88 million in the second half of 1997, and public markets yielded $180 million. 36. From January through June 1998, the cable industry acquired more private debt than during the same period in 1997. Between January and June 1998, the industry acquired $1.6 billion of private debt compared with $735 million for the same period in 1997. Less public debt was issued between January and June 1998 than during the same period in 1997. Approximately $5.8 billion of net new public debt was issued for the first half of 1998 while approximately $7 billion was issued during the same time period in 1997. Between January and June 1998, $1.7 billion of public equity activity was generated while $1.1 billion was generated for the same period in 1997. Private equity generated from January to June 1998 was $50 million whereas only $12 million was generated between January and June the year before. 37. Capital Expenditures/Capital Investment. In 1997, the cable industry invested a total of about $6.8 billion on the construction of plant and equipment, a 21% increase over the $5.6 billion spent in 1996. Total capital expenditures are expected to grow again in 1998 to reach an estimated $7.7 billion by year's end, an increase of 13%. Expenditures in 1997 included approximately $960 million for maintenance, $700 million for new builds, $1.65 billion for rebuilds, $2 billion for upgrades, and $1.46 billion for converters/ inventory. Most of the expenditures in 1997, projected expenditures for year- end 1998, and expenditures made in the past few years have been for upgrades or rebuilds (i.e. the improvement of existing plant). Since 1995, expenditures for the improvement of existing plant has increased approximately 20% each year. In 1995, operators spent $2.5 billion on upgrades and rebuilds combined, while in 1996, $3 billion was spent, and in 1997, operators spent $3.7 billion. Analysts estimate that in 1998 money spent on upgrades and rebuilds alone will reach $4.3 billion. 38. The trend to improve existing plant reflects the fact that while many systems currently have sufficient bandwidth to provide advanced services they cannot do so without sacrificing channel capacity for existing video services. Additionally, many systems have enough bandwidth to provide two-way services, but not without the risk of ambient interference. Higher amounts of bandwidth allow operators to increase channel capacity for video and other downstream services, as well as the capacity to maintain reliable two-way activated systems. In order to offer customers the advanced, two-way services, such as telephony and cable-only Internet access, cable operators must make their systems two-way activated. Thus, as was discussed earlier, MSOs are expected to improve their systems through increased channel capacity. Indeed, many cable operators are spending millions to upgrade and rebuild their systems. In addition, a substantial portion of total expenditures continues to be spent on new builds, as U.S. housing starts have grown since January 1997. 39. In 1997, many of the large MSOs spent as much as half a billion dollars each on capital expenditures. For example, Cox states that by the end of 1998, it will have spent $3.3 billion over the past five years to upgrade its infrastructure to deploy new services to subscribers. Capital expenditures in 1997 alone for Cox were $708 million. MediaOne spent approximately $1.6 billion in 1997 on rebuilds and upgrades. In 1996 and 1997, Comcast spent $800 million to upgrade most of its cable systems nationwide. In 1998, it expects to spend an additional $700 million. As a result of these investments, Comcast expects to meet its Social Contract commitments with the Commission, such that by March 31, 1999, 80% of its cable subscribers will be served by systems of 550 MHz or greater, with 60% of its cable subscribers served by systems of 750 MHz. Comcast says that 70% of its subscribers are presently served by systems at 550 MHz or higher. Additionally, Comcast has invested in infrastructure that will increase channel capacity and bring high-speed Internet access to several specific systems around the country. 40. In 1997, TCI's cable group spent $538 million, as compared to $1,834 million and $1,591 million during 1996 and 1995, respectively. It is estimated that almost $394 million of its expenditures were for maintenance and extension capital, while $69.2 was for the provision of data services, $56.6 million were for rebuilds and upgrades, and the remaining $20 million for miscellaneous expenditures. Though not specific about where most future upgrades might occur, TCI indicates, prior to its decision to potentially merge with AT&T, that it plans to spend $1.8 billion between 1998 and 2000 to complete its upgrade program. It states that these funds will be used to increase channel capacity, provide high-speed data, and pay-per-view video, but does not include plans for voice telephony. Both AT&T and TCI suppose that $400 to $500 million of the estimated $1.8 billion upgrade will be expended by TCI prior to the anticipated merger, so that one-third of TCI's existing cable plant will be upgraded by the consummation of the proposed merger. 41. As a result of these expenditures, some cable system subscribers now have access to improved cable plant. By the end of the third quarter of 1998, Comcast had upgraded 60% of its homes passed by two-way cable infrastructure of 750 MHz or higher. As of June 1998, Cox had upgraded 56% of its systems to 750 MHZ or higher with 50% two-way activated. Cablevision has just less than half of its systems, or 43%, at 750 MHz or higher, but it has almost three quarters, or 70%, of its systems two-way activated. Media One has 45% of its systems at 750 MHz or higher with 49% two-way activated. Adelphia has 30% of its systems at 750 MHz or higher with 21% two-way activated. And TCI has 20% of its systems at 750 MHz or higher with 26% two-way activated. 4. Other Performance Indicators 42. Cable System Transactions. The number of mergers, acquisitions, and exchanges between MSOs has fluctuated over the past few years. The number of systems sold increased between 1996 and 1997 from 99 to 112 systems. From January 1998 through June 1998, 45 transactions were recorded. The total number of subscribers served and the average system size of systems changing hands continue to vary greatly from year to year. The average system size increased 26.5% from an average 79,322 subscribers per system in 1996 to an average 100,353 subscribers per system in 1997. Between January and June 1998, the average number of subscribers per system transaction was 405,366, a half-year increase of over 300%. The total number of subscribers affected by system transactions in 1997 increased 43.4% from approximately 8 million subscribers in 1996 to approximately 11 million subscribers in 1997. Thus far in 1998, the total number of subscribers affected has been approximately 18 million subscribers. The total dollar value of transactions increased 41.5% between 1996 and 1997, following a 20.3% decrease between 1995 and 1996. The average dollar value per subscriber of transactions was approximately $1,164 between January and June 1998. 43. Overbuilding. From 1995, when overbuild activity began to increase, to June 1998, competing franchises have been awarded covering 149 communities in 21 states with the potential to pass 7.2 million homes. However, not all of the franchises awarded are currently in operation serving customers. Once a franchise is awarded, it takes a significant amount of time for the franchisee to build or gain access to a network over which to provide video service. For example, as of December 1998, Ameritech held 87 franchise awards, but of the communities included in those franchise areas, service is currently being offered in only 72 communities (i.e. parts or whole of the 87 franchise areas). Ameritech's 87 franchise awards gives it the potential to pass 1.5 million homes, and Ameritech thus far has passed 1 million of those homes with its infrastructure. As of December 1998, Ameritech had a total of 200,000 customers. Given these figures, it appears that Ameritech has achieved penetration rates of approximately 10% within its total of 87 franchise areas. This compares with a current national cable penetration rate of 68%. Because Ameritech has not completed construction in all 88 areas, however, its penetration rate in areas of direct competition is significantly higher. Other local exchange carriers ("LECs") also have yet to build out their entire awarded franchise areas. Bell South offers service in parts or whole of nine of its 18 franchise areas. GTE offers service in three of its 11 franchise areas, and SNET offers service in 12 cities within its Connecticut statewide franchise area. More discussion about Ameritech video service provision and other LEC video efforts are discussed later in this Report. 44. Among other smaller firms awarded competing franchises are RCN-BETG, McLeodUSA, Knology Holdings, Inc., Private Cable Ltd., Fiber Vision. New overbuilds since our 1997 Report include McLeodUSA's overbuild in Cedar Rapids, Iowa which competes with incumbent TCI. The competitor offers cable video and audio channels and Internet access, while the incumbent offers cable video and audio channels, with plans to offer Internet access by the end of November 1998. McLeodUSA is also expanding its fiber optic network in the area, over which it currently delivers local phone and long distance service in the city. The company plans to target Des Moines, Iowa next. In May, 1998, Knology Holdings, Inc. was awarded a franchise for 132,000 homes passed in Charleston, South Carolina, where it has started to compete with Comcast and Time Warner. Knology already passes 68,000 homes in Columbus, Ohio; 82,000 homes in Montgomery Alabama; and 97,000 homes in Huntsville, Alabama where it competes with TCI, Charter, Comcast, Media Communications, and Wireless One. Knology, similar to overbuilders RCN and McLeodUSA, offers its customers numerous services including video, telephony and high-speed Internet access services. 45. Among municipal overbuilds since the 1997 Report is Click!, a Tacoma, Washington, municipal overbuild that competes with TCI. Areas where overbuilding is being considered currently include the town of Lebanon, Ohio, and 11 communities in Northern Kentucky. Other communities, such as Breckenridge and Moorhead, Minnesota, have rejected municipal overbuilds. In Virginia, state legislators enacted legislation barring local municipal overbuilds capable of offering telecommunications services. Municipal overbuilding is especially active in Iowa, where 10 communities have decided to overbuild and 12 communities are considering overbuilding. 46. One indication that an overbuilt system may be in operation is the filing for determination of effective competition status, by the incumbent provider, with the Commission. Incumbent providers file such petitions when they believe that an overbuilder presents sufficient competition to meet one of the tests for effective competition in the rules. Since 1995, 57 petitions for determination of effective competition status have been granted by the Commission specifically on the basis of overbuild competition. Each petition represents a franchise which may encompass numerous systems in several communities. For example, within these 57 petitions are 60 individual community units, identified by a Commission-assigned Community Unit Identification number ("CUID"). 47. As discussed later in this Report, a study of selected areas where incumbent cable operators face head-to-head effective competition are discussed later in this Report, shows that such competition often result lower prices, additional channels at the same monthly rate, improved services, or additional nonvideo services. However, in general cable rates have risen more than four times the rate of inflation. According to the Bureau of Labor Statistics, between June 1997 and June 1998, cable prices increased by 7.3% compared to a 1.7% increase in the Consumer Price Index ("CPI"), which is used to measure general price changes. A portion of these rate increases is attributable to capital expenditures for the upgrading of cable facilities, an increase number of video and nonvideo services offered, and increased programming costs. In addition, we note that there is evidence indicating that where direct competition exists it affects cable operators' pricing decisions. 5. Provision of Advanced Broadband Services 48. Cable operators are continuing with the deployment of advanced technologies including digital video, Internet access, and telephony services over their cable systems. As indicated earlier, upgrades to their system infrastructure are being made so that operators can provide quality and reliable new services. Operators also may be choosing to make upgrades to increase system capacity prior to commencing digital transmission or two way services. Additionally, cable systems previously providing only one-way ("downstream") analog service to the customer may require upgrading to eliminate poor electronic connections and other sources of interference prior to providing two-way ("upstream" and "downstream") data services. Two-way infrastructure is necessary for services such as two-way cable modems where data is transmitted entirely over cable and the provision of telephone services over cable wiring. 49. Digital Video Services. As we reported last year, digital signal transmission, as compared to the analog signal transmission historically used in cable systems, can provide superior video picture quality and increased channel capacity through compression techniques. Subscriber reception of digital video signals requires a set-top device to decompress and decode incoming signals and to translate the digital signals into the analog signals used by current television sets. 50. TCI states that digital video is a widely appealing product that will achieve high penetration among its customers and it has made virtually all of its headends capable of delivering digitally compressed tiers. At the end of July 1998, TCI had approximately 600,000 digital customers. Cox is marketing its digital product in six major markets with plans to offer digital service in all nine of its major cluster markets by the end of 1998. Cox's most penetrated digital market is Orange County, California, where it has achieved 10% penetration on a 252,000 subscriber system. As of August, 1998, Comcast was offering digital service in Orange County and Sacramento, California; Greater Philadelphia, Pennsylvania; Baltimore, Maryland; parts of Middlesex, Union, and Essex Counties, New Jersey; Indianapolis, Indiana; and Southeast Michigan. It was expected that Comcast will have 50,000-60,000 digital subscribers by the end of the year. 51. As of June 1998, Time Warner and MediaOne had committed to smaller orders of digital set-top converter boxes, offering service in only a few selected markets. In May, 1998, Time Warner began testing digital cable in its Austin, Texas, system. Time Warner had expected to launch digital service in several major markets by December 1998. As of December 1998, MediaOne was offering digital service to 152,000 homes passed in the suburban Detroit cities of Canton, Plymouth, Northville, and Southfield, Michigan. There are 60,00 subscribers to MediaOne's digital services in the upgraded, 750 MHz system. Analysts predict that digital penetration for six of the nation's largest MSOs will reach between 25%-50% within the next three years. 52. Internet and High-Speed Data Services. Last year we reported thatInternet and other data can be transmitted faster over cable infrastructure than over most telephone systems. Cable systems and cable modems are reported to be offering speeds up to 27 megabits-per-second ("Mbps") as compared with telephone company xDSL technologies that allow consumers to surf the Internet at speeds between 1.5 Mbps and 52 Mbps, though most users experience between only 3 to 10 Mbps for cable and between 1.5 and 7.1 for ADSL, the most widely used form of xDSL. Telephone companies, however, are able to offer customers the ability to access the Internet, while simultaneously talking on the same telephone line. Additionally, telephone companies, in association with xDSL technologies, utilize the "dedicated lines" that run from the telephone company customer's home to the central office, thus can nearly guarantee certain speeds of data transmission. Cable networks use shared network infrastructure to the central office, thus the rate of speed can depend on the number of subscribers using the shared bandwidth at any given point in time. Consumers also can purchase traditional "low-speed" data access for the personal computer, which uses a traditional telephone modem and traditional telephone lines to transmit data, and which yields significantly slower data exchange rates. 53. The current most important differences in cable and high-speed telephone company products are availability and pricing. A number of telephone companies are offering dedicated ADSL. For example, in Washington, DC, Philadelphia and Pittsburgh, Pennsylvania, and Hudson River communities in New Jersey, Bell Atlantic offers 7.1 Mbps downstream (to the customer) and 680 kilobits-per-second ("K") upstream (to the provider) for $109.95 or $189.95 a month depending on whether or not the customer also subscribes to Bell Atlantic's Internet service provider ("ISP") service. There is a one-time $99 connection fee for all service levels. Most cable providers charge between $39.95 and $59.95 per month for service that may provide up to 10 Mbps. Installation for cable modems ranges from no charge up to $499 in rare cases. Typical installation for cable Internet access is around $100. Additionally, cable operators have been marketing their high-speed product longer than the telephone companies. 54. In the last year, access to the Internet over cable generally has become easier. Most cable operators do not require video subscription as a condition of subscription to the Internet. Among the least costly options for Internet access, considering both cable operator and telephone company offerings, are WebTV and Worldgate, which provide Internet access and "hyperlinking" technology. WebTV, which provides television content, as well as Web-surfing and hyperlinking capabilities, uses a special set- top box and keyboard, along with a television and a cable and a telephone connection to get "on-line." WebTV Plus offers programming content not available to regular viewers, and requires additional equipment such as a personal computer ("PC") with a television tuner add-on card and Windows98. WebTV still is working on a technology that would download video overnight for storage in the WebTV set-top box for "video-on-demand-style" service. Worldgate offers Internet access through the standard digital or analog set-top box, already used by consumers, and has its computer processing centralized at the cable headend, thus the data transfer is entirely over cable infrastructure. As such, Worldgate does not require its customers to purchase special equipment to get on-line. 55. The most popular way to get online through cable infrastructure is the use of a cable modem for the personal computer. The connection by cable modem is often less expensive if the customer is also a video subscriber, and the service received may or may not provide original content as well as a connection to the Internet. Virtually all of the major MSOs offer Internet access in some areas and they are expanding service areas to meet demand. Currently, however, service is limited to select markets, such as Orange County, California, and various locales in Connecticut, Florida and New York. Internet access through cable modems will continue to become more widely available as system infrastructure is upgraded, as discussed earlier in this section. Additionally, the commercial availability of cable modems may enhance MSOs' ability to market their Internet access services. Some MSOs, such as Cablevision, have chosen to provide Internet access only in areas where they can provide the access wholly over cable infrastructure instead of providing access with the downstream transfer of data over cable and the upstream path over telephone company wireline ("telco-return"). As of August 31, 1998, more than 15 million homes were passed by Internet access service through cable modem technology and there were approximately 300,000 subscribers. 56. Last year, we reported that cable modem subscribers also may benefit from two services specially designed to increase data transfer speeds through local and regional networks, the @Home network and Road Runner. These services are technologically different from other traditional dial-up on-line services. As we reported last year, @Home service provides its own local network. It has its own routing and caching (storage) servers, which allow the most frequently accessed material from its own content centers and from the Internet to be transferred from the source to these storage areas. As of June, @Home had 147,000 subscribers across North America. Service was available, or was in agreement to be available, for MSOs Bresnan, Cablevision Systems, Century, Comcast, Cox, InterMedia Partners, Jones, Marcus, and TCI customers, as well as Canadian MSOs Rogers and Shaw. As of September 30, 1998, @Home had 210,000 cable modem subscribers, an increase of 43% from just three months prior. As also reported last year, Road Runner Internet service did not build its own national network backbone and customer service infrastructure, rather it formed a partnership with MCI to provide dedicated national and regional backbone service connections to local cable system headends and a network operations center to monitor performance of local cable system data networks. In addition, Road Runner is testing a second version with additional interactive features. Road Runner, formed by Time Warner, reached an agreement in December 1997 to merge with MediaOne's Internet service MediaOne Express. By June 1998, Microsoft and Compaq had invested a combined $425 million in that venture. Road Runner provides service for Time Warner Cable and several MSO affiliates including MediaOne, Cablevision Systems Corp., Century Communications, and Fanch Communications for a combined Road Runner/MediaOne Express subscribership of 70,000. 57. Since our last report, a formal path of certification has been established for cable modem suppliers to obtain an "interoperability seal" for their high-speed data delivery devices under the cable modem standard, DOCSIS (Data Over Cable Service Interface Specification). Originally only one among many proposed standards, DOCSIS started to emerge as the leading option for a cable modem standard in late 1997. Between July 1997 and May 1998 vendors tested prototypes of the equipment. In March 1998, the International Telecommunications Union approved DOCSIS. In June, 1998, CableLabs hosted a series of "Interoperability and Certification Wave" vendor conclaves to initiate the final, "certification and commercialization" phase of a cable modem standard. The formal seal of DOCSIS compliance will be granted by a Certification Board made up of five MSO representatives and a liaison from CableLabs. The goal of all involved parties is to have a standard approved by the end of 1998, and for interoperable modems to become commercially available shortly thereafter. Currently, cable modems are commercially available in some areas, but these modems may not be technically compliant with DOCSIS standards, and may not be interoperable with modems that will appear after DOCSIS certification. Equipment issues are discussed more fully in the technical advances section below. 58. Telephone Services Offered by MSOs. As we reported last year, cable telephony requires sizeable and expensive upgrades and presents a number of technical obstacles. This year, some cable operators have publicly expressed interest in Internet Protocol Telephony ("IP telephony") as a potential alternative to cable telephony. An IP telephony voice call starts out similar to a cable telephony voice call in that both begin with special equipment that connects a household's twisted pair infrastructure and cable infrastructure to one another. The difference between the technologies is that cable telephony eventually turns the call over to traditional "circuit switched" processing, while IP telephony eventually turns the call over to the network of the Internet for Internet Protocol processing. IP telephony treats voice telephone calls like data are treated on the Internet; that is, digitized pieces of data are divided into discrete packets and are transported over the Internet following the path of least resistance. As a result calls made using IP telephony technology may encounter choppiness and delays ("latency"). Today, many features, such as call waiting, are not part of the package of IP Telephony, but will be available to residential customers within the next one to two years. The Internet itself is not designed to provide circuit switched connections, such as those now used by switched telephone networks. Although there are significant technological difficulties that need to be worked out with IP telephony, many MSOs are considering this approach to replace current cable telephony technology. TCI, in conjunction with AT&T, is currently the leading proponent of IP telephony. The cable industry's approach to eliminate latency in IP telephony is to eventually build a backbone network that is separate from the general public Internet backbone. IP telephony is currently being commercially offered on a small scale by providers such as AT&T, Sprint, Qwest Communications, NetWorks Telephony Corporation, Vocal Tec, and numerous small IP Telephony Service Providers ("IPTPs"), but for the most part remains in the development and trial stage, with larger scale deployments expected next year. 59. Last year, we reported that numerous MSOs were offering commercial cable telephony, and we indicated the specific locations where service was being offered. The number of locales where MSOs offer cable telephony has increased in the last year, and it is available to a large number of customers in many markets. For example, Cox is offering "Cox Digital Telephone" in parts of five major markets. MediaOne offers "MediaOne Digital Telephone" in parts of the Los Angeles and Atlanta metropolitan areas. Additional market launches are planned since the number of homes taking the service compared to the number of homes passed by the service ("penetration") has been ranging 10%-19%, and profit margins for cable telephony are in the range of 40%. Cablevision Systems Corporation has commercial telephone operations on Long Island, New York and in several Connecticut markets. It has more limited residential versions on Long Island, but has plans for widespread launches to 200,000 homes on Long Island and locales in Connecticut by the end of the year. Jones Intercable has had continued success with its rollout in the Washington, D.C., metropolitan area and plans to expand service within the region. Jones has attained 27% penetration among the 28,000 homes it passes with telephone service in the Washington, D.C., metropolitan area. TCI continues to provide cable telephony in Arlington Heights, Illinois and Hartford, Connecticut, but is not planning future launches. Time Warner terminated its commercial telephony launch in Rochester, New York, with no plans to launch elsewhere. As of July 1998, Time Warner does not offer local phone service to any of its customers. 60. Multi-Service Offerings. As discussed above, numerous MSOs are offering customers, in many of their service areas, more than standard video services. Multi-service offerings and bundling services for sale seem to enhance subscription to alternative services offered by cable companies. Digital audio and digital, high-resolution video, as well as telephony and Internet access through cable modems are becoming high demand services that cable has the bandwidth capability to offer, depending on the capacity of the particular system. Indications are that customers value receiving these services through "one-stop- shopping." For example, many large MSOs have found that bundling increases penetration of video and of new services. MSOs, such as Cox, MediaOne, Jones, and Cablevision, indicate that bundling their services increases consumer awareness, interest, and ultimately penetration of services while saving on administrative and marketing costs. Many of the small overbuilders such as McLeodUSA, RCN, and Knology started by offering video programming as part of bundled services. Many of these firms depend on their ability to offer multiple bundled services in discounted packages as a way to attract customers. B. Direct Broadcast Satellite Services 61. Direct broadcast satellite ("DBS") operators use satellites to transmit video programming to subscribers, who must buy or rent a small parabolic "dish" antenna and pay a subscription fee to receive the service. Each DBS operator transmits its programming services to subscribers from satellites located at specific orbital locations. DirecTV, United States Satellite Broadcasting ("USSB"), and EchoStar (marketed as the DISH Network) currently offer DBS video programming. In addition, there are several companies, licensed to operate a DBS system who have yet to begin service. Primestar is offered by means of a medium powered fixed satellite service ("FSS") that shares many of the attributes of DBS operators, but requires a larger antenna and has lower channel capacity. All of the above services offer various packages of programming for various monthly fees. DirecTV offers more than 200 channels. USSB, usually ordered in concert with DirecTV's service, offers 20 premium movie channels and access to pay-per- view events. EchoStar offers 240 channels of programming. Primestar offers 160 channels of programming. 62. Subscribership. DBS continues to represent the single largest competitor to cable operators and DBS subscribership continues to show strong growth. The four DBS providers furnished programming to more than 7.2 million subscribers as of June 1998. This is an increase of more than 2.2 million subscribers since June 1997, or nearly 43%. In addition, industry reports state that 2.2 million of the 3.6 million net new MVPD subscribers in 1998, or almost two thirds, are choosing DBS. The Strategis Group projects that DBS subscribership will grow to 20 million by 2003, with its share of the multichannel video market growing to 25%. SkyReport, a trade publication that tracks DBS subscriber growth, estimates that DBS will have 15.2 million subscribers by 2002. 63. DBS versus Cable. Both DBS and cable offer video programming to subscribers for a monthly fee along with premium and pay-per-view services. DBS subscribers continue to report higher levels of customer satisfaction, 30% higher than the cable industry average, according to one recent survey. DBS subscribers have reported that the main advantages of DBS are superior channel capacity (including the capacity for "Near Video On Demand" movies on pay-per-view), digital quality picture, CD- quality sound, and specialized programming such as National Football League or National Basketball Association packages. Some of these advantages, however, may diminish as cable operators roll out digital services that allow cable operators to match DBS operators in number of channels and signal quality. Consumers continue to report that the biggest drawbacks of DBS service are the difficulties associated with the provision of local broadcast signals, and the upfront cost of equipment and installation. As with DBS' advantages, however, these disadvantages vis-a-vis cable have been mitigated somewhat over the past year: equipment and installation prices are dropping, and DBS providers are working toward solutions by which they can supply local channels. It appears that, over time, the differences between cable and DBS will continue to diminish. Currently, it also appears that DBS represents a substitute for some consumers, especially those with access to local broadcast stations. As DBS equipment prices continue to drop and especially if DBS operators are able to offer local broadcast stations, DBS may become a closer substitute to cable for an increasing number of consumers. 64. In the Notice, we sought information for each type of MVPD that described the service provided (e.g., 50 channels of video programming, Internet access) and the average monthly cost to the customer of each service (e.g., video, data) provided by the MVPD. We asked commenters to provide separate cost figures for each type of service offered by the MVPD. We sought information that would reflect: (a) the up-front costs for equipment and installation for each service; (b) the costs of adding each service to more than one television set; (c) prices for the various program options and packages offered by each service; (d) the costs of receiving local broadcast stations along with each service; and (e) any other information relevant to consumer considerations when selecting among services. Further, we sought comment on the appropriate method for comparing the services and costs of different MVPDs. For example, for services that require the purchase, rather than the rental, of equipment, should the costs of equipment be amortized over a period of time? What is the appropriate time period? Are there other factors that we should consider in making such comparisons? Commenters did not provide information that would allow comparisons of the costs to consumers of subscriber to various MVPDs. We recognize that such comparisons are difficult to the the wide range of prices for equipment and the variability of programming packages offered and their prices. We also observe that some providers are now offering free equipment along with long term commitments to purchase programming, making such comparisons particularly difficult. 65. Availability of Local Broadcast Stations. In 1988, Congress passed the Satellite Home Viewer Act ("SHVA"). In the Satellite Home Viewer Act, Congress granted a limited exception to the exclusive programming copyrights enjoyed by television networks and their affiliates because it recognized that some households are unable to receive network station signals over the air. The exception is a narrow compulsory copyright license that direct-to-home (DTH) satellite video providers may use for retransmitting signals of a defined class of television network stations "to persons who reside in unserved households." The SHVA also contains a "superstation" compulsory copyright license with no geographic restrictions. The term "unserved household," with respect to a particular television network station is defined by SHVA to mean a household that -- (A) cannot receive, through the use of a conventional outdoor rooftop receiving antenna, an over-the-air signal of grade B intensity (as defined by the Federal Communications Commission) of a primary network station affiliated with that network, and (B) has not, within 90 days before the date on which that household subscribes, either initially or on renewal, to receive secondary transmissions by a satellite carrier of a network station affiliated with that network, subscribed to a cable system that provides the signal of a primary network station affiliated with that network. 66. In August 1997, the Copyright Office issued a report which, among other things, recommended that Congress amend the Satellite Home Viewer Act to eliminate the Grade B signal standard and the 90 day waiting period. In 1998, two bills were introduced in Congress to make changes in the SHVA. No Congressional action, however, was taken on this issue, and the two bills expired at the end of the Congressional term. 67. DirecTV and Primestar currently offer retransmission of distant broadcast signals to unserved households through third party satellite program packagers -- PrimeTime 24 and Netlink, respectively. USSB does not offer a package of distant signals to its subscribers. Most USSB subscribers, however, receive DirecTV and can request its package of network signals. EchoStar does not contract with an outside provider but, instead, offers its subscribers its own "DISH" branded packages of east coast and west coast signals. In addition, EchoStar states that it now offers local-into-local service to unserved households in 13 markets: Pittsburgh, Miami, Denver, Salt Lake City, Phoenix, San Francisco, Boston, New York City, Washington, D.C., Atlanta, Chicago, Dallas, and Los Angeles. These subscribers receive their local ABC, CBS, NBC, and Fox affiliates, and the national feed of PBS. EchoStar plans to add markets, eventually serving 20 local markets. EchoStar subscribers who want either form of broadcast signals must purchase a second dish, but do not need any other additional equipment. 68. Recently, this practice of retransmitting network broadcast stations by DBS has become the subject of civil litigation. Network broadcasters filed suit against PrimeTime 24 in Florida, North Carolina, and Texas, alleging that PrimeTime 24 was supplying network broadcast signals to DBS subscribers who were not "unserved" in violation of the SHVA. Thus far, rulings have been issued in the United States District Court for the Southern District of Florida, involving the local CBS and Fox affiliates and in a Raleigh, North Carolina federal district court, involving the local ABC affiliate. In both cases, the courts found that PrimeTime 24 had violated the SHVA. In the Florida case, the court, finding evidence that violations of the SHVA had taken place, issued a preliminary, nationwide injunction ordering PrimeTime 24 not to deliver CBS or Fox television network programming to any customer that does not live in an unserved household. The court initially provided PrimeTime 24 with 90 days to comply with the preliminary injunction, which applies only to subscribers who signed up with PrimeTime 24 after March 11, 1997 (the day the plaintiffs filed their lawsuit). The parties subsequently and jointly agreed to an extension of the compliance date to February 28, 1999, and the court approved the parties' agreement on October 6, 1998. If enforced, the preliminary injunction could result in the termination of network signals to an estimated 700,000 to one million subscribers. A permanent injunction could end satellite network service to as many as 2.2 million subscribers. 69. In the Raleigh case, the federal district court also ruled against PrimeTime 24. A permanent injunction followed on August 19, 1998. Similar to the Miami ruling, the court found that the SHVA defines unserved household and Grade B using strictly objective standards. PrimeTime 24 has provided network services to as many as 35,000 households in the ABC affiliate's Raleigh/Durham market. At the time of the court's decision, PrimeTime 24 continued to serve more than 9,000 subscribers within the affiliate's Grade B contour. 70. Subsequently, the NRTC, an investor in DirecTV and an MVPD serving home satellite dish ("HSD") customers, filed an emergency petition with the Commission urging that it adopt a new standard of "Grade B intensity" to be used to define unserved households in the SHVA. The effect of the NRTC proposal would be that many viewers who are now deemed able to receive a local network signal would be redefined as unserved households eligible to receive distant network signals from their satellite service providers. EchoStar, in a separate petition, asks the Commission to establish a more accurate way to predict and measure whether a household receives a signal of Grade B intensity as currently defined. The Commission issued an NPRM on November 17, 1998 in response to these petitions. EchoStar also has filed suit in Colorado Federal court against the four major networks and their affiliates, seeking a declaration that EchoStar's transmission of distant network signals is legal under the SHVA. Finally, in November, ABC, CBS, Fox, and NBC filed suit against EchoStar in the Miami District Court, claiming that EchoStar's DISH NETS offerings are an effort to circumvent the previous Miami ruling against PrimeTime 24. 71. The litigation, petitions, and legislative proposals do not, however, address the reception of local signals by satellite subscribers in their own local stations markets. According to the Copyright Office, the retransmission of local signals by satellite carriers is not specifically addressed in the SHVA "because the technology did not exist to make such local retransmission possible [but] if satellite carriers could retransmit the signals of local network stations to subscribers, the concern that led to the unserved household provision would theoretically become resolved." Technological issues, however, may make nationwide local-into-local service infeasible. The SHVA NPRM seeks comment on this issue. While cable systems are terrestrially-based and designed to deliver both local and national programming to discrete local markets, DBS systems deliver their programming on a national basis from orbital locations that cover the entire United States. In addition, there are over 1500 television broadcast stations in the U.S. and DBS providers may not have the channel capacity to accommodate the nationwide retransmission of local broadcast stations along with their currently offered national programming. We note that Northpoint Technology, L.P. has filed a petition with the Commission seeking permission to use DBS spectrum to transmit local broadcast signals (and other services). We further note that Capitol Broadcasting Company, Inc. has announced plans to provide local-into-local service to DBS operators for the entire country. 72. An additional retransmission issue involves the fees paid by DBS carriers for carriage of broadcast signals. In August 1997, the Copyright Office of the Library of Congress decided that the compulsory license fee for superstations (previously either 14 cents or 17.5 cents, depending on whether or not they carried nationally-cleared programming) and broadcast stations (previously six cents) should increase to 27 cents to reflect "fair market value." This determination became effective January 1, 1998, but is stayed pending review by the U.S. Court of Appeals for the D.C. Circuit. In 1976, Congress determined that the retransmission of copyrighted works by smaller cable systems whose gross receipts from subscribers were below a certain dollar amount deserved special consideration because of their mostly rural locations. Therefore, in effect, the cable compulsory license subsidizes smaller systems and allows them to follow a different, lower-cost royalty computation. Large systems, on the other hand, pay in accordance with a highly complicated and technical formula. The change in the royalty fee and confusion over the manner in which fees are assessed has led to even greater controversy as to whether an industry is being disadvantaged. SBCA stated that "average cable systems" pay an average fee of between 2.45 and 9.8 cents, and that the decision to raise royalty fees for satellite carriers to 27 cents creates a competitive disadvantage for DBS. The Leagues, however, assert that this comparison is invalid because, among other reasons, DBS operators do not compare evenly with the SBCA's "average cable system," and because cable systems pay a range of royalties as opposed to the flat fee paid by DBS operators. MPAA, representing copyright holders, performed its own analysis of comparative fees. Its approach shows that cable systems generally pay more than the 27 cent rate when carrying four or more distant signals. 73. Equipment Prices and Installation. In the 1996 Report and the 1997 Report, we noted that DBS equipment prices, and other "upfront costs," such as installation, were declining. We also noted that DBS operators were aggressively pursuing marketing plans and discount packages to increase demand for their products. Both trends have continued. Strategis Group found that ". . .equipment costs have spiraled downward." For example, EchoStar recently offered installation for $49, as opposed to the normal price of $199. EchoStar also launched separate promotions in which: (1) it will give new subscribers the second dish required for local signals, and (2) it will give away the DBS dish to new subscribers who sign up for a year of certain programming. In terms of specials, DirecTV has offered $200 of free programming with installation and orders for certain programming. In addition, some of the joint marketing agreements with telecommunications companies, discussed below, lower upfront costs. Customers still cite, however, the cost for connecting multiple television sets so that they can watch different programming on different sets, as compared to the lower cost for this capability with cable, as an area where cable has an advantage over DBS. 74. New Marketing Efforts. In the 1996 Report, we indicated a trend toward marketing satellite video programming with telecommunications and information services. In the 1997 Report, we noted that AT&T ended its effort to market DirecTV's and USSB's satellite programming and DBS equipment, but that an agreement with Cincinnati Bell had been very successful. Over the past year, DirecTV and USSB began joint marketing agreements with GTE, Bell Atlantic, and SBC. GTE markets the DBS service in Los Angeles and Dallas with inserts in its telephone bills, and sells the service through retail locations in those cities. Bell Atlantic and SBC have marketing programs they consider to be complete "cable replacements," and are buying the DSS equipment themselves and leasing it to subscribers, thus lowering upfront costs, and installing an antenna for local signals. In a new strategy, DirecTV signed an agreement under which it replaced a cable operator as the provider for an entire homeowners association. DirecTV also is involved in joint marketing, sales, and distribution agreements with three small cable operators: Austin, Texas-based Classic Cable, Chicago-based Anderson-Eliason Cable Group, and Sikeston, Missouri- based Galaxy Telecom. These agreements will result in joint analog-cable/digital-DBS basic programming packages. DirecTV has also signed similar agreements with SMATV operators, and with CS Wireless, an MMDS operator. EchoStar recently pledged that it will not raise its rates for certain types of programming until after March 1, 2000. 75. Data and Interactive Services. DirecTV offers a satellite-delivered high-speed Internet access service ("DirecPC"), with a telephone return path. This service allows up to a 400 kbps downstream connection, which is slower than cable modems, but is more than seven times faster than analog telephone modems. This service is available independent of DBS service or, with DirecDUO, a dual-functioning DBS antenna, consumers can receive both video programming and DirecPC services. EchoStar formed a deal with OpenTV, Inc. (a company which produces interactive television technology) in order to offer interactive services, to its subscribers early next year, such as e-mail and on-line banking, and to incorporate OpenTV technology in its next generation of receivers. Finally, both Motorola and Thompson announced that they were going to produce equipment, including DSS systems, which would include Internet access capability. 76. High Definition Television. DirecTV has aggressively promoted the advent of High Definition Television ("HDTV"). In late July, Thomson Multimedia entered an agreement with DirecTV under which Thomson would build televisions and set-top boxes which combine DSS reception with digital terrestrial signal reception. DirecTV also announced that it will begin its own transmission of 24-hour HDTV signals at the end of 1998, probably beginning with pay-per-view events. USSB has announced plans to carry HBO's HDTV signals as soon as they are available, perhaps at no additional cost to subscribers. EchoStar has said that it will carry some of HBO's HDTV programming, but has not specified how much. 77. Ownership. Beginning in September 1997, Primestar Inc., a medium power satellite company owned by the five largest cable companies in the U.S., sought to acquire the high power orbital location awarded to MCI (now MCI-WorldCom) by the Commission along with two high-power DBS satellites currently under construction for $1.1 billion in nonvoting convertible securities. Primestar also proposed to reorganize its ownership structure and sought to transfer control of the DBS channels licensed to Tempo from its subsidiary TSAT to Primestar. Acquisition of these high power DBS assets would have given Primestar the capacity to become a high-power DBS operator, allowing its customers to use smaller antennas and increasing its channel capacity. In May 1998, the U.S. Department of Justice ("DOJ") sued to block this transaction over concern that the cable ownership of Primestar, combined with the assignment of MCI's DBS channels would "substantially lessen competition and tend to create a monopoly in markets for the delivery of multichannel programming services." Subsequently, Primestar announced that it would withdraw its petition to acquire ASkyB's orbital slot and would focus on its medium power business and seek financing to support that business. It admitted at that time that it faced challenges in this area due to a lowered credit rating. Other reports indicated that Primestar was attempting to sell its subscribers and slots to either DirecTV or EchoStar. Primestar has subsequently announced that it would not need to sell its assets due to new support from its major shareholders, that it would continue to build its medium-power business, and that it would launch a new high-power DBS service using licenses and a satellite it is in the process of acquiring from TCI Satellite Entertainment. As noted above, EchoStar has reached an agreement to acquire ASkyB's satellite assets, but the agreement has not been finalized. Finally, also noted above, DirecTV's parent corporation, Hughes, has reached an agreement to acquire USSB, but the agreement has not closed. 78. DBS Public Interest Obligation. On November 19, 1998, the Commission adopted rules implementing Section 25 of the 1992 Cable Act, which imposed certain public interest obligations on DBS providers. The statute requires DBS service providers to set aside a percentage of channel capacity for non-commercial programming of an educational or informational nature. In implementing the statutory requirement, the Commission ruled that DBS providers must set-aside four percent of their channel capacity exclusively for non-commercial programming of an educational or informational nature. In carrying out Congress's mandate, the Commission balanced two important goals -- providing DBS subscribers access to a greater diversity of non-commercial, educational programming, and providing flexible rules for an industry that promises to provide significant competition to cable television. The Commission anticipates that a variety of programming could soon become available on DBS systems, including, for example, distance learning programs produced for all ages, major university research projects shared nationwide, and health applications developed for rural America. As specifically required by statute, DBS licensees must also now comply with the political broadcasting rules of Section 312(a)(7) of the Communications Act, granting candidates for federal office reasonable access to broadcasting stations, and 315 of the Act, granting equal opportunities to candidates at the lowest unit charge. 79. Barriers to Competition. DirecTV, NRTC, and SBCA also favored a broad extension of the Commission's rules on placement of over-the-air reception devices to MDUs and renters to allow further competition for households in these situations. The Commission recently modified the rules to permit viewers who rent property to install and use antennas where they have exclusive use, such as balconies or patios, in order to remove this barrier to competition to the extent permitted by Section 207 of the Telecommunications Act of 1996. DirecTV and NRTC also urge that the Commission's program access rules must be strengthened to include terrestrially-delivered programming, to impose damages for evading program access rules, and to expedite the resolution of program access complaints. For instance, DirecTV states in its comments that, "...if meaningful competition to the television industry is ever to emerge, the law's provisions should be strengthened, not diluted." DirecTV states that, in regard to the Commission's Inside Wiring rules, exclusive contracts for providing service to MDUs should be forbidden, and that incumbents in MDUs should be required to share inside wiring where technically feasible. DirecTV also supports proposals in Congress to require cable operators to provide a lifeline tier. C. Home Satellite Dishes 80. As we have previously reported, the difference between DBS service and HSD service is mainly the use of a much larger dish. While some HSD owners receive only non-subscription programming, the number of subscribers most relevant to an assessment of the MVPD market is the figure for authorized subscribers who receive much of the same programming generally provided to cable and other MVPD subscribers. HSD package programming subscribership has declined from 2,184,472 in June 1997 to 2,028,225 in June 1998, or by 7.2%. Much of the decline in HSD subscribership results from owners switching to DBS services. DBS firms like DirecTV have launched aggressive advertising and promotional campaigns encouraging consumers to switch from HSD to DBS service. D. Wireless Cable Systems 1. Multichannel Multipoint Distribution Service 81. MMDS systems, often referred to as "wireless cable," transmit programming to subscribers through 2 GHz microwave frequencies, using Multipoint Distribution Service ("MDS") and leased excess capacity on Instructional Television Fixed Service ("ITFS") channels. An MMDS system must have a line-of-sight ("LOS") path between the transmitter or signal booster and the receiving antenna. When using analog signals, MMDS operators have a maximum of 33 microwave channels available in each market, including 13 MDS channels and 20 ITFS channels. Digital MMDS significantly increases this signal capacity, and also improves picture and audio quality, along with making two-way services, such as high- speed Internet access and telephony, possible. 82. At present, the MMDS industry provides competition to the cable industry only in limited areas. The capacity of analog MMDS systems, 33 channels, is generally not competitive with most cable systems, and subscribership drops for MMDS reflect this fact. These subscribership drops, coupled with capital spending aimed at the development of digital MMDS, has put MMDS operators under severe financial strain. According to one report, WCA believes, however, that the advent of digital MMDS and high-speed Internet access will improve the industry's financial status. 83. MMDS Capacity to Serve Television Households and Subscribership. The number of homes with a serviceable line of sight to an MMDS operator's transmission facilities grew from 60,300,000 at the end of 1996 to 61,800,000 at the end of 1997, an increase of 2.5%. The number of homes capable of receiving an MMDS operator's signal (commonly referred to as "homes seen") grew from 31,500,000 at the end of 1996 to 34,000,000 at the end of 1997, an increase of 8%. MMDS subscribership fell from 1,180,000 at the end of 1996 to 1,050,000 at the end of 1997, a decrease of 11%. As stated in the 1997 Report, this drop in subscribership may have resulted from a reduction of marketing of analog MMDS service in some markets in anticipation of deployment of digital service. 84. Financial Performance. The wireless cable industry's total revenues for 1997 were $440 million, a 4.8% increase from the $420 million in 1996. Numerous questions about the industry's viability were raised in the last year, however. First, in April, Standard & Poor's lowered the debt rating on all wireless cable companies to CCC+, and Heartland Wireless, a large wireless operator, to D, stating that analog wireless cable is not a viable competitor to cable. Three months later, CAI Wireless, one of the largest wireless cable operators, declared Chapter 11 bankruptcy. More recently, Heartland Wireless also declared bankruptcy. As stated above, according to one report, WCA believes that the advent of digital MMDS and high-speed Internet access will improve the industry's financial status. 85. Internet and High-Speed Data Services. On September 17, 1998, the Commission adopted an order authorizing two-way digital ITFS and MDS communications. This action will permit these licensees to provide two-way high-speed Internet access, video conferencing, distance learning, continuing education, or any other two-way service using MMDS and ITFS spectrum. While three wireless cable operators have already received limited approval to offer wireless two-way services, the Two-Way Order provides licensees and operators greater flexibility to provide broadband two-way wireless services, and establishes a framework for expedited licensing of two-way facilities. In addition, Commission staff has granted developmental authority for wireless two-way services in several markets. 86. Barriers to Competition. WCA requests that Congress amend the program access statute to apply to all programming, regardless of method of delivery or affiliation, in order to assure wireless cable operators access to all programming and thus improve their ability to compete in the MVPD market. Antilles, a small wireless operator, in its comments states, "Smaller wireless operators like Antilles Wireless suffer from a serious lack of accessibility to programming. While the Cable Television Consumer Protection and Competition Act of 1992 theoretically outlawed discrimination by programmers in the offering of programming to wired and wireless video operators, the real world has yet to see the benefits of the law." Several other commenters, however, disagree with WCA's position on program access, stating that expanding program access rules could damage the programming industry. WCA also states that: (a) the Commission's cable-MDS cross-ownership rule, cable-MDS cross-leasing rule, and cable-ITFS cross-leasing rule unduly restrict investment in the wireless cable industry by the cable industry; (b) Congress should clarify the Commission's jurisdiction over home run wiring, thus improving cable competitors' ability to provide service to MDUs; and (c) Congress should clarify that competitive bidding is not required to resolve new, mutually exclusive ITFS applications to assure the continuation of ITFS as a local and non-commercial service. An additional competitive issue was whether the Commission's OTARD rules would be extended to MDUs and renters. As noted earlier, the Commission recently modified the rules to permit viewers who rent property to install and use antennas where they have exclusive use, such as on balconies or patios. 2. Local Multipoint Distribution Service 87. Previously, the Commission reported that LMDS was a potential competitor in the MVPD market. It now appears the LMDS licensees will not be competitors in the video market, at least in the short term. Analysts and bidders in the LMDS auctions stated that plans for LMDS were for commercial voice and high-speed data, and that LMDS is not currently suited for video delivery or for residential service. At the end of November 1998, the only existing provider of video over LMDS, CellularVision in New York City, sold more than half its spectrum to WinStar, a competitive local exchange carrier. Winstar intends to use this spectrum to build an Internet access business. CellularVision has announced that it will quit the video business and use its remaining spectrum to offer high-speed Internet access. E. Satellite Master Antenna Television Systems 88. As we indicated in last year's Report, SMATV systems are satellite systems used to distribute television signals to households located in one or more adjacent buildings, primarily serving urban and suburban MDUs. SMATV systems do not use public rights-of-way and, thus, fall outside of the Communications Act's definition of a cable system. As such, SMATV operators are subject to less regulatory oversight than traditional cable systems. Some SMATV systems also are using microwave transmissions and wires to serve multiple buildings that are not commonly owned. Under the 1996 Act, SMATV operators may use wires to connect separately owned buildings, as long as the wires do not traverse public rights-of-way. It was thought that the statutory change that allowed SMATV systems to connect separately owned buildings would encourage growth in the private cable industry. 89. On January 10, 1998, Entertainment Connections, Inc. ("ECI") filed a motion for declaratory ruling with the Commission seeking a determination that it was not a cable operator, and therefore, not required to obtain a franchise under section 621 of the Communications Act of 1934. ECI uses Supertrunking Video Transport Service, provided by Ameritech, to transport video programming across public rights-of-way to subscribers located in multiple dwelling units ("MDUs") in two Michigan cities. ECI's facilities are located solely on private property, not crossing any public rights-of-way, and Ameritech's facilities that deliver signals from ECI's headend facilities to the MDUs served by ECI are not owned, managed, or controlled by ECI. On June 4, 1998, the Commission adopted a Memorandum Opinion and Order, granting ECI's Motion for a Declaratory Ruling. The Commission concluded that ECI is not a cable operator as defined by the Communications Act and is not obligated to comply with the requirements of Title VI of the Communications Act, including the franchising obligations of Section 621. In granting ECI's motion, the Commission decided that ECI's facilities and Ameritech's facilities do not constitute a single integrated cable system, and that it is Ameritech, not ECI, that "uses" the rights-of-way as the Commission and courts have interpreted the term. 90. Growth. As we have reported in the past, the SMATV industry is composed of hundreds of private and public, small and medium size firms throughout the nation. As of 1990, there were almost 31.5 million "households" (or, individual "dwelling units") in MDUs in the United States, compromising approximately 28% of the total housing units nationwide. As such, SMATV operators continue to have the potential to serve over one quarter of housing units nationwide. Last year, we reported that there were approximately 1,162,500 residential SMATV subscribers, as of June 30, 1997. This year, there are several varying estimates of SMATV subscribership. One source estimates that there were 940,000 residential SMATV subscribers, as of June 1998, a decrease of 19.1% from the previous year. This estimate would place SMATV's share of the MVPD market at 1.21%. Another source estimates that as of June 1998, there were approximately 800,000 residential SMATV subscribers, and anticipates that the number of SMATV subscriptions will continue to decline. A SMATV industry source estimates that as of June 1998 there were approximately 1.5 to 1.6 million subscribers. It states that this figure is an estimate based on a growth rate in excess of 10% per year, consistent with growth rates in prior years. 91. Although subscribership over the past year appears to have declined, certain technological advents have the potential to foster SMATV growth. As we reported last year, many SMATV operators are upgrading their systems to 750 MHz hybrid fiber coaxial broadband architecture capable of transmitting hundreds of channels using digital compression. This year, common carrier supertrunking and the continued use of technologies that integrate DBS antennas and standard SMATV technology, as described below, have the potential to foster SMATV industry growth as well. These technological advances and the regulatory changes that have allowed SMATV operators to use them, enable operators to serve separately- owned buildings and increased numbers of potential subscribers. Future growth, however, not only depends on the ability of SMATV operators to provide channel lineups and basic services comparable to those offered by franchised cable operators, but also demands that SMATV providers offer combination services as well as video, at attractive prices. 92. Technology. As we reported last year, some SMATV operators offer local and long distance residential telephone service as well as closed-circuit security monitoring, interactive and Internet access, voice mail, paging, and other business services tailored to the needs of residential tenants. This year, the demand for these services has increased. As a result, some SMATV operators have begun to upgrade their networks for providing local residential phone service. Many have started to use a variety of new networking arrangements, turning away from private branch exchange ("PBX") technology to a standard central-switch operation enabling SMATV operators to offer service levels on their telephone service equal to that of the independent local exchange carriers, including caller ID, call return, call rejection, distinctive ringing, and other such specialized features. OpTel, one of the largest SMATV operators, is currently licensed as a CLEC in each state in which it competes. Additionally, new technologies are being introduced into the SMATV industry that are not found with other MVPD technologies. For example, one entrepreneur has developed an electronic, touch-screen monitor kiosk to be placed on-site at the MDU that provides information about the services offered in the MDU including channel lineup, rates, a credit-card swipe to order services such as PPV, Internet, and telephone service. 93. SMATV/DBS Combination Services. According to some industry observers, the decision of SMATV providers to take advantage of DBS technology to provide video programming service to residents of multiple dwelling units has been beneficial for both SMATV and DBS providers. As we reported last year, satellite providers such as DirecTV/USSB, Primestar, and Echostar offer SMATV operators a low-cost, technically-advanced, digital programming service that significantly increases channel capacity and adds special programming that is otherwise unavailable from cable systems or MMDS operators. DirecTV, for example, has formed a number of alliances with SMATV operators such as WirelessOne, OnePoint Communications, and Heartland Wireless. NCTA states that, in the case of Wireless One, the company keeps approximately 20% of the revenue generated, with the rest going to DirecTV, which supplies equipment and programming. 94. Real Estate Owners and Property Managers. As we reported last year, Real Estate Investment Trusts ("REITS") and other national property management companies and ownership groups, with numerous interstate property holdings, are negotiating with programming and other MVPD services on a national basis. According to industry observers, private property owners are becoming more adept in negotiating contracts with SMATV operators, allowing for revenue sharing and demanding increased services for subscribers. An industry source indicates that an increasing number of small and large MDU owners and real estate investment trusts are negotiating with SMATV operators to provide service in their buildings regionally and nationally because SMATV can offer a viable alternative to other MVPDs in terms of number of channels, installations and maintenance, and the provision of service at rates comparable or lower than incumbent providers. SMATV operators in Cincinnati and Chicago, in particular, are finding REITS and apartment building owners are forming consortiums and seeking SMATV bids for thousands of apartment buildings. F. Broadcast Television Service 95. Broadcast networks and stations are competitors to other MVPDs in the advertising and program acquisition markets. Additionally, broadcast networks and stations are suppliers of content for distribution by MVPDs. Since the 1997 Report, the broadcast industry has seen continued growth in the number of operating stations and in advertising revenues. The number of commercial and noncommercial television stations increased to 1583 as of August 31, 1998, from 1561 as of July 31, 1997. Broadcast total advertising revenues reached $32.5 billion in 1997, a 4% increase over 1996. Advertising revenues for the six broadcast networks alone reached $15.2 billion in 1997. Network advertising rates, however, are estimated to have dropped by 3% between the 1998-99 and 1997-98 seasons (in comparison to an average increase of 6.5% since 1980), mainly because of competition from cable networks. Broadcasters sold slightly more advance commercial time for the 1998-99 season (between $6.4 and $6.5 billion) than was sold for the 1997-98 season (between $6.25 billion and $6.3 billion). In comparison, cable programming networks received $5.7 billion in advertising revenue in 1997, an increase of 16% over 1996. 96. During the 1997-98 television season, the four major networks (i.e., ABC, CBS, Fox, and NBC) accounted for a combined 55% share of prime time viewing among all television households (compared to 59% in the previous year); UPN and WB, the two newest networks, achieved a combined 9% share of prime time viewing, the same as last year. The most recent data available for households subscribing to cable service indicate that programming originating on local broadcast television stations accounted for a combined 58% share of all day viewing in the 1996-97 television season, while non-premium cable networks and pay cable services achieved a combined 54% share of all day viewing, up from 51% the previous season. On August 31, 1998, PaxTV, a new national broadcast network began operation. PaxTV generally offers family-oriented programming, and uses cable carriage or C-Band carriage to reach some households in areas where it does not have a broadcast affiliate. 97. The Commission took several actions on digital television ("DTV") during the past year. First, the Commission reallocated television channels 60-69 for public safety use and to free some of the spectrum for auction. Four of the freed channels were allocated for public safety, and the rest will be auctioned. Second, the Commission reaffirmed its service rules for the conversion by all U.S. broadcast television stations to DTV, including build-out construction schedules, analog and DTV channel simulcasting, and the return of analog channels to the government by 2006. Finally, the Commission adopted the final DTV allotment table, reaffirming DTV channel assignments and other technical rules and procedures with minor modifications. 98. As stated in the 1997 Report, affiliates of the top four networks in the top ten markets are required to be on the air with digital signals by May 1, 1999. Certain volunteer stations in the top ten markets agreed to be on the air by November 1, 1998, and 41 stations planned to begin DTV service on or near that date. As reported in the 1997 Report, as of December 31, 1997, seven DTV construction permits had been granted. This year, as of December 2, 1998, 118 DTV construction permits had been granted, with an additional 71 pending. Chicago and San Francisco appear to be the only top ten market in which none of the broadcast stations met the November 1, 1998 deadline, due to tower problems. 99. While the first DTV sets went on sale in August, these televisions are not compatible with the cable industry's preferred method of delivering DTV signals. While cable operators are today capable of simply "passing through" an 8VSB-modulated DTV signal which can be received by current DTV receivers, the cable industry's preferred method of delivering DTV signals involves using the IEEE 1394 standard to connect cable set-top boxes and DTV receivers. Unfortunately, no currently-available DTV receiver contains IEEE 1394 inputs. Accordingly, the ability of these first-generation DTV sets to receive DTV programming over cable will depend on whether individual cable operators implement alternative compatibility solutions, such as 8VSB pass-through or component video conversion, and it is possible that some customers will initially not be able to receive DTV signals through their cable systems. The Consumer Electronics Manufacturers Association ("CEMA") and NCTA released an interoperability specification based on the IEEE 1394 standard on November 2, 1998, which, they indicate, should allow for commercial deployment by November 1999. 100. In addition, the issue of copy protection is not fully resolved. Copy protection is an important issue for the transition to DTV because, unlike copies of analog video content, digital copies do not deteriorate when copied repeatedly and can be widely distributed over today's digital networks, such as the Internet. Until a copy protection solution is defined, content owners may limit the availability of high- value content for display on DTV receivers, which may in turn slow consumer adoption of DTV equipment. In response to requests for proposals by the Copy Protection Technical Working Group ("CPTWG") -- a study group that includes representatives from the major production studios -- several copy protection solutions for video content have been proposed. One leading proposal is the Digital Transmission Content Protection ("DTCP) method, which has been developed by the so-called "5C" group of companies consisting of Intel, Toshiba, Sony, Hitachi, and Matsushita. Recently, Zenith and Thomson proposed a different copy protection standard, known as the Extended Conditional Access or "XCA" method, which they claim offers a better overall solution than the 5C method. A number of other proposals also have been offered. Until resolved, the copy protection issue could slow the deployment of next-generation DTV consumer products (e.g., DTV receivers that incorporate the 1394 digital interface) because manufacturers may choose to await the eventual completion of a satisfactory copy protection solution prior to completing the design of new products. Additional potential problems include the fact that current indoor antenna designs may not always provide satisfactory over-the air reception. Also, with respect to DBS, at least one manufacturer is now selling DTV sets with a built-in satellite receiver, but current DBS subscribers will need a digital-to- analog converter to display DTV signals on their existing analog television receivers. 101. DTV has the potential to allow the broadcasters to become more effective competitors with cable operators in the MVPD market. Under the Commission's rules for DTV, digital encoding and transmission technology will permit stations to broadcast one or perhaps two High Definition Television ("HDTV") signals, multiple streams of Standard Definition Television ("SDTV") signals, or some combination. Some broadcasters have proposed that they combine the digital spectrum of all stations in a local television market to create a 40 to 50 channel service that could compete with MVPDs. At this time, however, it is unclear the proportion of HDTV to multicast SDTV that broadcasters will offer, or what broadcasters would show on multiple channels, and no deals on combining digital spectrum have been announced. Thus, at least for the near term, it appears unlikely that broadcast television will offer consumers a multichannel video programming service in competition with cable. G. Other Entrants 1. Internet Video 102. At the end of 1997, 44% of all households owned a personal computer and 60 million adults and 20 million children were Internet users. Previously, we reported on the availability of software technologies that make real-time and downloadable audio and video from the Internet accessible through a personal computer. We also noted that there are technologies available for the provision of Internet video over a television using set-top box Internet access and through the WebTV and Worldgate service packages. As of June 1998, investment and development of Internet video services was continuing, although long form video programming offered by Internet video still remains less than broadcast quality. Media companies continue to offer increasing amounts of video over their websites in the expectation that the pictures will reach broadcasting, cable or VCR quality of play. 103. In the 1997 Report, we indicated that several firms were providing software for placing video content on the Internet, but that the availability of video content was limited. Since then, some providers of Internet video software have grown such that they now offer access to more traditional video content. A few Internet streaming providers formed alliances with content producers such as major record labels and broadcasters. As a result they now provide direct access to video programming content through their products. In July 1998, RealNetworks formed an alliance with Atlantic Records and Sony music, introducing a music service with archives of full-length music videos available for access through streaming. In August 1998, NBC announced plans to invest in Intertainer Inc., a start-up online service, to provide movies, television programs and music on demand through personal computers. Under this agreement, viewers would be able to see NBC-owned programming (e.g., Dateline) at their convenience, although there is some concern about the reaction of local affiliated stations to this plan. The website broadcast.com offers broadcasts of 21 television stations and cable networks. 104. Some cable networks also are creating Internet video content, stored on their websites, available for playback over RealNetworks' RealPlayer G2 or other similar software packages. In June 1998, the American Health Network ("AHN") began offering a weekly operating room series, Behind the Mask, and other "special events" such as a live birth and a heart surgery. AHN uses RealNetworks' RealVideo streaming technology to video-stream its programming choices. Cable News Networks has archived, on its main website, episodes of Larry King Live and Crossfire for viewing through two different streaming video software packages. The Independent Film Channel ("IFC") and Bravo have created "broadband sites" that offer originally produced full-motion Internet video that supplements their standard cable video networks. Users, however, can only gain access to these sites through cable operators offering this service who provide it to customers with cable modem access. 105. Despite the increase in interest in Internet video, the medium is not seen as a direct competitor to traditional video services at this time. Currently, Internet video is used primarily for news, sports clips, and other brief video excerpts because of the inferior quality of the picture and the need for viewers to have the proper software and hardware. Webcasters hope that streaming will eventually improve so that they can offer movies, sports, and television shows, but industry observers believe video streaming is unlikely to be compete with traditional video media in the foreseeable future. Despite financial investments by firms such as Intel, Sony, US West, Comcast, Sun Microsystems, Oracle, Microsoft, and others, limitations in video streaming remain. 2. Home Video Sales and Rentals 106. Previously, we stated that we consider the sale and distribution of feature film entertainment through video tape sales and rental outlets as part of the video programming market since they provide video services similar to the premium and pay-per-view services offered by MVPDs. We also observed that premium and pay-per-view cable services are not regulated because they are competitive and that the video rental industry is highly competitive. It is estimated that 88% of all U.S. television households own at least one VCR. There were approximately 27,000 video specialty stores in the U.S. selling or renting video tapes, with a large video store carrying as many as 10,000 titles. This revenue stream is now the largest single source of revenue to movie studios, representing approximately $4.5 billion, or 45%, of the $9.9 billion of estimated domestic studio revenue in 1996. Recently, Blockbuster and Hollywood Video, the two largest video retailers, began revenue sharing arrangements with the movie studios that lowered their costs in return for sharing rental revenues with the studios. For example, Blockbuster previously purchased video tapes through a distributor at $65 each. Now it buys tapes for one tenth that price directly from the movie studios and then gives about 40% of its rental revenue to the studios. 107. Laser discs also provide a means for consumers to view video programming, especially movies. Introduced into the home video market in the early 1980s, laser discs, require their own laser disc players, deliver better quality pictures than video tapes and digital/compact disc ("CD") quality sound. Laser discs often have features not included on video tapes, such as original movie trailers and behind-the-scenes information. There are a large number of movies available on laser discs, with major movies released simultaneously on laser disc and video tape. 108. In the future, laser discs are likely to be replaced by Digital Versatile Discs ("DVDs"). DVD technology was introduced in 1997, and its increased availability has been the most significant development in the home video marketplace in the last year. DVD technology provides picture and audio quality that is superior to that of video cassettes and offers many advanced features, but discs are not yet available with recording capability. Currently, DVD players are available from 15 manufacturers and range in price from $395 to $1600, although prices are expected to drop as new models are introduced. As of September 1998, over 700,00 DVD players had been sold, which represents a much faster acceptance rate than VCRs or CDs. There are over 1000 movies now available on DVDs, ranging from contemporary to classic films, documentaries, animation and recorded concerts. The price of movies in DVD ranges from $14.95 to $29.95. They also can be rented at prices comparable to those of video cassettes. 109. In September 1998, Digital Video Express ("Divx") was introduced nationwide. Divx is a pay-per-view alternative for digital discs using a Divx-enabled DVD player that is connected to a phone line to forward playing and billing information to a central computer. Twice a month the Divx player calls a toll-free number at Divx headquarters, sending data on what was watched and billing the consumer's credit card. The consumer purchases a Divx video and is able to view the movie an unlimited number of times during the 48-hour period after it is first played. A video in Divx format sell for $4.49 for the first 48 hours of viewing. After that time, the consumer pays approximately $3.25 for a second 48-hour viewing period. Six consumer electronics manufacturers have agreed to make Divx-enabled DVD players, which sell for approximately $400. A limited number of retailers market Divx, including Circuit City, the good guys!, Ultimate Electronics, SoundTrack, Audio King, Future Shop, Nationwide and Sixth Avenue Stores. Divx currently has licensing agreements with six of the major movie studios. H. Local Exchange Carriers 110. Section 302(b)(1) of the 1996 Act eliminated the restriction on LECs providing video service directly to subscribers in their telephone service areas. This statutory change permits telephone companies to provide video services under one of several options. The specific options set forth in the Communications Act provide that common carriers may: (1) provide video programming to subscribers through radio communications under Title III of the Communications Act; (2) provide transmission of video programming on a common carrier basis under Title II of the Communications Act; (3) provide video programming as a cable system under Title VI of the Communications Act; or (4) provide video programming by means of an open video system ("OVS"). 111. In previous Reports, we noted that LECs did not yet represent a national presence in the MVPD market, and that they were weighing their options for entry. Generally, this is still true. The competitive presence of LECs in the video market, however, is growing. In certain areas, especially in the midwest, LECs are already or are becoming significant regional competitors. Particularly notable are the efforts of Ameritech as a cable overbuilder and BellSouth as an overbuilder and MMDS operator. RCN also is entering several markets as an OVS operator, sometimes in concert with local power utilities. In addition, Bell Atlantic and SBC are acting as agents for another MVPD, the DBS operator DirecTV, by marketing, selling, and installing DirecTV DBS video service. The growth of the LEC competitive presence in the MVPD market will probably continue in the same manner as it has until now: deliberately, and by a number of different delivery mechanisms. Whether LECs will become nation-wide competitors to the cable industry is less clear. 1. Current and Planned LEC Video Delivery 112. MMDS. At the time of the 1997 Report, BellSouth and SBC Communications ("SBC") were the largest LEC investors in MMDS licenses and systems. Since then, SBC has sold most of its interest in its digital MMDS system in Los Angeles and Orange County to PrimeOne, an affiliate of Prime Cable. As a result, BellSouth is now the largest LEC investor in MMDS. Since the 1997 Report, BellSouth has launched its digital MMDS service in Atlanta and Orlando, in addition to the service it already provided to New Orleans. BellSouth plans to launch digital MMDS service in Daytona Beach, Jacksonville, and Miami, Florida, and Louisville, Kentucky over the next two years. In addition, in April 1998, GTE launched a digital MMDS system in Oahu, Hawaii. 113. In-Region Cable Franchises. Ameritech continues to be the most aggressive of the LECs with respect to in-region cable service. Ameritech has acquired 87 cable franchises in Illinois, Michigan, Ohio, and Wisconsin, potentially passing more than 1.5 million homes, and it continues to seek new franchises. Seventy-two of these cable franchises were operational as of December 1, 1998. Ameritech serves 200,000 subscribers through these systems as of November 1998, and has become the 33rd largest MSO in the country. 114. At the time of the 1997 Report, BellSouth had acquired cable franchises in 18 areas in Alabama, Florida, Georgia, South Carolina, and Tennessee, giving it the potential of passing 1.2 million cable homes. BellSouth now reports that nine of those franchises are offering service, and that it is negotiating with localities for further franchises. GTE has signed ten competitive cable franchises, and one non-competitive franchise. Of those, the non-competitive franchise in Cerritos, California, and the competitive franchises in Ventura County, California, and St. Petersburg and Clearwater, Florida, are operational. As reported in the 1997 Report, SNET has received a state-wide cable franchise in Connecticut, and offered service to Uniondale. In addition to Uniondale, SNET now offers cable service in Darien, Farmington, Fairfield, Meriden, New Britain, North Haven, Norwalk, Old Greenwich, Wallingford, West Hartford, and Westport. U S West, despite the separation of most of its cable operations into a separate company, discussed below, is operating video systems in Omaha, Nebraska, and Phoenix, Arizona. The cable system in Omaha was converted from U S West's video dialtone trial. In Phoenix, U S West is using, for the first time anywhere or by anyone, very high speed digital subscriber Line ("VDSL") technology to deliver video programming, high-speed Internet access, and telephone service over existing copper telephone lines. 115. Prior to the 1997 Report, SBC acquired Pacific Telesis, and its Pacific Bell Video Services subsidiary. Subsequently, SBC ended its own in-region video efforts, sold its out-of-region systems, scaled back the video plans of Pacific Bell Video Services, and, later, sold most of its interest in Pacific Bell Video Services. SBC later acquired SNET, and proposed to acquire Ameritech. In front of the Senate's Antitrust Subcommittee, SBC Chairman Edward Whitacre would not commit to maintaining Ameritech's cable overbuild operation. SBC, however, as a condition of approval of the SBC-SNET merger, promised the Connecticut Department of Public Utility to continue cable operations for two years. The Connecticut Department of Public Utility gave SBC the right to petition for modification of the state- wide franchise agreement once SBC studies SNET's cable operations. Some have observed that since Ameritech has a well-established cable operation, one that has continued to expand even as the merger is pending, it is less likely that it will be sold or abandoned. Some analysts also have pointed out that the Ameritech cable operation could become more important, in terms of offering a complete package of telecommunications services, in light of the pending AT&T-TCI merger. 116. Out-of-Region Cable Systems. We previously reported that the last out-of-region cable systems owned by a LEC, those of Continental Cablevision (now MediaOne), owned by U S West, were to be separated into an independent company by mid-1998. This transaction was completed on June 12, 1998, so that the cable systems of MediaOne are no longer LEC out-of-region systems. 117. OVS. Although OVS is one of four means for LEC entry into video, the OVS rules do not preclude other types of entities from using the OVS rules. Currently, most of the firms receiving certification from the Commission as OVS operators are not LECs. The Commission has certified 11 OVS operators to offer OVS service in 17 areas. One operator, MFS, however, withdrew its certifications in two areas, Boston and New York City, because it does not plan to operate open video systems in those areas. Currently, Bell Atlantic in Dover Township, New Jersey, and RCN in New York City and Boston are the only operating open video systems, with no change since the last Report. The Bell Atlantic video distribution system in Dover Township, however, which seemed likely at one time to be the prototype for telephone entry into the video business, will be terminated by the end of 1998 or very early in 1999. Pursuant to its joint marketing agreement with DirecTV, Bell Atlantic will give its Dover subscribers the opportunity to switch to DirecTV. Starpower, a joint venture of RCN and Potomac Electric Power Company ("PEPCO") in Washington, D.C., opened offices in March 1998, and is serving 20,000 customers with Internet access, local or long distance telephone service, or all three. These customers are in addition to 180,000 Internet customers acquired by purchasing the Internet service provider Erols Internet. Starpower reports that it plans to begin video service before the end of the year and has signed agreements with Washington, D.C. and Gaithersburg, Maryland, allowing it to begin video service in those areas. 118. Barriers to Competition. In its comments, BellSouth mentions several impediments to competition: (1) lack of "full and fair access to programming;" (2) long licensing processing delays for MDS and ITFS licenses; and (3) the stautory requirement that OVS operators make two-thirds of their capacity available to unaffiliated programmers. With respect to access to programming, BellSouth requests that Congress amend the programming access statute to apply to all programming, regardless of method of delivery or affiliation, and that Congress or the Commission prevent programmers from awarding what BellSouth terms discriminatory programming discounts to large MSOs. BellSouth states that, "...the program access protections in the 1992 Cable Act are no longer adequate in light of the dramatic transformation of the marketplace over the past six years." A number of commenters representing cable interests, however, disagree with BellSouth's position on program access, stating that expanding program access rules could damage the programming industry. With respect to OVS, BellSouth requests that Congress relax the two-thirds capacity requirement for OVS, and give the Commission the authority to make this requirement more consistent with the leased access requirement faced by cable operators. Other comments on OVS include those of RCN, which states that it is subject to anticompetitive practices of incumbent cable operators, such as repeated filing of administrative complaints with local authorities and failure to follow the Commission's inside wiring regulations. Cablevision, however, claims that RCN does not have a commitment to OVS and that RCN has used the OVS certification process to gain leverage in an attempt to become a cable operator. Ameritech also cites the increase in horizontal integration and vertical integration, delays in the franchising process caused by incumbent cable operators, and shortcomings in the inside wiring rules as threats to emerging competition. 2. Video Programming and Packaging 119. In the 1997 Report, we reported that the two LEC joint ventures for providing original video programming and packaging of existing and original video programming, Tele-TV and Americast, had ended or been scaled back. In the past year, PrimeOne acquired the Tele-TV brand and will use it to market the Southern California MMDS system it bought from SBC, under the name PrimeOne Tele-TV. This joint venture, therefore is no longer LEC-owned or operated. Americast was originally set up to package programming, provide equipment, and market the MVPD offerings of Ameritech, GTE, SNET, SBC, and BellSouth. Currently, Americast brand programming is offered by Ameritech, GTE, SNET, and BellSouth, but each member of Americast is marketing its own programming. I. Electric and Gas Utilities 120. Utilities have the potential to become major competitors in the telecommunications industry generally, and in the cable industry in particular. Utilities possess existing fiber-optic networks in many areas, and have access to public rights-of-way in the areas they serve. Utilities' provision of non-energy services may extend the value of their existing network and non-network assets. We reported last year that utilities use communications networks for load management, thereby saving energy and reducing capital investment, and that they may be able to use these networks to provide multichannel video and other services to derive additional revenue with proportionately low additional investment. In addition, deregulation of utilities, accompanied by the advent of competition, has occurred or is going forward in most states, putting pressure on utilities to diversify and find new revenue streams. As we reported last year, industry observers consider utilities' reputations, long-term customer relationships and billing systems to equal those of telephone companies, thereby forming an appropriate foundation for the provision of non- energy services. Thus far, however, utilities are not significant or nation-wide competitors in the cable television market. 121. Since the 1997 Report, several utilities have announced, commenced, or moved forward with ventures involving multichannel video programming distribution. Tacoma City Light, the municipal utility in Tacoma, Washington, signed up its first cable customers and commenced service. PEPCO has formed a joint venture with RCN, named Starpower, which is certified as an OVS operator in the Washington, D.C. area. Starpower reports that it plans to begin video service before the end of the year. PEPCO is mainly providing its fiber optic backbone to the Starpower joint venture. Black Hills Corporation, an electric utility, announced plans to invest $40 million to provide telephone, cable television, and Internet access near Rapid City, North Dakota, in partnership with GLA International, a consulting and partnering firm. Finally, residents in Coldwater, Michigan, voted in November 1997 to authorize construction of a municipal utility overbuild cable system, with service scheduled to begin this year. III. MARKET STRUCTURE AND CONDITIONS AFFECTING COMPETITION A. Horizontal Issues in Markets for Video Programming 122. In this section, we examine several issues concerning horizontal structure and rivalry in markets for video programming. We are particularly interested in two video programming markets: the downstream (or "retail") market for delivery of video programming and the upstream (or "wholesale") market for acquisition of video programming. We first identify the market for the downstream delivered product and examine changes since the 1997 Report in market concentration and the extent of competition in local markets. We then examine the extent of competition in the MDU markets. Lastly, we look at the upstream market and consider the changes in concentration at the regional and national levels. 1. Market Definition 123. As we explained in earlier reports, the relevant market for examination of horizontal issues for both the downstream and upstream markets for video programming consists of two elements, a relevant product market and a relevant geographic market. In the downstream market, we use multichannel video programming services delivered to the customer as a starting point for the definition of the relevant product. 124. We found that in the downstream market, the relevant geographic area for assessing MVPD competition is local and its extent can be defined by the overlap of the service areas of the various service providers. This area of overlap determines the potential MVPD choices available to a typical household or MDU. We continue to believe that the relevant product market will depend on the substitutability or relative attractiveness (including the price, equipment, and installation charges) among the MVPD choices delivered to the household or MDU. For purposes of this Report, however, data availability limits our ability to identify more specifically the overlap areas in question or to measure the market shares of non-cable MVPDs in each individual local market across the country. 125. As explained in the 1997 Report, in the upstream market for video programming, the buyers of video programming are MVPDs including cable operators and other video service providers, and the sellers are programmers. This market enables MVPDs to buy programming for packaging and delivery to consumers. One competitive issue is whether cable operators acting alone or acting together can exercise market power in the purchase of video programming. This upstream market tends to be regional or national since programmers attempt to develop networks much broader than the local cable franchise area. Although cable operators usually do not compete to serve the same subscribers in local downstream markets, they may have an incentive to coordinate their decisions in the upstream market for the purchase of programming on a national or regional level. Concentration of ownership among buyers in this market is one indicator of the likelihood that coordinated behavior among buyers will be successful. The more concentrated the market, the more likely that buyers will possess some market power (or "monopsony" power). 2. Concentration in Local Markets 126. Local markets for the delivery of video programming (i.e., the downstream markets) continue to be highly concentrated and characterized by substantial barriers to entry by potential MVPDs. In MDU markets, landlords may have a choice of more than one provider. In the 1997 Report, however, we found that potential entry into MDU markets may be discouraged or limited by incumbent video providers that have negotiated long-term exclusive contracts. Several commenters suggest that competing MVPDs continue to experience difficulties in obtaining quality programming, both from vertically integrated satellite cable programmers and from unaffiliated program vendors who continue to make exclusive agreements with cable operators. If incumbent MVPDs can successfully limit new entry into their markets, there may be a tendency for prices to rise above competitive levels and for product quality, innovation, and service to fall below competitive levels in both household and MDU markets. 127. In order to obtain a summary measure of concentration in local markets for the delivery of video programming, we first consider the market shares held by cable and non-cable MVPDs in a hypothetical local market. The use of this hypothetical local market paradigm is due to the lack of readily available MVPD subscribership data for each local market. Using this approach, we assume that each local market is identical and reflects the market shares that each MVPD holds on a national basis. A second measure we use is the Herfindahl-Hirschman Index ("HHI"). Although cable operators continue to be dominant providers in most local markets, we estimate the HHI in a hypothetical local market to measure the influence of a growing competitive fringe of non-cable MVPDs and to provide a point of reference for assessing the degree of competition among MVPDs over time. 128. As in the last report, we find that downstream local markets for the delivery of video programming remain highly concentrated. Our approach uses the nationwide total number of subscribers to cable and non-cable MVPDs found in Table C-1, a surrogate for measuring the availability and attractiveness of various options in the hypothetical local market. In this hypothetical local market, as of June 1998, the shares of the market participants, grouped by competing technologies, would be roughly: cable, 85.3%; DBS/HSD, 12.1%; wireless cable, 1.3%; and SMATV 1.2%. Continuing the trend found in the 1997 Report, some non-cable MVPDs have increased their customer base, but it has not had a significant effect on cable subscribership. DBS continues its expansionary trend of gaining new subscribers, but the market share of cable only decreased from 87.1% in June 1997 to 85.3% in June 1998. Using the market shares for each technology, the estimate of the HHI is 7015, a decrease from the HHI of 7567 for 1997. Nevertheless, an HHI of 7015 remains several times greater than the 1800 threshold at which a market may be considered "highly concentrated." 3. Competitors Serving Multiple Dwelling Unit Buildings 129. The MDU market is an important segment in some local MVPD markets. MDUs comprise a wide variety of high density residential complexes, including high- and low-rise rental buildings, condominiums, and cooperatives. Townhouse and mobile home communities, nursing homes, hospitals and hotels may also represent important consumer segments in some local markets. As of 1990, there were almost 31.5 million "households" in MDUs in the U.S., comprising approximately 28% of the total housing units nationwide. MDUs under 10 units account for 58% of MDU households, structures with 10 to 49 units account for 30%, and structures with more than 50 units account for 14% of MDU households. Historically, cable and SMATV operators provided MVPD services to MDU subscribers. More recently, however, DBS is beginning to supply programming to both SMATV providers serving MDUs and to MDUs directly. 130. In October 1997, the Commission adopted new inside wiring procedures directed at eliminating disputes over the control and usage of the wires necessary to reach each unit in a building. Key procedures adopted address: (a) the disposition of "home run" wiring; and (b) subscriber access to cable home wiring prior to termination of service. The home run wiring is that part of the wire transmitting the video signal from the point the wire becomes dedicated to an individual unit in an MDU to the cable "demarcation point," which is located at or about 12 inches outside a unit. Generally, the home run wire is the portion of the wire extending down the hallway of an apartment building to the individual unit. The Commission's home wiring rules require that an incumbent MPVD who no longer has a legally enforceable right to remain in the building must expeditiously choose to sell, remove, or abandon the home run wiring. The rules cover circumstances where the MDU owner seeks a new provider for the entire building or where the MDU owner permits two or more providers to compete for subscribers on a unit-by-unit basis. According to the rules, consumers are permitted to provide or to install their own cable wiring inside their dwelling unit, or redirect, reroute or connect additional wiring to the cable operator's home wiring, as long as the cable operator's wiring is not substantially altered or harmed. 131. In spite of the changes brought about by the inside wiring rules, commenters disagree about whether there has been any progress in terms of the ability to compete in the MDU market. Some commenters and industry observers believe that the new rules on inside wiring are very important in setting firm timetables by which a franchised cable operator must relinquish its wiring after being notified that the customer or property owner has chosen a competing provider. 132. However, entrants raise several concerns about inside wiring and exclusive contracts that may hinder entry into MDU markets. One competitive concern is that the lack of access to inside wiring by alternative providers discourages entry. The costs of duplicating the wiring may not be economic or a profitable alternative for some potential entrants. Some commenters claim that the inside wiring rules should apply to all incumbent MVPDs whose service contracts would not be renewed if the inside wiring could be made available to a more desirable MVPD. The current rules only apply to a MVPD that no longer has a legally enforceable right to remain on the MDU premises. Ameritech says that this is a rare situation, because many cable operators have perpetual MDU agreements for as long as they are franchised in the community. Also, "right of access" laws in many states give cable operators a legal right to remain on the premises. According to Ameritech, these two conditions ensure that cable operators never lose their right to remain on the premises, which precludes competitors and new entrants from gaining access to the home run wiring. Ameritech also states that even though the rules give MVPDs the option of removing the inside wiring, there is a disincentive because residents will be without service for a period of time between one MVPD's removal of the wiring and another's installation. NCTA, on the other hand, claims that the Commission's rules remove any conceivable anticompetitive concerns. To go any further would be unfair, according to the NCTA, since competitors would be relying on the prior investments and facilities of cable operators. 133. Other commenters assert that the demarcation point may not be accessible because it is located behind sheet rock, and the MDU management will not permit the entrant to bore through sheet rock or to install molding to carry its wires. Building managers also often reject a complete overbuild within the building due to the disruption to the building that an overbuild would cause. Cablevision asserts that it does not see this as a problem because boring through sheet rock does not represent a significant modification of the building as would cutting through brick, metal conduit, or cinderblock. NCTA asserts that the Commission's rules effectively remove such competitive concerns. Other issues that the Commission has been asked to reconsider include (a) whether the incumbent should be required to make the home run wiring accessible at the same time as its initial remove, sell, or abandon election; (b) whether OVS providers should be eligible to use existing home run wiring; (c) whether the Commission should preempt all state mandatory access statutes; and (d) whether a purchase price should be established for the home run wiring. 134. In addition, the Commission issued a Second Further Notice of Proposed Rulemaking regarding whether there are circumstances where the Commission should adopt restrictions on exclusive contracts in order to further promote competition in the MDU marketplace. According to DirecTV, exclusive contracts protect the incumbent cable operator from competition and therefore constitute a barrier to entry. The cable industry disagrees, arguing that the current rules are sufficient to remove any competitive concerns. 135. Another competitive concern raised by entrants into MDU markets relates to the Commission's rules on over-the-air reception devices ("OTARD"). The OTARD rules, adopted on August 6, 1996, with some exceptions and conditions, generally prohibit certain governmental and nongovernmental restrictions on the installation of antennas one meter or less in diameter. The August 6, 1996 OTARD rules applied only to property within the exclusive use or control of the viewer where the viewer had a direct or indirect ownership interest in the property. Commenters urge the Commission to extend the OTARD rules to all renters and common property. Since these commenters filed these comments in this proceeding, on November 20, 1998, the Commission extended the OTARD rules to allow renters to install antennas within their leaseholds, i.e. apartments, homes, gardens, patios, terraces, and balconies. The Commission declined to extend the rules to permit the installation of antennas on common property or on property to which a viewer was not permitted access, such as the locked roof of an apartment building. 136. Firms Serving Primarily MDUs. RCN, OpTel, and Cable Plus are the leading firms that specialize in serving high density local MDU markets. RCN delivers video programming services using open video systems, wireless, and cable systems whereas OpTel and Cable Plus use SMATV technology. These firms plan to offer telecommunications services packages, including video programming, telephone, and Internet services. They also prefer to offer services under long term contracts with MDU owners. 137. In some markets, RCN is joining together with local electric utility and telephone companies to deliver video services using the utilities' fiber optic distribution lines. As of March 31, 1998, RCN had approximately 15,600 subscribers to its OVS service, approximately 40,860 connections attributable to its wireless video systems, and approximately 187,000 connections attributable to its traditional cable systems. In addition to its video programming delivery services, RCN offers full-featured local exchange telephone service, including standard dial tone access, enhanced 911 access, operator assisted services, and directory assistance, as well as a variety of value-added services such as call forwarding and call waiting, in competition with incumbent local exchange providers and other competing LECs. In the Washington DC metro area, the new bundled service is called "Starpower". RCN also had approximately 3,200 telephone service connections on its advanced fiber optic networks (OVS systems) and approximately 40,000 customers for resold telephone service. The company plans to offer service packages that include video programming, telephony, and Internet services. As explained in last year's report, RCN typically enters into five- to ten-year access agreements with the owners/managers of MDUs. 138. OpTel continues to expand its SMATV multichannel video programming services and telephone services offered to residents of MDUs. As of May 31, 1998, the company had 217,100 cable television subscribers, making OpTel the largest SMATV provider of video programming services in the United States. OpTel also has 7,700 telecommunications lines in service. In two of its major markets, Houston and Dallas-Ft. Worth, the company now uses its own central office switch and its own transport network to provide facilities-based residential telephone service in competition with the incumbent LEC. OpTel is now licensed as a competing LEC in each state in which it competes. As indicated in the 1997 Report, OpTel provides services under ten- to fifteen-year contracts with MDU owners and institutions (e.g., hospitals and hotels), making OpTel an effective alternative to the incumbent LEC for telecommunications services in some markets. 139. Cable Plus offers SMATV multichannel video programming services and security services to 90,000 customers in MDUs in 16 states, and also provides telephone service to 25,000 customers in 10 states. MediaOne asserts that Cable Plus is one of the four SMATV operators that has established a national presence. Cable Plus is exploring plans to offer telecommunications services packages including Internet access services. Like OpTel, Cable Plus attempts to negotiate long term contracts with MDU owners. 140. The new entrants in MDU markets state that they have encountered extensive and systematic anticompetitive efforts on the part of incumbents in an effort to thwart their entry into the market. RCN provides a list of the alleged actions taken by Cablevision, the incumbent cable operator in both the New York City and Boston markets where RCN has sought entry. RCN states that the significance of these efforts lies not so much in their individual effect, but in their pervasive and repetitious pattern. The company urges the Commission to play a more active role in fostering competition by establishing and enforcing ground rules that will restrain such anticompetitive behavior. Moreover, RCN notes that both Cablevision and Time Warner have apparently invited the aid of other cable industry participants including state-level cable industry trade associations in this effort to impede RCN's competitive entry into their markets. 141. Cable Operator Services to MDUs. Traditional franchised cable operators continue to compete for MDU business, and appear to be combining nonvideo telecommunications services with their multichannel video offerings to MDUs. For example, Cox Communications, the sixth largest MVPD, currently offers video programming and local digital telephone services to MDUs in Orange County and San Diego, California; Omaha, Nebraska; New England; Phoenix, Arizona; and Hampton Roads, Virginia. Some cable firms offer price discounts for MDU service. In New York City, for example, Time Warner offers a significant discount to MDUs where RCN is a competing provider. Like other competing providers, cable operators attempt to negotiate contracts with MDU owners that provide for some form of exclusivity. 142. LEC Service to MDUs. Some LEC affiliates report that they are providing MVPD services to MDUs. During the year ending June 30, 1998, Ameritech reached agreements to provide cable television service to 442 MDUs (with 36,147 units) in communities in which it is a franchised cable operator. Of the 620 MDUs (with 62,542 units) in these communities that have declined Ameritech New Media's cable television service, 322 MDUs (with 40,912 units), or approximately one-half, have cited their exclusive agreements with other cable operators as the reason for denying access to Ameritech. In addition, Ameritech asserts that incumbent cable operators often raise spurious issues with the local franchising authority designed to delay the ability of Ameritech to gain a new franchise to enter a new market. Others, like Bell Atlantic, are entering MDUs as agents of DBS providers. 143. DBS Service to the MDU Market. DBS currently offers video programming service to about 7.2 million subscribers through four service operators. DirecTV, USSB, EchoStar and Primestar continue to increase their service to the MDU market. As of June 1998, however, there are only approximately 20,000 DBS MDU subscribers. It has been estimated that within the next decade, nearly 90% of all MDUs in the U.S. will be able to receive DBS service. That is, buildings will have been wired and have access to receiving antennas to some of the DBS satellites. DirecTV and USSB, for example, have been especially active in developing alliances with wireless cable operators, telephone operators, and SMATV operators. In an MDU, DirecTV is combined with an over-the-air antenna or a limited basic cable service to receive local broadcast channels. LECs such as Bell Atlantic are now able to enter MDU markets by offering programming packages delivered by DBS. SBC and GTE have also entered the market as distributors of DirecTV and USSB. 4. Regional Concentration of Cable Systems 144. As we explained in the 1997 Report, clustering, a process by which MSOs consolidate system ownership within separate geographical regions, can have both procompetitive and anticompetitive effects. Clustering provides a means of improving efficiency, reducing costs, and attracting more advertising. Clustering also better positions cable as a potential competitor for local exchange services. It enables cable providers to offer a wide variety of broadband services at lower prices to customers in a geographic area that is larger than a single cable franchise area. For this reason, clustering makes cable providers a more effective competitor to LECs whose service areas are usually larger than a single cable franchise area. On the other hand, clustering can eliminate the most likely potential overbuilder. Another concern is that clustering may make the terrestrial delivery of regional video programming services feasible, thereby possibly preventing competitors from gaining access to vertically integrated programming. Section 628 of the 1992 Cable Act is intended to prevent incumbent cable operators from denying competitors access to satellite delivered, vertically integrated programming. Terrestrially delivered programming, therefore, falls outside of the scope of the program access statute, although Congress could bring such programming within the scope of the law. 145. Since the last report, cable MSOs have continued to undertake or announce system mergers, acquisitions, divestitures, swaps, and joint ventures with the objective of creating regional "clusters" of contiguous cable systems. During 1997, there were more than 100 such cable transactions. Most of these transactions resulted in the expansion of existing clusters of cable systems or the creation of new clusters. In 1997, these transactions had a total market value of approximately $22.2 billion and involved approximately 11 million subscribers. A similar pattern seems to be continuing in 1998. 146. The upward trend in the total number of clusters serving at least 100,000 subscribers observed in 1994, reached a peak in 1996, and began to decrease in 1997. Although the total number of clusters declined from 139 at the end of 1996 to 117 at the end of 1997, the total number of subscribers associated with these clusters increased from about 33.6 million to 34.3 million between the end of 1996 and 1997. 147. Although the total cumulative number of clusters actually decreased since the last report, the trend for clusters to increase in subscribership or size appears to be continuing. As we suggested in the last report, this tendency toward larger clusters may reflect greater economies of scale. Between 1996 and 1997, the number of clusters and subscribers in the two smallest size categories, (100,000 to 199,000 and 200,000 to 299,000 subscribers), decreased, while the number of clusters and subscribers in each of the remaining three size categories either remained the same or increased. In the largest size category (over 500,000 subscribers), the number of clusters increased by 60% and the number of subscribers increased by 54.5%. 148. The plans of TCI, Time Warner, and the other large MSOs to consolidate and cluster their systems are changing the market structure of the cable industry. TCI continues to pursue its clustering strategy and has announced a number of substantial transactions with other MSOs in furtherance of this strategy. For example, in the Chicago metropolitan area, at the end of 1996 there were five cable operators with large subscriber bases, TCI, Time Warner, MediaOne, Jones, and Multimedia in addition to Ameritech, Prime, and Triax. Since September 1997, TCI has announced a number of swaps and acquisitions through which it has gained control of the systems previously owned by Time Warner, MediaOne, Jones, and Multimedia that would allow TCI to control more than 90% of the Chicago metropolitan market. 149. System Mergers and Acquisitions. Two of the biggest transactions, measured by number of subscribers, that have been announced since the last report involve Paul Allen, the co-founder of Microsoft. In April 1998, Allen announced his intention to acquire Marcus Cable, one of the top 10 MSOs, for about $2 billion plus $1 billion in debt. It appears that Allen plans to use cable to gain access to the home in order to offer customers new services such as Internet access over the cable lines. Marcus's franchise areas are primarily in Alabama, Indiana, Southern California, Wisconsin, and Fort Worth, Texas. In July 1998, Allen announced the acquisition of Charter Communications, another top 10 MSO, for approximately $4.5 billion. Both Charter and Marcus serve the Southeast, but the systems are not tightly clustered. Charter's primary systems are in Los Angeles, Alabama, and Fort Worth, Texas. Together with the Marcus acquisition, the new still unnamed company will serve more than 2.4 million cable subscribers. Both companies offer high-speed data services in the larger markets. The combined companies will be run by Charter executives. 150. System Trades. As discussed in the 1997 Report, system-for-system "swaps" or trades enable MSOs to increase their regional clusters while minimizing financial outlays and avoiding capital gains taxes. Since the last report, many of the largest proposed swaps, measured by number of subscribers, involve TCI. The largest proposed system-for-system swaps are between TCI and Time Warner, TCI and MediaOne, TCI and MultiMedia, and TCI and Insight. TCI, for example, recently agreed to swap some of its systems in Florida, Hawaii, Maine, New York, Ohio, Texas, and Wisconsin with 598,000 subscribers for Time Warner systems with 540,000 subscribers in Illinois, Oregon, Missouri, New Jersey, Pennsylvania, and Texas. TCI also agreed to swap 508,000 subscribers in Southeast Florida and Georgia for 542,000 MediaOne subscribers in Chicago, Illinois. 151. System Partnerships and Joint Ventures. Since the last report, a number of joint ventures have been announced between TCI and other MSOs. In order to improve the management of its systems, lower its operating costs, and reduce debt from its balance sheet, TCI continues to form partnerships and joint ventures with other MSOs. TCI's strategy is reflected in a number of deals in which it has reduced debt and traded non-clustered cable systems in exchange for equity stakes in other MSOs or partnership interests in joint ventures. These deals either involve ceding the systems to other operators, or forming joint ventures with other operators in order to combine some TCI systems with other MSOs' systems. For example, TCI and Time Warner propose to form a joint venture in Texas. Time Warner would manage the systems contributed by both TCI and Time Warner, which currently serve more than one million subscribers. TCI would contribute 520,000 subscribers and Time Warner would contribute 510,000 subscribers. TCI has also agreed to form joint ventures with Century (comprising systems with 745,000 subscribers in California), Insight (comprising systems with 320,000 subscribers in Indiana), and Cox (comprising systems with 270,000 subscribers in Oklahoma). 5. Concentration in the National Market 152. As explained in the 1997 Report, the 1992 Cable Act directs the Commission to place limits on the concentration of ownership of cable systems at the national level. This direction reflects concerns that such concentration could have anticompetitive effects on the supply of programming to MVPDs and reduce the diversity of content available. It has been estimated that programmers need fifteen to twenty million subscribers to ensure long-term viability. TCI, with 17.8 million subscribers, is the only MSO large enough to provide this number of subscribers on its own. Hence, new programmers almost invariably need to negotiate for carriage with multiple cable operators. The fewer operators a programmer needs to negotiate with, the lower the transactions costs of securing carriage. When the Commission recently maintained its 30 percent of homes passed horizontal cable ownership limit (while also asking for comments on its modification), it found that the ceiling made it unlikely that a single MSO or combination of two MSOs acting together could thwart entry by a new programmer. This is not to say that a large MSO might have some bargaining power vis-a-vis programmers. Indeed, commenters raise concerns about dominant cable operators winning price concessions from programmers. If such price concessions represent the market power of large MSO buyers, then new MVPD entrants in the downstream market for delivered video programming may not be as competitive with the large MSOs. On the other hand, our program access rules are designed to ensure that vertically-integrated cable programmers do not discriminate in pricing across MVPDs. 153. In assessing the impact that national concentration may have in the MVPD programming market, we believe that it is appropriate to consider the presence of all MVPDs and MVPD subscribers in national concentration figures, and not just cable MSOs and cable subscribers. As non-cable MVPD subscribership increases, the significance of DBS, MMDS, and SMATV operators in the MVPD program purchasing market also increases. For example, the continuing growth of DBS systems, such as DirecTV/USSB, Primestar, and Echostar, has resulted in all three non-cable providers being among the top eleven MVPDs nationwide. Nevertheless, cable operators continue to be the main distributors of multichannel video programming, controlling 85.3% of total MVPD subscribers. 154. The top four firms in the upstream MVPD nationwide programming market are TCI (with a share of 26.5%), Time Warner (with a share of 16.0%), MediaOne (with a share of 6.3%), and Comcast (with a share of 5.8.%). The share of subscribers of these top four MVPDs, all MSOs, has changed little over the past year. In 1997, the four largest MVPDs (TCI, Time Warner, MediaOne, and Comcast) served 54.3% of all MVPD subscribers. These same top four firms this year serve 54.6% of all MVPD subscribers nationwide. As indicated, because these shares relate to the broader MVPD market rather than specifically to the cable market, they are different than the numbers relevant for horizontal ownership rule purposes. The current horizontal ownership rules measure concentration in terms of homes passed by a cable multiple system operator in relation to the total homes passed by the cable television industry rather than in terms of subscribers in relationship to the MVPD market as a whole. Based on the measurement and attribution rules used in the horizontal ownership rules, TCI estimates that its systems and those attributed to it will pass 35,192,000 homes after consummation of the Cablevision, Falcon, and Insight transactions. Based on this information its systems and those attributed to it would pass approximately 37% of total homes passed by cable. 155. To assess the potential for market power resulting from concentration in the upstream MVPD programming market, the reported MVPD shares can be appropriately translated into HHI figures because MVPD programming networks are often purchased on a "per-subscriber" basis. The nationwide purchaser MVPD HHI is 1096 -- "moderately concentrated" under the Merger Guidelines. The HHI is 70 points lower than the HHI of 1166 reported in last year's report. 156. The data on concentration in the cable market and in the MVPD market that we use does not include a number of transactions that have been announced but have not yet been consummated. The transactions involved are principally those discussed in the preceding section involving systems owned or controlled by TCI that will be transferred to or managed by another system operator with a large cluster of other systems in the region. However, if the arrangements are such as to create attributable interests, the result would be a significant increase in TCI's share of the national market. 157. To summarize, our reexamination of upstream national MVPD concentration currently reveals a relatively low level of concentration. Because programmers have an incentive to minimize transactions costs of securing access to the 15-20 million subscribers needed for viability, large MSOs have some bargaining power, especially vis-a-vis startup programming networks. However, no single MSO or pair of MSOs currently control a large enough share of cable subscribers to be able to block entry by a new programmer. In downstream local markets for delivered video programming, our concentration estimates continue to suggest that local markets remain highly concentrated. B. VERTICAL INTEGRATION AND OTHER PROGRAMMING ISSUES 1. Status of Vertical Integration 158. This section addresses the extent to which video programming services are affiliated with cable operators. As we have noted in previous reports, vertical relationships can have beneficial effects, although under certain market conditions, strategic vertical restraints (achieved by exclusive distribution contracts or monopsonistic pressure) can also deter entry and competition in the video marketplace, and can limit the diversity of cable programming, reducing the number of voices available to the public. 159. Since the 1997 Report, the number of both vertically and non-vertically integrated national satellite-delivered video programming services has increased significantly. This year, of the 245 national satellite-delivered video programming services identified, 95 (39%) are vertically integrated with at least one MSO and 150 (61%) are not. We note that, in addition to the national satellite-delivered video programming services discussed in this Report, there are also regional video programming services, some of which are vertically integrated with MSOs. In the 1997 Report we reported that, of the 172 national satellite-delivered video programming services identified, 68 (40%) were vertically integrated and 104 (60%) were not. Most of the increase can be attributed to new digital programming packages recently launched. For instance, TCI/Liberty's Canales ¤ is a new digital package of eight unique video programming services and the recently launched TVN Digital Cable offers 35 unique video programming services comprised of three analog channels and a digital package of 32 channels. 160. While the number of vertically integrated programming services has increased since the 1997 Report, the percentage of vertically integrated programming, relative to the total number of national, satellite-delivered programming services, has decreased slightly to 39%. This continues a four-year decline in the percentage of vertically integrated programming. The 1997 Report reported that 40% (68 of 172) of national satellite-delivered video programming services were vertically integrated; the 1996 Report reported that 46% (67 of 147) of national satellite-delivered video programming services were vertically integrated; the 1995 Report reported that 51% (66 of 129) of national satellite-delivered cable programming services were vertically integrated; and the 1994 Report reported that 53% (56 of 106) of national satellite-delivered video programming services were vertically integrated. 161. Overall vertically integrated ownership interests have increased in recent years. In 1998, cable MSOs, either individually or collectively, owned 50% or more of 78 national video programming services. In 1997, cable MSOs owned 50% or more of 50 networks. In 1996, cable MSOs owned 50% or more of 47 national cable programming networks. 162. In 1998, 29 of the 50 most subscribed to video programming services are vertically integrated. In addition, two other top 50 services (C-SPAN and C-SPAN2), while not directly owned by cable operators, were developed with significant involvement by the cable industry. In 1997, 26 of the 50 most subscribed to video programming services were vertically integrated. In 1998, in terms of prime time ratings, nine of the top 15 video programming services are vertically integrated, whereas seven of the top 15 services were vertically integrated in 1997 and eight of top 15 were vertically integrated in 1996. 163. Vertical integration in national cable programming continues to involve principally the largest cable system operators. Ownership interests in each of the 95 vertically-integrated services are held by any one of seven of the nation's eight largest cable MSOs. Many of these programming services are jointly held by multiple MSOs. TCI, the largest MSO, holds ownership interests in 28% (67 of 242) of all national programming services. In 1997, TCI held ownership interests in 23% (39 of 172) of all national programming services. In 1996, TCI held interests in 23% (34 of 147) of all national programming services. Time Warner, the nation's second largest MSO, holds ownership interests in 12.5% (30 of 240) of all national programming services; in 1997 it held interests in 11.6% (20 of 172) of national programming services. Time Warner's ownership interests were slightly greater in 1996, when it held interests in 15% (22 of 147) of all national programming services. 164. The data set forth above generally identifies vertical ownership relationships by reference to the ownership attribution standards associated with the Commission's horizontal and vertical (channel occupancy) rules. For these purposes, equity interests that carry no present voting rights are not considered to be attributable. For other purposes, such as the program access rules, a more inclusive standard is employed so that any stock interest, voting or nonvoting, creates a cognizable ownership interest. 165. Within the context of vertical ownerships in the cable industry, we also note the following horizontal relationships. TCI has a 10% ownership interest in Time Warner, Inc. and all of its subsidiaries, including a 10% ownership interest in Time Warner Cable -- the nation's second largest MSO -- and a 10% ownership interest in Time Warner/Turner programming services. MediaOne, the third largest MSO, has a 25% ownership interest in Time Warner Entertainment, L.P., which includes a 25% ownership interest in Time Warner Cable. Furthermore, Comcast Corporation, the nation's fourth largest MSO with 4.5 million subscribers, will soon acquire Jones Intercable, the nation's eighth largest MSO with 1.5 million subscribers, in a deal expected to be finalized in early 1999. 166. In a recent Notice of Proposed Rulemaking ("Attribution Notice"), the Commission initiated a review of its cable attribution rules which define what constitutes a "cognizable interest" that triggers application of various Commission rules relating to the provision of cable television services. The attribution rules seek to identify financial, ownership and other business relationships that confer on their holders a degree of ownership or other economic interest, or influence or control over providers of communications services such that the holders should be subject to the Commission's regulation. The Commission initiated the Attribution Notice in light of recent developments in the cable industry, including numerous strategic alliances, partnerships, system swaps, and mergers and acquisitions among cable entities; various Commission proceedings related to the issue of cable ownership; and the Commission's review, in a separate proceeding, of the broadcast attribution rules on which many of the cable attribution rules were based. The purpose of the Attribution Notice is to examine whether current cable attribution rules are accomplishing the goals of ensuring a competitive, diverse and fair video marketplace; and to determine whether fewer, additional or different restrictions are warranted. 167. In a related proceeding, the Commission recently released a Second Memorandum Opinion and Order on Reconsideration and Further Notice of Proposed Rulemaking ("Horizontal Further Notice") regarding the Commission's cable television horizontal ownership rules. In the Horizontal Further Notice, the Commission maintained the current 30% horizontal ownership limit and denied the motion to lift the voluntary stay on enforcement of that limit. However, in order to facilitate monitoring of cable ownership interests, the Commission lifted the voluntary stay insofar as it applies to the information reporting requirements of 47 C.F.R.  76.503(c). The Horizontal Further Notice sought comment on possible revisions of the horizontal ownership rules and the method by which horizontal ownership is calculated. Specifically, the Commission asked in the Horizontal Further Notice whether changes are needed to provide a more accurate measure of horizontal concentration to reflect changes in the market as alternative MVPDs continue to grow in the future. 168. The Commission has identified 65 planned national programming services that are expected to launch in the near future. This generally correlates with the 77 planned services reported in the 1997 Report and the 63 prospective services reported in the 1996 Report. Most of the planned programming services do not have a satellite transponder for cable distribution nor a scheduled launch date. Many of these services have been in the planning and development stage for over a year, and have thus been listed as planned programming services in previous Reports. 169. In recent years there has been a general trend by existing programming service providers, regardless of whether they are vertically integrated with MSOs, to create derivative programming services or brand extensions of their programming offerings. For example, in October 1996, The Discovery Channel, which is affiliated with TCI and Cox Communications, launched several new networks, including Animal Planet, Discovery Civilization, Discovery Kids, Discovery Science, and Discovery Travel and Living. This year, TCI launched Canales ¤, a digital package of eight audio and eight video Spanish-language channels which includes derivatives of four of TCI's existing programming services -- Discovery en Espa¤ol, Fox Sports Americas, CNN en Espa¤ol and CBS Telenoticias. Viacom, a major program provider that is not affiliated with any MVPD, has also utilized derivative programming and brand extension approaches. Viacom's MTV launched M2 in 1996, and Viacom has since announced that it will launch three new programming services in January 1999 -- Nickelodeon Game & Sports, Nick Too, and Noggin. Another non- vertically integrated program provider is Lifetime Television. On June 29, 1998, Lifetime launched a new network, the Lifetime Movie Network ("LMN"). LMN is a 24-hour, basic cable network which airs made- for-television movies and theatrical films targeted to women. 2. Other Programming Issues 170. In addition to information on national programming services, the Commission's Notice in this proceeding requested comment on other programming issues. We sought comment on whether there are certain programming services (i.e., "marquee" program services) or specific classes of service (e.g., movie, sports or news channels) that an MVPD needs to provide to subscribers in order to be successful. In addition, we requested information on electronic programming guides offered by cable operators and other MVPDs. We also sought information on the extent to which MVPDs are now offering or plan to offer consumers discrete programming choices (i.e., service on an "a la carte" or individual channel basis) rather than programming service packages (i.e., tiers of programming services). Moreover, we sought information and comment regarding public, educational and governmental ("PEG") access and leased access channels; and information and analysis regarding the effect of increased programming costs on rates, especially for cable service. Finally, commenters were asked to provide information regarding the effectiveness of the Commission's program access rules. 171. Sports Programming. Sports programming in the market for the delivery of video programming increasingly warrants special mention because of its widespread appeal and strategic significance for MVPDs. In this Report, the Commission identifies 29 regional sports programming networks. Ameritech states that sports programming is marquee programming for MVPDs. Increasingly, cable operators have acquired interests in the sports industry which, Ameritech asserts, gives operators leverage with respect to competitors' access to sports programming. Ameritech has previously stated that access to sports programming is so essential to the success of a cable system that many operators will pay exorbitant prices and agree to entertain other less attractive business arrangements just to obtain it. 172. ESPN, a programming service of Disney, is one of the most successful cable programming services in terms of circulation and revenues, and has been the principal supplier of national sports programming for cable television and MVPD distribution. Cablevision and News Corp./TCI Liberty Media ("Fox/Liberty") have created Fox Sports Net, a national network of 20 regional Fox Sports outlets that is seen as a viable competitor to ESPN. Some of the Fox Sports channels are former Cablevision SportsChannel services, and all are currently held in various measures by TCI's Liberty Media, News Corp. and Cablevision. In contrast to ESPN's national programming, Fox Sports Net offers home games to viewers in local markets and supplements these with national programming, and provides national and regional advertisers with a "one-stop-shopping" vehicle to reach sports viewers across the country. Fox/Liberty also has an ownership interest in Cablevision's other sports businesses and networks, including the Madison Square Garden Network, the Madison Square Garden arena complex, and the New York Knicks National Basketball Association ("NBA") and Rangers National Hockey League ("NHL") teams. 173. Further, in July 1996, Comcast Corporation ("Comcast") acquired a 66% interest in the Philadelphia Flyers L.P. to form a new partnership named Comcast-Spectacor. Comcast-Spectacor owns the following sports assets: 1) the Philadelphia Flyers NHL team; 2) the Philadelphia 76ers NBA team; and 3) the CoreStates Spectrum and CoreStates Center sports arenas. Also in 1996, Comcast Spectacor entered into a joint venture agreement with the Philadelphia Phillies Major League Baseball ("MLB") team to create SportsNet. SportsNet supplies cable television sports programming in the Philadelphia area, and also has access to programming produced by Fox Sports Net. Comcast acquired the Philadelphia 76ers NBA and Philadelphia Flyers NHL teams to anchor programming for SportsNet. 174. With a few exceptions, Fox/Liberty and other smaller regional networks have programming contracts with most professional sports teams, including 25 of 30 Major League Baseball ("MLB") teams, and 26 of 29 NBA teams. In addition, Fox/Liberty shares the current television rights for 19 of 26 NHL teams with ESPN. Fox/Liberty and ESPN also have exclusive television rights to most major college conferences for football and basketball. While the availability of national and regional sports programming has increased, some in the industry have stated that its high cost contributes to higher cable television programming rates. ESPN recently signed a $600 million, five-year agreement with the NHL to broadcast up to 200 NHL games per year, as well as the first two games of each year's Stanley Cup Finals. This is more than double the cost of the current package shared by ESPN and Fox/Liberty which expires after the 1998-1999 season. Earlier this year, ESPN imposed a 20% rate increase to cable operators shortly after announcing its $600 million, eight-year broadcast deal with the National Football League ("NFL"). ESPN has not yet set an overall rate for 1999, but some cable operators are concerned that ESPN will pass along NHL fees in the 1999 rate to be determined. 175. Some cable operators would like to start their own sports services to target local sports programming, such as high school football and minor league baseball, due to the high cost and low availability of remaining marquee sports programming. This local programming gives operators a brand identity in their respective communities with which to compete against rival MVPDs. Local sports also holds value for operators because local sporting events often generate higher ratings than other cable and broadcast programming. 176. News Programming. Another form of regional programming that is experiencing growth is news-oriented programming. There are approximately 25 local and regional news networks in the United States. These news services compete for ratings with national news networks such as CNN as well as broadcast news programs in their markets. The typical content of most local and regional news programming services is local or regional news and information, while other services may primarily showcase public affairs programming or local and regional government assembly sessions. Cablevision Systems Corp. has developed the concept of local news programming further by launching three "hyperlocal" channels in the New York designated market area ("DMA"). These three hyperlocal channels -- MSG Metro Guide, MSG Traffic and Weather, and MSG Metro Learning Channel -- offer localized "neighborhood" programming content. 177. PEG Programming. Pursuant to Section 611 of the Communications Act, local franchising authorities may require cable operators to set aside channels for PEG use. PEG access centers throughout the nation currently produce over 1,000,000 hours of original programming per year for cable system distribution, although only 16% of cable systems carry PEG stations of any kind. Cable operators do not have ownership interests in PEG access programming, though under some franchise agreements, they may provide services, facilities and equipment to make such programming available. All PEG access programming is therefore considered to be non-vertically integrated with MSOs. 178. Of note is a recent proposal to create a non-traditionally owned and operated PEG access service via a merger between a PEG access corporation and a Public Broadcasting System ("PBS"). 'Olelo (a public-access corporation) and the Hawaii Public Broadcasting Authority (a PBS affiliate) are seeking such a merger with the belief that it will also serve to secure funding for both entities through cable franchise fees. The merger is supported by Hawaii Governor Ben Cayetano and PBS CEO Ervin Duggan, who sees it as a "possible model for other communities across the nation." Others in the cable-production community view the merger as an infringement on PEG access channel capacity and contend that PEG programming and PBS programming have conflicting missions. 179. Section 335 of the 1992 Cable Act directed the Commission to initiate a rulemaking to impose public interest or other requirements for providing video programming on DBS service providers. Section 335(b) mandates that DBS providers reserve between 4% and 7% of their channel capacity exclusively for noncommercial programming of an educational or informational nature. 180. In March 1993, the Commission initiated a proceeding to implement Section 335. In September 1993, after the Commission had received comments in this proceeding, the U.S. District Court for the District of Columbia held that Section 335 was unconstitutional. This ruling effectively froze the proceeding. On August 30, 1996, the U.S. Court of Appeals for the District of Columbia Circuit reversed the District Court and held that Section 335 was constitutional. In January 1997, the Commission issued a Public Notice seeking to update and refresh the record in its proceeding implementing Section 335. As discussed above, the Commission subsequently adopted a Report and Order ("DBS Report and Order") in November 1998 which requires DBS service operators to set-aside 4% of their channel capacities exclusively for noncommercial programming of an educational or informational nature. The DBS Report and Order also requires that DBS operators comply with the political broadcasting rules of Section 312(a)(7) of the Communications Act, granting candidates for federal office reasonable access to broadcasting stations, and Section 315 of the Act, granting equal opportunities to candidates at the lowest unit charge. 181. Electronic programming guides. In the Notice in this proceeding, we requested information on electronic programming guides ("EPGs") offered by cable operators and other MVPDs. Ameritech states that EPGs will become increasingly critical to consumers as the number of channels increases and as more interactive information is provided along with programs, such as sports statistics to accompany sports programming. 182. Gemstar is the developer and distributor of electronic programming guide technology. Gemstar is not affiliated with any MVPD and, earlier this year, resisted a $2.8 billion takeover offer from UVSG. Gemstar's method of transmission of its EPG services varies, including distribution by telephone lines to an MVPD's headend for subsequent distribution to subscribers or by use of the VBI in program signals. Gemstar's revenues are generated from a continuing license fee from consumer electronic manufacturers and other licensees, although Gemstar states that it is currently considering including advertising in its EPG. 183. According to Gemstar, several MVPDs offer or plan to offer EPGs that do or will compete with Gemstar. These include: SuperGuide offered by SuperGuide Corporation available to C-band subscribers; PreVue Guide, offered by PreVue Networks Inc., a wholly owned subsidiary of United Video Satellite Company, which is controlled by TCI; Time Warner Cable's announced interactive guide as part of its Pegasus digital offering; and DBS companies DirecTV/USSB and EchoStar, who provide their own EPG offerings. 184. Ameritech expresses concern that vertically-integrated programmers could steer viewers to their own programming through the design of their guides. Ameritech asserts that because of TCI's EPG provider affiliation, TCI could potentially seek exorbitant licensing fees, engage in exclusionary licensing practices and favor affiliated advertisers and programmers. Gemstar asserts that certain cable operators that offer or plan to offer their own programming guides have engaged in anticompetitive conduct by interrupting the transmission of competing guides. Gemstar states that this behavior eliminates competitive alternatives and creates a barrier to market entry, contrary to the intent of the 1996 Act as a whole, and specifically to Section 628 of the Communications Act. Section 628 of the Communications Act prohibits cable operators and satellite programming vendors from engaging in "unfair methods of competition or unfair or deceptive acts or practices" that hinder MVPDs efforts to provide programming to consumers. Gemstar further notes that the Commission, when implementing Section 629 of the Communications Act in the Navigation Devices Order, recognized concerns regarding limitations on consumer access to content, and stated that it intended to monitor developments in this area with respect to EPGs. Gemstar states that it also will monitor the EPG industry for instances of anticompetitive interference. NCTA, however, states that Section 628 is not applicable to EPG issues, and that there is no statutory basis in the Communications Act for the Commission to require cable operators to configure their systems in order to transmit competing EPGs. NCTA further observes that, while the Commission took note of anticompetitive concerns in the Navigation Devices Order, the Commission found no reason to act on these concerns beyond monitoring developments in the EPG market. 185. Programming Costs. In the Notice, we asked about the effect of increased programming costs on rates, especially for cable service. In the 12-month periods ending in July, 1996 and July, 1997, rates for regulated cable programming and equipment rose 8.8% and 8.5% respectively. During those same periods, average monthly rates on a per channel basis rose 5%, while inflation rose approximately 2%. ABC asserts that programming costs have risen because of the increase in demand for scarce resources, such as film or sports stars, and because a variety of media are competing against each other for these resources. A&E notes that changes in programming costs are not the sole component of cable rate increases to consumers and that the Commission's Report on Cable Industry Prices found that equipment costs, system upgrades, channel additions, programming fees and inflation all contributed to increases in cable rates. NCTA notes that programming expenditures by basic cable networks increased from $3.0 billion in 1995 to $4.0 billion in 1997. During that time, cable networks spent more on originally produced movies and programming, on additional and renewed sports rights, and on syndicated programming. 186. A La Carte/Unbundling of Cable Programming Services Tiers. In the Notice, we sought information on the extent to which MVPDs offer or plan to offer consumers discrete programming choices (i.e., service on an "a la carte" or individual channel basis) rather than programming service packages (i.e., tiers of programming services). We asked what would be required to allow operators to offer more customization in their programming packages than is currently available; what are the technical requirements that permit an MVPD to offer customized service; and what are the economic, legal or other impediments to offering programming services in this manner. 187. Tiering of programming services dates to the time when cable operators began to offer satellite-delivered programming. As systems have upgraded their channel capacity and more programming services have become available, the enhanced basic tiers have become larger and some operators have added mini-tiers. According to NCTA, tiering generally has been the best way to provide the programming that subscribers want at the lowest cost even if all of the services on the tier are not wanted. Commenters generally identify three main issues concerning a la carte delivery of programming services: 1) a la carte delivery entails increased operating and equipment costs which would result in higher subscriber rates; 2) a la carte delivery is not technically feasible without the use of addressable set-top converter boxes, which most cable subscribers do not have; and 3) a la carte delivery is not economically feasible for new programming services because new services benefit from their association with bundled tiers where they can be sampled by casual viewers. 188. ABC asserts that potentially distinct products, such as an assortment of programming services, are bundled in order to lower transaction costs, exploit scale and scope economies, or to enhance the attractiveness or convenience of the product to consumers. Bundling of programming services reduces operating costs and is beneficial to subscribers and cable operators in terms of larger industry output and lower average price per channel. NCTA emphasizes that programming services rely on a duel revenue stream comprised of advertising and license fees, where 60% of revenues are attributable to ad sales. NCTA then provides the following example of how subscriber rates would increase if a programming service offered on a tier today instead were to be delivered a la carte: If a basic network that today charges an operator $.30 per subscriber per month instead were to be carried a la carte, and only 20% of cable households were to subscribe to the network on an a la carte basis, then the network -- in order to maintain the same monthly revenue amount -- would have to charge the operator $3.30 per subscriber per month to replace advertising and license fee revenues resulting from the loss of 80% of its subscriber base. The higher costs charges to operators would ultimately be passed on to subscribers of the service delivered a la carte. 189. ABC states that the primary reason for bundling services is to enable subscribers to forgo additional equipment and transaction costs for the purchase or rental of addressable set-top converter boxes; and NCTA states that an important technical limitation to offering programming on an a la carte basis is the inability to offer services on a discrete channel-by-channel basis without the use of such converter boxes. These commenters state that fewer than half of today's cable subscribers have set-top converter boxes; therefore any requirement that programming be offered on an a la carte basis would make it impossible for most cable consumers to receive cable programming without incurring the inconvenience and extra cost of having an addressable set-top converter box for each television that they use to watch cable programming. 190. An important feature of bundling programming on a tier of service, according to ABC, is that it enables the launch of new and previously unsampled programming services that contribute to the diversity of programming available to the public. Moreover, ABC states that new programming services benefit greatly from their association on bundled tiers with well established networks; and it is through that association that new services have the greatest opportunity to be sampled and hence to find an audience. A&E states that the use of tiers enables operators to package new or niche programming with established programming -- thus broadening a new service's potential audience -- while enabling established networks to maintain the subscribership necessary to attract advertisers. A&E further asserts that interference with the ability to bundle programming would make developing new or novel programming more risky, as programmers or operators would have to be willing to absorb the upfront costs of starting -- or paying the license fees for -- new programming without being assured some initial audience. We note, however, that the technical concerns raised to the provision of a la carte services may not apply to the creation of a limited number of "mini-tiers" and should be obviated altogether to the extent that cable operators have transitioned to digital. Comcast provides three or more levels of programming service, including a low priced basic service tier, a CPS tier, and an NPT tier. Comcast asserts that it is beneficial to market their services in this way. 191. Regulatory Issues Related to Program Access, Carriage Rules. The Commission established rules pursuant to the 1992 Cable Act concerning programming arrangements between MVPDs and satellite-delivered programming vendors (the "program access" rules). These rules prohibit unfair competition and discriminatory practices by cable operators and vertically-integrated, satellite-delivered programmers that may deter competition from other MVPDs. The program access rules also prohibit exclusive distribution contracts for satellite cable or broadcast programming between vertically integrated cable operators and programmers, unless the parties can demonstrate to the Commission that the contract is in the public interest. The Commission's program access and carriage rules are intended to promote the public interest, convenience, and necessity by increasing competition and diversity in the multichannel video programming market, to increase the availability of satellite cable programming and satellite broadcast programming to persons in rural and other areas not currently able to receive such programming, and to spur the development of communications technologies. 192. On August 10, 1998, the Commission released a Report and Order ("Program Access Order") which amended certain of the program access regulations. In the Program Access Order, the Commission found that its existing statutory forfeiture authority can be used in appropriate circumstances as an enforcement mechanism for program access violations. The Commission affirmed its statutory authority to impose damages for program access violations and found that the imposition of damages could be appropriate in the implementation of program access rules. The Commission also imposed time limits for the expeditious resolution of program access cases, finding that denial of programming cases (unreasonable refusal to sell, petitions for exclusivity, and exclusivity complaints) generally should be resolved within five months of the submission of the complaint to the Commission and that all other program access complaints should generally be resolved within nine months of the submission of the complaint to the Commission. 193. The Commission also addressed the issue of terrestrial delivery of formerly satellite- delivered programming and its impact on the program access rules. Numerous commenters in the Program Access Order asserted that the Commission has the statutory authority under Section 628 of the Communications Act to enforce remedial measures upon a vertically-integrated programmer that moves from satellite-delivered programming to terrestrial-delivered programming for the purpose of evading the program access requirements. In the Program Access Order, the Commission noted that it has received only two complaints against the same vertically-integrated programmer related to moving the transmission of programming from satellite to terrestrial delivery for the alleged purpose of evading the program access rules. 194. While the Commission indicated that the record did not then show a significant anti- competitive impact necessitating Commission action, we recognized that reasonable concerns were raised regarding the scope of the statutory language. The Commission stated that the issue of terrestrial distribution of programming could eventually have a substantial impact on the ability of alternative MVPDs to compete in the video marketplace, and indicated that it would continue to monitor this issue and its impact on competition in the video marketplace. In addition, the Commission noted that Congress is considering legislation which, if enacted, would introduce important changes to the program access provisions, including clarification of the Commission's jurisdiction over terrestrially-delivered as well as non-vertically integrated programming. C. Technical Advances 195. In this section, we update the information provided in the 1997 Report regarding technological developments and discuss recent activities to promote the commercial availability of the equipment used to access video programming and other services pursuant to the requirements of the 1996 Act. Cable operators and other MVPDs continue to develop and deploy advanced technologies, especially digital compression techniques, in order to deliver additional video options and other services (e.g., data access, telephony) to their customers. To access these wide ranging services, consumers use "navigation devices." Navigation devices are television set-top boxes, converter boxes, interactive communications equipment, and other equipment that a consumer uses to access video programming and other services offered by MVPDs. Today, the most common navigation devices in use are the boxes that sit on top of television sets to access cable television and which typically include a descrambler and tuner. 1. Deployment of Digital Technology 196. In the 1997 Report, we discussed the advantages and disadvantages of cable systems that rely solely on digital compression to add video channels to their systems. We further stated that TCI has employed an advanced digital compression technique called statistical multiplexing for its Headend in the Sky ("HITS") prepackaged programming service. This technique allows cable operators to receive prepackaged digital video channels by satellite which then are passed through the headend to subscribers. The success of HITS during the past year has resulted in the widespread deployment of this technology by many other MSOs and small system operators. This trend is expected to continue, and cable operators could begin migrating programming from the analog tier to the digital tier. As analog channels are removed, the vacated bandwidth can be used to provide additional digital video programming and other advanced digital services. 197. In the wake of the success of HITS, Time Warner has announced plans to launch its "AthenaTV" compressed digital programming feed. Time Warner states that AthenaTV will give it the ability to offer more than 150 additional cable channels and can be tailored to advanced systems which already have upgraded their plants to 750 MHz. Time Warner's primary goal is to provide programming not already carried by most cable systems. In contrast, HITS provides many program offerings which may already be included in an upgraded cable system's analog tier. 198. While the cable industry is generally relying on digital video compression to provide additional video channel choices to better compete with other MVPDs, especially DBS, it is also redoubling its efforts to take advantage of its large bandwidth capacities from its coaxial and optical fiber cable. As such, it is concentrating in other digital and data areas including cable modem and Internet services, IP telephony, other data deliveries and general cable telephony. 2. Navigation Devices 199. Section 629 of the Communications Act directed the Commission to adopt rules to ensure the commercial availability of navigation devices in order to expand the opportunities for consumers to purchase this equipment from sources other than their service providers. Since the 1997 Report, the Commission adopted rules to implement Section 629 and industry groups have undertaken efforts to develop standards consistent with the rules and the goals of Section 629. In particular, the rules will benefit consumers and further the Commission's goal of providing competition in the telecommunications marketplace by creating a market for consumers to own equipment to access video programming and other services. In addition, competition in the manufacture and distribution of consumer devices should lead to innovation, more choices in services and products and lower prices that are expected to increase competition for equipment used to access MVPD services. 200. Specifically, Section 629 of the Communications Act requires the Commission, in consultation with appropriate industry standard-setting organizations, to adopt rules to assure the commercial availability of navigation devices from manufacturers, retailers and other vendors not affiliated with any MVPDs. Section 629 provides that any rules the Commission adopts may not jeopardize the security of video services offered or impede a video programming provider's legal rights to prevent theft of service. Multichannel video programming providers may continue to offer equipment as long as they do not subsidize the equipment prices with the charges for their services. The rules will lapse when the Commission determines that the markets are competitive and that elimination of such rules would serve the public interest. 201. On June 11, 1998, the Commission adopted rules and policies to implement Section 629. In the Navigation Devices Order, the Commission determined that Section 629 covers cable television, multichannel broadcast television, DBS, MMDS, and SMATV systems, but not open video systems. We concluded that, while the focus of Section 629 is on cable television set-top box descramblers and cable modems that have historically been available only on a lease basis from the service provider, the statute covers equipment used to access services offered over multichannel video programming systems, such as televisions, VCRs, cable set-top boxes, personal computers, program guide equipment, and cable modems. The Navigation Devices Order notes that subscribers have the right to attach any compatible navigation device to a multichannel video programming system and that commercial availability is furthered only if consumers are aware of the availability of equipment from alternative sources. The rules prohibit service providers from taking actions that would prevent navigation devices that do not perform conditional access functions from being made available from retailers, manufacturers, or other unaffiliated vendors. The rules also provide that cable operators and other MVPDs can take the necessary steps to guarantee the security of their systems and their programming in accordance with the provisions in the Communications Act that prohibit the manufacture, sale and distribution of equipment designed to allow for the unauthorized reception of service. 202. Under the rules, MVPDs must separate out security functions from non-security functions by July 1, 2000. An exception is made for navigation devices that operate throughout the continental United States and are commercially available from unaffiliated sources, which includes DBS. The rules rely heavily on the representations of the various interests involved that they will agree on relevant specifications, interfaces, and standards in a timely fashion, thus permitting the manufacture and sale of navigation devices. In the interim, MVPDs may continue to offer devices that have security and non-security functions integrated. We intend to require that integrated boxes no longer be available after 2005, at the latest, although we will assess the state of the market beginning in 2000 to determine whether it is reasonable for such requirement to be implemented at an earlier time. The Commission also found that existing equipment rate rules applicable to cable systems not facing effective competition fulfill the statute's requirement to prohibit subsidies. Finally, the Commission adopted rules implementing the statute's waiver and sunset provisions. 203. As discussed in the 1997 Report and in our Navigational Devices Order, Cable Television Laboratories, Inc. ("CableLabs") and its members are developing "Open Cable " specifications needed for interoperable digital set-top boxes intended to convert digital signals for reception by current analog television sets. CableLab's objective is to incorporate interoperability standards in equipment that will enable a new range of interactive services to be available to cable customers. The Open Cable project specifically is aimed at identifying, qualifying and supporting Internet based voice and video products over cable systems. As part of the Navigational Devices Order, the Commission is requiring the filing of reports at six month intervals to ensure that the CableLabs OpenCable process, a private effort by several cable companies, is progressing towards the requirement of separation of security by July 1, 2000. 204. The cable industry also has begun widespread deployment of cable modems. This deployment is aided by the finalization of the Data Over Cable Service Interface Specification ("DOCSIS") by CableLabs. The goal of the DOCSIS project is to provide manufacturers with a set of standards that will enable the production of interoperable cable modems. Modem manufacturers are currently seeking DOCSIS compliance certification and interoperable cable modems may be available at retail this year. This will allow cable modems to compete at retail with traditional twisted pair modems once cable modem service is available in a community. Further, major computer manufacturers recently announced that they will begin to incorporate DOCSIS compliant modems into their product lines when these modems become available. 205. Moreover, the cable industry is exploring using solely cable plant for the provision of all digital services, including voice, video, data and other enhanced services, such as faxing and video-conferencing. The PacketCable project recently announced by CableLabs serves as an extension of the Open Cable and DOCSIS standards. The goal of PacketCable is to create an IP-based set of standards that will facilitate the manufacturing of interoperable equipment for the provision of these enhanced services. As these projects advance, the cable industry may become a strong competitor to voice and data service providers across the telecommunications sector industries. 206. The actual commercial availability of navigation devices is at the earliest stages. For example, TCI recently announced that it would require customers using standardized cable modems to buy them at retail when it launches its high-speed data services in Spokane, Washington. Previously, consumers have had the option of leasing or purchasing at retail. TCI plans to rely on retailers to be able to sell modems that the industry certifies as compliant with the DOCSIS standards, although no modems have been certified as DOCSIS compliant yet. Spokane is expected to serve as a test for consumer acceptance of the need to buy modems at retail. Specifically, TCI is interested in evaluating the effect that requiring consumers to purchase modems costing $319.99 will have on penetration levels. IV. COMPETITIVE RESPONSES 207. During 1998, a number of new distributors entered specific existing cable markets. In these communities, incumbent cable operators have responded to entry in a variety of ways, such as lowering prices, adding channels at the same monthly rate, improving customer service, or adding new services such as interactive programming services. In subsection A below, we analyze the initial responses of both incumbents and new entrants in a sample of local franchise areas where the incumbent cable operator has petitioned the Commission for a determination of "effective competition." If the Commission finds that a cable system is subject to effective competition, its rates for programming service tiers and equipment are not subject to regulation by either the Commission or local franchising authorities. The samples analyzed below includes localities in which an incumbent cable operator has been determined to face effective competition from one new entrant, as well as markets in which a petition for effective competition has been filed and is pending a decision before the Commission. These case studies do not suggest what would happen if there were additional competitors. A. New Case Studies 1. Barron, Wisconsin 208. In April 1997, CTC TelCom ("CTC"), a subsidiary of Chibardun Telephone Cooperative, Inc. ("CTCI"), was formed to provide cable television and local telephone service to Barron, Wisconsin. CTCI is an incumbent LEC in Wisconsin, and CTC is both an affiliate of CTCI and a competitive LEC. 209. CTC entered the market in October of 1997, leasing copper cable facilities from GTE until it completed construction of its advanced fiber optic cable network. CTC has activated approximately 75% of its new cable facility which will offer service to the entire City of Barron. CTC's new network delivers cable television, telephone, high-speed data, and wireless personal communications services. 210. CTC offers a 14 channel basic service package for $12.95 per month and a 48 channel basic plus expanded service package for $19.95. The CTC expanded basic service includes most of the 40 channel package offered by Marcus Cable, the incumbent cable operator, at $27.37 per month. In response to CTC's entry into the market, Marcus has added 19 channels to its expanded basic service with no rate increase, added additional premium services such as adding more HBO channels to the HBO package with no increase in price, upgraded its system by adding PPV channels and an on screen programming guide, and increased its marketing efforts such as offering free remote controls. 211. Prior to CTC's entry into the market, Marcus Cable had 1,009 subscribers in the City of Barron. Within the first three months of CTC's entry, Marcus lost 32% of its subscriber base. As of January 1998, CTC passed more than 50% of the households in Barron and served more than 15% of the households in Barron. Consequently, in January 1998, Marcus filed a petition for determination of effective competition claiming that it met the requirements of the LEC test for showing effective competition. Marcus asserted that CTC is affiliated with a LEC, serves customers in Barron, offers comparable service, and has elicited a competitive response from Marcus. The Cable Services Bureau used the fact that CTC satisfied the two prongs of the competing provider test as unqualified evidence that CTC's service was "offered" to the franchise area as required by the LEC test. The Bureau granted the petition, which was unopposed, in May 1998. 2. Los Angeles and Orange Counties, California 212. In May 1997, Pacific Bell Video Services ("PBVS"), a wireless cable operator, began a market trial to offer commercial video programming services on a limited basis in Los Angeles and Orange Counties, California. During the market trial, PBVS had about 3,500 test customers or "friendlies," who receive the service free of charge. As discussed in the LEC Section of this report, SBC Communications, the new owner of PBVS and of PBVS's parent company (Pacific Telesis Group, "PacTel"), has taken a more limited approach to marketing video programming than initially announced by PacTel. Although PacTel has spent several hundred million dollars to develop its services, PBVS is expected to market its services on a commercial basis only to several thousand households in the Los Angeles market, a market with 3.5 million potential customers. PBVS states that a gradual rollout of its services is necessary to maintain service quality and to test market its acceptance. Some MVPDs are beginning to question whether PBVS will become a significant provider in the market. 213. PBVS's commercial offering includes more than 150 channels of CD-quality sound and high quality video. Its $31.95 per month basic service package, Digital Select, includes 49 local and satellite channels, 31 music channels, an on-screen interactive program guide, and a digital set-top box with remote. Unlike DBS providers, PBVS can offer the local networks ABC, NBC, and CBS and local independent and other stations. One premium channel package, such as HBO and HBO2 or Cinemax and Cinemax2, costs an additional $8 per month. In addition to the monthly service fee, there is a one-time installation charge of $100. 214. Time Warner, an incumbent cable operator, currently offers a 52 channel expanded basic service for $27.95 per month, but has announced a price increase to $29.95. Time Warner has recently upgraded its Orange County System and partially upgraded its Los Angeles System to add more channels, established a seven day per week, 24 hours per day in-house customer service office, and provides new installations six days per week. Nevertheless, Time Warner asserts that it is losing subscribers to PBVS. As of October 1997, some industry observers estimated PBVS subscribership in Southern California at 8,000 to 10,000 customers. 215. Time Warner filed a petition with the Cable Services Bureau for the 19 franchise areas in the Counties of Los Angeles and Orange for determination of effective competition. Time Warner's petition was opposed by the Cities of Cypress, Gardena, Garden Grove, Hawthorne, Lawndale, Los Alamitos, Torrance, and the Public Cable Television Authority on behalf of the Cities of Fountain Valley, Huntington Beach, Stanton,and Westminster (the "Cities"). The Cities claimed that PBVS did not "offer" service to the Cities, and that the viability of PBVS is questionable. The Cities claimed that PBVS was not offered throughout each of the cable franchises in the Cities and that a substantial number of residents in each of the cable franchises in the Cities were not aware of PBVS's service offerings. In addition, the Cities argue that, from a technical or operational perspective, PBVS did not provide evidence demonstrating that each of the communities in the Cities can be offered service, given the diverse topography and geography of the Cities. 216. Time Warner submitted samples of PBVS direct mailing materials in support of its petition. It also claimed that 80% of the 4,000 PBVS test market customers in Southern California who initially received service at no charge became paying subscribers by October 1997. Time Warner subsequently submitted evidence showing that almost 1,200 of its customers residing in the Cities had cancelled their Time Warner service and switched to PBVS. 217. On May, 1, 1998, Time Warner's petition was denied. The decision denying the petition found that Time Warner did not demonstrate that PBVS "offers" service as that term is used in effective competition determinations. Time Warner, it was concluded, had provided insufficient evidence that PBVS has engaged in marketing efforts relevant to the 19 cable franchise areas and that PBVS's marketing efforts were not sufficient to make potential subscribers reasonably aware of the availability of PBVS's service. It was expressly noted PBVS's statement that it was intentionally limiting its marketing to "very specific demographics." Nor was there any evidence specifying the scope of PBVS's direct mail campaign. Although Time Warner may have lost 1,200 subscribers to PBVS, it remained unclear whether subscribers were lost in each of the 19 cable franchise areas involved. Further, the estimated subscriber loss represented only 0.3% of the 375,000 Time Warner subscribers in the Cities. 218. On June 1, 1998, Time Warner submitted a petition for reconsideration which included additional evidence of the scope of PBVS's marketing efforts in each specific cable franchise area in the Cities. The petition for reconsideration is currently being reviewed. 3. Thousand Oaks (and Camarillo), California 219. As we reported in the 1997 Report, the City of Thousand Oaks, California awarded a cable franchise to GTE Media Ventures ("GTE") in February 1996. GTE is wholly owned by the GTE Corporation, a LEC serving customers in 28 states. GTE Corporation is also the parent of GTE California, the incumbent LEC providing telephone services in California, including Thousand Oaks. GTE faces two incumbent cable operators, Falcon Cablevision and TCI, that serve different parts of the city. Falcon was the first incumbent operator to petition the Commission for a finding of effective competition in the Thousand Oaks franchise area. The Commission granted Falcon's petition April 1997. TCI also filed a petition with the Commission, asking the Commission to find that TCI is subject to effective competition in Thousand Oaks. The petition was unopposed. In February 1998, the Commission granted TCI's petition for special relief. 220. TCI, the second incumbent cable operator, has a subscriber base of 32,000 and is the larger of the two incumbents. It operates Ventura County Television, which serves the entire county of Ventura including the City of Thousand Oaks and Camarillo. TCI charges $10.51 for a 21 channel basic tier service and $26.30 for an expanded 54 channel service. 221. GTE began offering its new cable service in September 1996 at $10.95 for 28 channels. GTE also offers a larger expanded service (64 channels) than TCI at about the same price, $26.94. TCI claimed that GTE was providing service to approximately 10, 250 subscribers in Thousand Oaks and approximately 4,000 subscribers in Camarillo. Based on subscriber disconnect information, TCI asserts that many of these subscribers are former TCI customers. 222. To counter GTE's entry, TCI did not apply a nationwide 7% rate increase to areas in Ventura County where it was competing with other MVPDs. TCI asserts that it also offered discounts up to 15% to subscribers who agreed to take long-term subscriptions. Since the competitors offer similar program packages at similar prices, both appear to be planning to compete on other terms. TCI has stated that it may begin offering new services such as "interactive television." The new service would allow viewers to customize a program. For example, while watching Prime Sports, the viewer can request game statistics, watch interviews with players, or follow a star player throughout the game. GTE is also testing a similar interactive service that appears to be more high-tech than TCI's service. TCI's focus, however, remains on improving customers' programming choices and access. 223. The Cable services Bureau found that TCI met its burden by satisfying the two prongs of the competing provider test for effective competition. First, the Bureau found that TCI passes 94% of the households in Thousand Oaks and GTE passes over 90%. In addition, the programming of the competing operators is comparable. Second, the Bureau found that GTE, the smaller of the two systems, has more than a 23% penetration rate in Thousand Oaks. 4. Troy, Michigan 224. In April 1996, the City of Troy awarded a cable franchise to Ameritech. Ameritech is a LEC serving customers in Illinois, Indiana, Ohio, Michigan, and Wisconsin, and is the parent holding company of Michigan Bell, the incumbent LEC serving Troy. 225. In November 1996, Ameritech began providing service to about 70 percent of the city, serving approximately 2,500 subscribers. TCI Cablevision of Oakland County ("TCI"), the incumbent cable operator in Troy, serves approximately 17,000 subscribers. Ameritech offered an 18 channel "Localcast" service and a 60 channel "Premiercast" service compared to TCI's 31 channel basic service and 85 channel "Cable Plus" service. 226. Upon entering the market, Ameritech started an aggressive pricing policy which offered premiercast (which includes 12 premium channels) for about the same price that TCI was charging for its basic cable service plus HBO and Showtime. In response to Ameritech's entry, TCI lowered its basic cable rate by over $4 from $10.58 to $6.51, added PASS Sports to its cable plus line-up, and moved the Disney channel from a premium service to its expanded basic tier. A 1996 price comparison of monthly charges for cable and premium services, equipment, and a remote showed that TCI charged $53.90 per subscriber compared to $59.06 charged by Ameritech. Ameritech asserts that TCI is continuing to use promotional offers to win back or retain subscribers. For example, in March 1998, TCI began offering the first three months of digital service free of charge, which amounts to $30 of free services to current or new subscribers. 227. TCI petitioned the Cable Services Bureau for determination of effective competition in Troy, and the Bureau granted the petition on February 5, 1998. The Bureau found that Ameritech's extensive marketing efforts and press coverage of its construction ensure that potential subscribers are aware of the availability of Ameritech's service. Also, potential subscribers are able to receive Ameritech service for little or no additional investment and without encountering regulatory and technical difficulties. The Bureau also noted lower cable rates and added services as a result of competition in Troy. 5. Vestavia Hills, Alabama 228. In October 1995, BellSouth Interactive Media Services ("BellSouth") was granted a cable franchise to serve the City of Vestavia Hills. Rather than build its own facilities, BellSouth provides cable service over transmission facilities owned by its affiliate, BellSouth Telecommunications. BellSouth Telecommunications is the incumbent LEC serving Vestavia Hills. In December 1996, BellSouth began to offer cable service in Vestavia. BellSouth targeted Vestavia as a new market because its size and terrain made building a system affordable and because its affluent residents are more likely to purchase video programming services. TCI, the incumbent cable provider, states that BellSouth currently passes all 9,797 households in Vestavia and is providing service to 1,468 (or 15 percent) of those households. DirecTV serves approximately 295 customers or 3 percent of the market. 229. BellSouth's 15 channel basic service (Localcast) is offered at $9.95 per month. Its expanded service (Premiercast) contains 30 additional channels for an additional charge of $14.54, and its expanded plus service includes 8 additional satellite channels (including The Golf Channel, Animal Planet, Home & Garden, Country Music TV, and Classic Sports Network) for $3 per month. TCI provides a 15 channel basic service for $9.86 per month that is similar to BellSouth's basic service. With one exception, TCI's 43 channel expanded basic service at $17.66 is similar to BellSouth's expanded and expanded plus services at $17.54. The exception is the Disney Channel which is included in BellSouth's expanded service, but is considered a premium service only available at an extra charge on TCI's system. BellSouth charges $8 per month for one premium service such as HBO or Showtime compared to $13.70 charged by TCI. Thus, adding the Disney Channel to TCI's expanded plus service would cost $31.36 compared to the comparable BellSouth service at $27.49. BellSouth also offers one free month of basic and expanded service, free installation, free converter box and remote, and a 30 day money-back guarantee if the customer is not satisfied with the service, including reconnection to the former provider. 230. BellSouth plans to use its reputation for customer satisfaction to encourage TCI customers to switch to its services. BellSouth and TCI both plan to offer interactive services in the future. TCI was not specific regarding its competitive response to BellSouth's entry, except to say that it will continue to ensure the best quality service it can. 231. TCI filed a petition for determination of effective competition for the Vestavia Hills franchise area. TCI claimed that Vestavia satisfied the "competing provider" effective competition test. The petition was unopposed. In March 1998, the Cable Services Bureau granted TCI's petition for special relief. The Bureau found that TCI and BellSouth both serve the entire market, that their programming is comparable, and that the number of households subscribing to an MVPD other than to the largest MVPD exceeds 15 percent of the households in the market. B. Preliminary Findings 232. Each of the actual case studies detailed above considers the rivalry between the incumbent cable system and the overbuilder, most of which are using similar wired delivery systems. The one exception is the Cities associated with Los Angeles and Orange Counties where entry occurred using MMDS technology. In the current case studies as well as in the case studies in the last report, incumbent cable operators, when challenged by a new MVPD entrant, are responding in a variety of ways. Incumbents have responded by offering better customer services, new services, new products, larger channel complements for the same price, and, in two cases, apparently cutting prices. TCI cut its basic rates in Troy and claimed that, in Thousand Oaks, it offered price discounts for long term subscriptions and refrained from a planned rate increase, thus apparently holding rates below what they would have been in the absence of entry. Ameritech also supports the proposition that price concessions are a response by incumbents to entry in some markets. 233. Incumbent operators in Barron and Troy increased their service offerings in an attempt to protect or maintain customer bases in the face of entry. In Troy, some of the new channels added by the incumbent were previously offered as premium channels (such as the Disney Channel) and moved onto expanded basic service tiers ("CPSTs") at no additional cost. In Los Angeles and Orange Counties, and Troy, the channel line-up of the incumbent was larger than that of the entrant. 234. Incumbents in the above examples appear to be responding to entry on both a price and nonprice basis. We do note that, in at least one instance, the initial price decline occasioned by an overbuilder was transitory. In fact, it may be, given the economies of scale in delivered video programming services, that there are few competitive overbuild systems that will be economically viable over the long term. Although overbuilders attempt to respond to consumer complaints about the slow speed of upgrades, poor picture quality, and the lack of customer service, overbuilders may find it difficult to earn a profit over the long run. 235. In this Report, we find competition in the video marketplace is increasing (cable's market share has dropped from 87% to 85%). In communities where cable operators face competiton, consumers often receive benefits, including as lower prices, additional channels at same monthly rate, improved customer service or new services such as interactive programming. However, competitive alternatives and consumer choices are still developing and potential competitors to incumbent cable operators continue to face barriers to entry into markets for the delivery of video programming. V. ADMINISTRATIVE MATTERS 236. This 1998 Report is issued pursuant to authority contained in Sections 4(i), 4(j), 403, and 628(g) of the Communications Act of 1934, as amended, 47 U.S.C.  154(i), 154(j), 403, and 548(g). 237. It is ORDERED that the Office of Legislative and Intergovernmental Affairs shall send copies of this 1998 Report to the appropriate committees and subcommittees of the United States House of Representatives and the United States Senate. 238. It is FURTHER ORDERED that the proceeding in CS Docket No. 98-102 IS TERMINATED. FEDERAL COMMUNICATIONS COMMISSION Magalie Roman Salas Secretary APPENDIX A List of Commenters Intitial Comments A&E Television Networks ("A&E") ABC, Inc. ("ABC") Ameritech New Media, Inc. ("Ameritech") Antilles Wireless Cable TV Company ("Antilles") (late-filed) BellSouth Corporation, BellSouth Interactive Media Services, Inc. and BellSouth Wireless Cable, Inc. ("BellSouth") Cable Communications Agency, City of Indianapolis ("Indianapolis") Cox Communications, Inc. ("Cox") DIRECTV, Inc. ("DirecTV") Gemstar International Group Limited and Starsight Telecast, Inc. ("Gemstar") MediaOne Group, Inc. ("MediaOne") National Cable Television Association ("NCTA") National Rural Telecommunications Cooperative ("NRTC") OpTel, Inc. ("OpTel") RCN Telecom Services, Inc. ("RCN") Satellite Broadcasting and Communications Association ("SBCA") Small Cable Business Association ("SCBA") Wireless Communications Association International, Inc. ("WCA") Reply Comments Cablevision Systems Corporation ("Cablevision") Comcast Corporation ("Comcast") Lifetime Entertainment Services ("Lifetime") Motion Picture Association of America ("MPAA") National Cable Television Association ("NCTA") Office of the Commissioner of Baseball, National Basketball Association, National Hockey League and the National Collegiate Athletic Association ("Leagues") RCN Telecom Services, Inc. ("RCN") Viacom Inc. ("Viacom") APPENDIX B TABLE B-1 Cable Television Industry Growth: 1990 - June 1998 (in millions) U.S. Television Households ("TH") Homes Passed ("HP") Basic Cable Subscribers ("Subs") TV Households Passed by Cable (HP/TH) TV Households Subscribing (Subs/TH) U.S. Penetration (Subs/HP) Year Total Change From Previous Year Total Change From Previous Year Total Change From Previous Year 1990 91.1 -0.5% 86.0 3.9% 51.7 4.9% 94.4% 56.8% 60.1% 1991 92.1 1.1% 88.4 2.8% 53.4 3.3% 96.0% 58.0% 60.4% 1992 93.1 1.1% 89.7 1.5% 55.2 3.4% 96.3% 59.3% 61.5% 1993 94.0 1.0% 90.6 1.0% 57.2 3.6% 96.4% 60.9% 63.1% 1994 94.9 1.0% 91.6 1.1% 59.7 4.4% 96.5% 62.9% 65.2% 1995 95.9 1.0% 92.7 1.2% 62.1 4.0% 96.7% 64.8% 67.0% 1996 97.0 1.1% 93.7 1.1% 63.5 2.3% 96.6% 65.5% 67.8% 1997 98.0 1.0% 94.6 1.0% 64.9 2.2% 96.5% 66.2% 68.6% Jun 98 98.0 0.0% 95.1(e) 0.5% 65.4(e) 0.8% 97.0% 66.7% 68.8% (e) Based on year-end estimate by Paul Kagan Associates Note: This table contains data that was revised by the source. Sources:  U.S. Television Households: 1990 to 1997: Paul Kagan Assoc., Inc., Basic Cable Network Economics 1983-2007, Cable Program Investor, Mar. 13, 1998, at 2. June 1998: 1998 from Nielsen Media Research as cited in Broadcasting & Cable, Jun. 29, 1998, at 70.  Homes Passed and Basic Cable Subscribers: 1990 to 1997: Paul Kagan Assoc., Inc., History of Cable and Pay-TV Subscribers and Revenues, Cable TV Investor, Apr.14, 1998, at 3. January to June 1998e: Paul Kagan Assoc., Inc., Cable Industry 10- Year Projections, Cable TV Investor, Aug. 10, 1998, at 4. TABLE B-2 Premium Cable Services: 1990 - June 1998e (in millions) Premium Cable Service Subscribers Premium Units Year-end Year-end Total Change From Previous Year Year-end Total Change From Previous Year 1990 23.9 1.3% 39.9 7.8% 1991 24.0 0.4% 43.1 8.0% 1992 24.7 2.9% 46.5 7.9% 1993 26.4 6.9% 47.0 1.1% 1994 28.1 6.4% 47.4 0.9% 1995 29.8 6.0% 51.6 8.9% 1996 31.0 4.0% 54.6 5.8% 1997 31.5 1.6% 56.0 2.6% Jan-Jun 98(e) 33.7 7.0% 56.4 0.7% (e) Based on year-end estimate by Paul Kagan Associates. Note: This table contains data that was revised by the source. Sources:  Premium Cable Service Subscribers: Premium Cable Services Subscribers refers to the total number of homes subscribing to one or more premium services. Each home is counted once, regardless of the number of premium services to which it subscribes. 1990 to 1997: Paul Kagan Assoc., Inc., History of Cable and Pay-TV Subscribers and Revenues, Cable TV Investor, April 14, 1998, at 3. January to June 1998e: Paul Kagan Assoc., Inc., Paul Kagan's 10-Year Cable TV Industry Projections, The Cable TV Financial Databook, 1998, at 10.  Premium Units: Premium Units refers to the total number of premium subscriptions. Each subscription is counted separately, thus may exceed the number of premium subscribers. 1990 to 1997: Paul Kagan Assoc., Inc., History of Cable and Pay-TV Subscribers and Revenues, Cable TV Investor, April 14, 1998, at 3. January to June 1998e: Paul Kagan Assoc., Inc., Paul Kagan's 10- Year Cable TV Industry Projections, The Cable TV Financial Databook, 1998, at 10. TABLE B-3 Channel Capacity of Cable Systems: October 1996 - October 1998 1996 1997 96-97 1998 97-98 Channel Capacity Number of Systems Percent of Systems Number of Systems Percent of Systems Percent Change Number of Systems Percent of Systems Percent Change 54 and + 1,724 16.3% 1,886 19.0% 9.4% 2,040 20.7% 8.2% 30 to 53 6,410 60.8% 6,374 64.1% -0.6% 6,288 63.9% -1.3% 20 to 29 1,607 15.3% 971 9.8% -39.6% 879 8.9% -9.5% 13 to 19 337 3.2% 309 3.1% -8.3% 258 2.6% -16.5% 6 to 12 456 4.3% 399 4.0% -12.5% 363 3.7% -9.0% 5 or less 12 0.1% 10 0.1% -16.7% 11 0.1% 10% Not Avail. 937 - 889 - -5.1% 880 - -1.0% Total 11,483 - 10,838 - -5.6% 10,719 - -1.1% Sys. w/30+ channels 8,134 77.2% 8,260 83.0% 1.5% 8,328 84.6% 0.8% Sys. w/less than 30 channels 2,412 22.8% 1,689 17.0% -30.0% 1,511 15.4% -10.5% Note: Figures are as of October 1, 1996, October 1, 1997, and October 30, 1998. Note: All "Percentage of Systems" calculation excludes "not available" data, (this includes the percentage tabulations in the categories of "Systems with 30+ channels" and "Systems with less than 30 channels.") Sources:  1996: Warren Publishing, Inc., Channel Capacity of Existing Cable Systems, Television & Cable Factbook: Services Volume No. 65, 1997 Edition, at I-81.  1997: Warren Publishing, Inc., Channel Capacity of Existing Cable Systems, Television & Cable Factbook: Services Volume No. 66, 1998 Edition, at I-81.  1998: Warren Publishing, Inc., Channel Capacity of Existing Cable Systems, (facsimile) (Television & Cable Factbook: Services Volume No. 67, 1999 Edition, to be released). TABLE B-4 Channel Capacity for Subscribers: October 1996 - October 1998 (in millions) 1996 1997 96-97 1998 97-98 Channel Capacity Number of Subscribers Percent of Subscribers Number of Subscribers Percent of Subscribers Percent Change Number of Subscribers Percent of Subscribers Percent Change 54 and + 33.58 55.3% 35.73 58.4% 6.4% 38.91 61.5% 8.9% 30 to 53 26.06 42.9% 24.35 39.8% -6.6% 23.57 37.3% -3.2% 20 to 29 0.81 1.3% 0.85 1.4% 4.9% 0.61 1.0% -28.2% 13 to 19 0.10 0.2% 0.09 0.1% -10.0% 0.06 0.1% -33.3% 6 to 12 0.19 0.3% 0.19 0.3% 0.0% 0.09 0.1% -52.6% 5 or less 0.00 0.0% 0.00 0.0% 0.0% 0.00 0.0% 0.0% Not Avail. 0.09 - 1.22 - 1255.6% 1.20 - -1.6% Total 60.83 - 62.43 - 2.6% 64.44 - 3.2% Sys. w/30+ channels 59.64 98.2% 60.08 98.2% 0.7% 62.5 98.8% 4.0% Sys. w/less than 30 1.10 1.8% 1.13 1.8% 2.7% 0.8 1.2% -32.7% Note: Figures are as of October 1, 1996, October 1, 1997, and October 30, 1998. Note: All "Percentage of Systems" calculation excludes "not available" data, (this includes the percentage tabulations in the categories of "Systems with 30+ channels" and "Systems with less than 30 channels.") Sources:  1996: Warren Publishing, Inc., Channel Capacity of Existing Cable Systems, Television & Cable Factbook: Services Volume No. 65, 1997 Edition, at I-81.  1997: Warren Publishing, Inc., Channel Capacity of Existing Cable Systems, Television & Cable Factbook: Services Volume No. 66, 1998 Edition, at I-81.  1998: Warren Publishing, Inc., Channel Capacity of Existing Cable Systems, (facsimile) (Television & Cable Factbook: Services Volume No. 67, 1999 Edition, to be released). TABLE B-5 Growth By Network Type: 1996 - June 1998 1996 1997 96-97 Jan-June 98 third/yr Network Type Number of Network s Percent of Networks Number of Network s Percent of Networks Change Number of Network s Percent of Networks Half-year Change Basic/No-Chrg 126 77.8% 131 79.9% 4.0% 133 77.7% 1.5% Premium 18 11.1% 14 8.5% -22.2 % 20 11.6% 42.9% Pay Per View 7 4.3% 6 3.7% -14.2% 9 5.3% 50.0% Combination 11 6.8% 13 7.9% 18.1% 9 5.3% -30.8% Total 162 164 1.2% 171 4.3% Note: "Combination" refers to cable networks that fall under more than one service category. For example, the Disney Channel, which is part of the basic tier in some systems, and is sold as a premium service on other systems, is considered a "combination" network. Source:  1996 to April 1998: National Cable Television Association, National Cable Video Networks By Type of Service: 1978 - 1998, Cable Television Developments, Spring 1998, at 6.  April 1998 to June 1998: According to National Cable Television Association, there were no increases in the net number of networks between April and June and only possibly a re- categorization of existing networks, therefore numbers for April are considered appropriate for June. TABLE B-6 Cable Industry Revenue and Cash Flow(1): 1994 - 1998e 1994 1995 1996 1997 1998 Total Total % Change Total % Change Total % Change Estimated Year-End Total Avg Basic Subscribers (mil) 58.5 60.9 4.1% 62.8 3.1% 64.2 2.2% 65.4 Revenue Segments (mil.) Regulated Tiers $15,164 $16,860 11.2% $18,395860 9.1% $20,008 8.8% $21,509 Pay Tiers $4,324 $4,776 10.5% $4,955 3.7% $4,952 -0.1% $4,913 Local Advertising $1,204 $1,433 19.0% $1,662 16.0% $1,925 15.8% $2,214 Pay-Per-View $494 $535 8.3% $647 20.9% $823 27.2% $781 Home Shopping $127 $144 13.4% $145 0.7% $152 4.8% $160 Advanced Svcs (Ana./Dig.) n/a $23 - $91 296% $208 128.6% $424 Equipment and Install $1,697 $1,787 5.3% $2,055 15.0% $2,320 12.9% $2,626 Total Revenue (mil.) $23,010 $25,558 11.4% $27,950 9.4% $30,388 8.7% $32,627 Revenue Per Subscriber $393.33 $419.67 6.7% $445.06 6.0% $473.33 6.4% $498.88 Operating Cash Flow (mil.) $9,936 $10,977 10.5% $11,972177 9.1% $13,369 11.7% $14,440 Cash Flow per Subscriber $169.84 $180.25 6.1% $190.64 5.8% $208.24 9.2% $220.80 Cash Flow/Total Revenue 43.2% 42.9% -0.7% 42.8% -0.2% 44.0% 2.8% 44.3% (1) Cash flow as reported in this table is operating cash flow. Industry-wide figures are generally reported in terms of operating cash flow; these are the data we report here. Firm-specific cash flow figures are generally reported in terms of EBITDA ("earnings before interest, taxes, depreciation, and amortization"). This differs from previous reports where we reported the most readily available cash flow figure. (e) Year-end estimate by Paul Kagan Associates Note: Cash flow and its proxies (e.g. EBITDA) are often used to value the operations of a communications firm without regard to the firm's capital structure. Cash flow from operations is the net result of cash inflows from operations (revenue) and cash outflows from operations (expenses), thus ignoring non-cash charges to net income such as depreciation and amortization. Cash flow from operations indicates a firm's ability to meet its net finance and investment obligations. Note: All "per subscriber" figures are calculated using average number of basic subscribers reported in the top row. Sources:  1994 to 1997: Average Number of Basic Subscribers: Paul Kagan Assoc., Inc., History of Cable and Pay-TV Subscribers and Revenues, Cable TV Investor, Apr. 14, 1998, at 3; Revenue Segments: Paul Kagan Assoc., Inc., Paul Kagan's 10-Year Cable TV Industry Projections, Cable TV Investor, May 20, 1997, at 9; Paul Kagan Assoc., Inc., Total Cable TV Advertising Revenue (1980-2007), Cable TV Financial Databook, Aug. 1998, at 15. Operating Cash Flow: Paul Kagan Assoc., Inc., Estimated Capital Flows In Cable TV, Cable TV Finance, May 31, 1998, at 1.  1998e: Average Number of Basic Subscribers: Paul Kagan Assoc., Inc., Cable Industry 10- Year Projections, Cable TV Investor, Aug. 10, 1998, at 4. Revenue Segments: Paul Kagan Assoc., Inc., Cable Industry 10-Year Projections, Cable TV Investor, Aug. 10, 1998, at 4; Paul Kagan Assoc., Inc., Total Cable TV Advertising Revenue (1980-2007), Cable TV Financial Databook, Aug. 1998, at 15. Operating Cash Flow: Paul Kagan Assoc., Inc., Estimated Capital Flows In Cable TV, Cable TV Finance, May 31, 1998, at 1. TABLE B-7 Acquisition of Capital: 1990 - June 1998 ($ in million) Year Private Debt Public Debt (2) Private Equity Public Equity Total Capital Raised From Financing Sources(3) Sum Raised % of Total(1) Totalal Sum Raised % of Total Sum Raised % of Total Sum Raised % of Total 1990 $3,869 92% $249 6% $85 2% $0.44 0% $4,203 1991 $770 29% $1,426 55% $292 11% $127 5% $2,615 1992 $(1,842) -77% $2,493 105% $1,711 72% $23 1% $2,385 1993 $(3,584) -186% $5,280 275% $62 3% $165 9% $ 1,923 1994 $ 4,803 103% $(715) ))(715)$, operator ofS) facility, acastliteDB (ite satel directoad br$$ -154% $100 2% $461 10% $ 4,649 1995 $(714) -10% $2,825 40% $1,109 16% $3,919 55% $7,139 1996 $538 11% $1,355 29% $49 1% $2,818 59% $4,760 1997 $310 4% $5,337 70% $1,910 25% $80 1% $7,637 Jan-Jun 1998 $1,632 18% $5,835 63% $50 0.5% $1,677 18% $9,194 Total: 1990-June1998 $5,782 $680 $ 24,085 $2,834 $5,368 $632 $9,270 $1,091 $44,505 Average Raised Per Year $5,236 (1) Column entitled "% of total" represents the percent of total capital raised from financing sources for that given year. (2) Public Debt is expressed in terms of Net New Public Debt. (3) Total Capital Raised From Financing Sources = Private Debt + Public Debt + Private Equity + Public Equity. Sources:  1990 to 1992 - Public Debt and Private Debt: Paul Kagan Assoc., Inc., Discussion with Elaine Blaisdell Taylor, Research Associate, August 28, 1998. Public Equity and Private Equity: Paul Kagan Assoc., Inc., Cable Financing Snapshot, Cable TV Finance, January 31, 1997 at 10.  1993 to 1997 - Paul Kagan Assoc., Inc., Estimated Capital Flows in Cable TV, Cable TV Finance, May 31, 1998 at 1.  June 1998 - Paul Kagan Assoc., Inc., Cable Financing Snapshot - June, Cable TV Finance, Sept 9, 1998 at 8. TABLE B-8 System Transactions: 1995 - June 1998 1995 1996 95-96 Change 1997 96-97 Change Jan - June 1998 Number of Systems Sold 142 99 -30.3% 112 13.1% 45 Total Number of Subscribers 11,065,502 7,852,900 -29.0% 11,306,800 43.9% 18,241,470 Average System Size 77,926 79,322 1.8% 100,954 27.3% 405,366 Number of Homes Passed 17,237,503 12,641,500 -26.7% 18,193,400 43.9% 29,347,076 Avg. # of Homes Passed 121,390 127,692 5.2% 162,441 27.2% 652,157 Total Dollar Value (mil.) $20,240 $16,124 -20.3% $22,830 41.6% $52,377 Average Dollar Value (mil.) $143 $163 14.0% $204 25.2% $1,164 Dollar Val. per Home Pass'd $1,174 $1,275 8.6% $1,273 -1.6% $1,785 Dollar Val. per Subscriber $1,829 $2,053 12.2% $2,056 -10.15%.7- 2,871 Cash Flow Multiple 9.7x 9.9x 2.1% 9.5x -4.0% 13.2x Sources:  1995 to 1997 - Paul Kagan Assoc., Inc., Year-To-Date Cable System Sale Summary, Cable TV Investor, Feb. 24, 1998, at 7.  Jan 1998 to June 1998 - Paul Kagan Assoc., Inc., Year-To-Date Cable System Sale Summary, Cable TV Investor, August 10, 1998 at 10. Table B-9 Cable Modem Deployment as of June 1998 MSO City(ies) Modem Supplier Monthly* Install Type of Svc. Adelphia Palm Beach County, FL; Coudersport, Lansdale, Mt. Lebanon, Bethel Park, West Mifflin, & Plymouth Mtg., PA; Amherst, Tonawanda, Grand Island, Buffalo & Niagra Falls, NY; Plymouth, Adams & N. Adams, MA; Hilton Head, SC; Macedonia, OH; Blacksburg, Staunton, and Wincester, VA General Instrument/ Bay Networks $34.95- $39.95 N/A þTelephone line return ("Telco- return") þ2-way Cable Bresnan Marquette, MI Bay Networks $39.95 N/A þ2-way Cable Cablevisio n Systems Westport, CT & Oyster Bay, NY Bay Networks $44.95 N/A þ2-way Cable þ@home Century Norwich, NY Motorola $39.95- $49.95 $199 þRoad Runner Charter Riverside & Pasadena, CA General Instrument, Com21 $44.95- $64.95 up to $169 þTelco-return þ2-way Cable Comcast Baltimore, MD; Sarasota, FL; Union, NJ; Detroit, MI; Phila., PA; Orange Cnty, CA Motorola $39.95 - $59.95 $175 þ@home Cox Orange County, Eureka & San Diego, CA; Phoenix, AZ; Meridian, CT; Omaha, NE Oklahoma City, OK; Newport News, VA Providence, RI Motorola, Bay Networks, Hybrid Networks $41.90 - $54.95 $149 - $175 þ@home þTelco-return InterMedia (*) Nashville Metro area and Kingsport, TN; Greenville and Spartanburg, SC Motorola, General Instrument $39.95- $44.95 $99- $150 þ@home þTelco-return þ2way expctd Jones Intercable Alexandria, Price William County, VA & Prince Georges Cnty, MD Bay Networks, Hybrid Networks $43.90 up to $125 þJones Intrnt Chn'l (Telco) þ@home Marcus Highland Prk & University Prk, TX Bay Networks $49.95 $499 þ@home Media One Boston metro & Chestnut Hill, MA; Salem, NH; Detroit metro & Ann Arbor, MI; Dade Cnty, Jacksonville, & Broward Cnty, FL; Chicago, IL; Atlanta, GA; Los Angeles, CA Bay Networks, General Instruments, and Motorola $34.95 - $49.95 up to $99.95 þMediaOne Express þTelco-return TCI Arlington Heights, IL; Seattle, WA; East Lansing, MI; Alameda, Antioch, Dublin, Castro Valley, Fremont, Hercules, Livermore, Petaluma, Pinole, Pittsburg, Pleasanton & San Ramon, CA; Hartford, CT; Denver, CO; Garland, McKinney & Stonebridge, TX Zenith, Bay Networks, and Motorola, Com 21 $34.95 - $44.95 ($80 for 10Mbps) up to $69 - $150 þ@home þTCI-NET Time Warner Akron, Canton, Youngstown & Columbus, OH; Corning, Elmira, Binghamton, Albany, Troy & Saratoga, NY; San Diego, CA; Tampa Bay, FL; Oahu, HI; Memphis, TN; El Paso, TX; Portland, ME Motorola, Hewlett Packard, and Toshiba $39.95- $44.95 N/A þRoad Runner Note: Monthly Rate ("Monthly") and Installation Fees ("Install") depend on the type of service and hardware received by the customer. Note(*): Intermedia's Nashville Metro area includes Davidson, Williamson, Rutherford, and Wilson counties, and was expected to include Sumner County in late October, 1998. Additionally, Intermedia currently offers telco-return in Kingsport, TN, but was expected to offer cable-two-way service in late November, 1998. Sources:  Michael Harris, Cable Modem Commercial Launches and Trials in North America, Kinetic Strategies, May 15, 1997. See http://CableDatacomNews.com/cmic7.htm.  Telephone Interview with William Haggarty, Intermedia Partners, September 11, 1998.  E-mail contact with Ellen East, Cox Communications, August 18, 1998. Appendix C Table C-1 Assessment of Competing Technologies (i) Technology Used Dec. 1994 Dec. 1995 Dec. 1996 Jun. 1997 Jun. 1998 (1) TV Households(ii) Pct. Change 95,400,000 1.27% 95,900,0000. 52% 97,000,0001. 15% 97,000,0000. 00% 98,000,000 1.03% 97,000,000 0.00% (2) MVPD Households(iii) Pct. Change Pct. of Households 63,936,620 6.06% 67.02% 68,487,750 7.12% 71.42% 72,370,950 5.67% 74.61% 73,646,970 1.76% 75.92% 76,634,200 4.06% 78.20% (3) Cable Subs. Per Cent Change Pct. of MVPD Total 59,700,000 4.37% 93.37%59,7004.37% 93.37% 62,100,000 4.02% 93.37% 63,500,000 2.25% 87.74% 64,150,000 1.02% 87.10% 65,400,000 1.95% 85.34% (4) MMDS Subs. Pct. Change Pct. of MVPD Total 600,000 51.13% 0.94% 851,00041.8 3% 1.24% 1,180,000 38.66% 1.24% 1,100,000 -6.78% 1.49% 1,000,000 -9.09% 1.30% (5) SMATV Subs. Pct. Change Pct. of MVPD Total 850,000 -15.34% 1.33% 962,000 13.18% 1.40% 1,126,000 17.05% 1.56% 1,162,500 3.24% 1.58% 940,000 -19.14% 1.23% (6) HSD Subs. Pct. Change Pct. of MVPD Total 2,178,000 35.11% 3.41% 2,365,400 8.60% 3.45% 2,277,760 -3.71% 3.15% 2,184,470 -4.10% 2.97% 2,028,200 -7.15% 2.65% (7) DBS Subs. Pct. Change Pct. of MVPD Total 602,000 760.00% 0.94% 2,200,000 265.45% 3.21% 4,285,000 94.77% 5.92% 5,047,000 17.78% 6.85% 7,200,000 42.66% 9.40% (8) OVS Subs. Pct. Change Pct. of MVPD Total 2,190 0.0% 3,000 36.99% 0.0% 66,000 2,100% 0.09% (9) VDT Subs. (Trials) (iv) Pct. Change Pct. of MVPD Total 6,620 0.01% 9,350 41.24% 0.01% 0 -100.00% 0.00% 0 0.00% 0.00% 0 0.00% 0.00% NOTES: (i) Some numbers have been rounded. (ii) The year-end 1996 and June 1997 figures are the same because Nielsen's annual update does not take effect until September, the beginning of the new television season. (iii) The total number of MVPD households is likely to be somewhat less than the given figure due to households subscribing to the services of more than one MVPD. See e.g. 1994 Report, 9 FCC Rcd 7480  74 (1994). The number of such households is likely low, however, so the given total can be seen as a reasonable estimate of the number of MVPD households. See (2) under Sources below. (iv) The 1996 Act repealed the VDT framework. For details, see 1997 Report Section II.H. 108. These trials were converted to an OVS format and cable franchises. SOURCES: (1) Television households: 1994 from A. C. Nielsen Co. as of January of the following year cited by Veronis, Suhler & Associates, Homes Passed by Cable and Incidence of Subscription, The Veronis, Suhler & Associates Communications Industry Forecast, July 1995, at 145; 1995 from Nielsen Media Research as cited in Broadcasting & Cable, Jan. 8, 1996, at 50; 1996 from Nielsen Media Research as cited in Broadcasting & Cable, Jan. 13, 1997, at 118; 1997 from Nielsen Media Research as cited in The TV Column, Washington Post, Aug. 26, 1997, at E4; and 1998 from Nielson Media Research as cited in Broadcasting & Cable, Jun. 29, 1998, at 70. (2) Total MVPD households: The sum of the total number of subscribers listed under each of the categories of the various technologies. See note (ii) above. Because there were no permanent VDT subscribers, trial VDT subscriber figures were used in 1994-95. (3) Cable subscribers: 1994 from Paul Kagan Associates, Inc., History of Cable and Pay-TV Subscribers and Revenues, Cable TV Investor, June 30, 1995, at 5; 1995-97 from Paul Kagan Associates, Inc., Paul Kagan's 10- Year Cable TV Industry Projections, Cable TV Investor, May 20, 1997, at 9; and 1998 from Paul Kagan Associates, Inc., Cable Industry 10-Year Cable Projections, Cable TV Investor, Aug. 10, 1998, at 4. (4) MMDS subscribers: 1994 from Paul Kagan Associates, Inc., Wireless Cable Industry Projections,1992-2002, The 1995 Wireless Cable Databook, Jan. 1995, at 23; 1995-1996 from Paul Kagan Associates, Inc., Wireless Cable Futures, Wireless Cable Investor, Dec. 31, 1996, at 10-11; 1997 from WCA Comments at 8. The 1998 subscribers were estimated by the FCC. (5) SMATV subscribers: 1994 based on discussion with John Mansell, Senior Analyst, Paul Kagan Associates, Inc. and reference to Cable & Pay TV Census -- December, Marketing New Media, Dec. 19, 1994; 1995-1996 from Private Cable Growth, Private Cable Investor, Jul. 1997, at 3; 1997 subscribers were estimated by the FCC based on data from Paul Kagan Associates, Inc., Private Cable Growth, Private Cable Investor, Jul. 1997, at 3; and 1998 from NCTA Comments at 6. (6) HSD subscribers: 1994 from 1994 Net Authorizations, SkyREPORT, Feb. 1995, at 9. (The 1994 HSD subscriber figure was reduced by 1% to account for the estimated number of Canadian subscribers.) 1995 from DTH Subscribers, SkyREPORT, Jan. 1997, at 8 and SBCA Comments at Appendix A; 1996-1997 from DTH Subscribers, SkyREPORT, Nov. 1997, at 10; and 1998 from SkyREPORT.Com at http://www.skyreport.com/dth_us.htm. (7) DBS subscribers: 1994 from Kent Gibbons, DBS: We're Walking the Walk, Multichannel News, Jan. 16, 1995, at 3, 52; 1995 from DTH Subscribers, SkyREPORT, Jan. 1997, at 8; 1996-1997 from DTH Subscribers, SkyREPORT, Nov. 1997, at 10; and 1998 from Minal J. Damani and Jennifer E. Sharpe, U.S. DBS Marketplace: 1998, The Strategis Group, Jul. 1998, at 6. (8) OVS subscribers: 1996 from Bell Atlantic Comments at 5. The 1997 and 1998 subscribers were estimated by the FCC. (9) VDT trial subscribers: 1994-95 from Section 214 Applications, ex parte letters and associated filings with the FCC. TABLE C-2 Number and Subscriber Size of Major Cable System Clusters (Cumulative Figures) Range of Clustered Subscribers (thousands) 1994 1995 1996 1997 Clusters Subs. (millions) Clusters Subs. (millions) Clusters Subs. (millions) Clusters Subs. (millions) 100-199 58 8.0 76 10.4 76 10.3 49 6.7 200-299 26 6.0 35 8.4 34 8.3 33 8.2 300-399 6 2.0 8 2.8 11 3.7 11 3.8 400-499 3 1.3 10 4.5 8 3.6 8 3.7 > 500 4 2.8 8 5.1 10 7.7 16 11.9 Total 97 20.1 137 31.2 139 33.6 117 34.3 Sources: Paul Kagan Associates, Inc., Major Cable TV Systems/Clusters, The Cable TV Financial Databook, 1995, at 38-39; 1996, at 38-40; 1997, at 39-41; 1998, at 38-42. TABLE C-3 1998 MVPD Horizontal Concentration Nationwide Rank Company Per Cent of Subscribers 1 TCI 26.48 2 Time Warner 16.04 3 MediaOne 6.32 4 Comcast 5.79 Top 4 54.63 5 DirecTV 4.60 6 Cox 4.24 7 Adelphia 2.60 8 Century 1.72 9 Charter 1.62 10 Marcus 1.62 Top 10 71.04 Top 25 80.99 Top 50 86.08 HHI 1096 Table C-4 Consummated and Announced Cable Transactions July 1997 - June 1998 YEAR BUYER SELLER SYSTEMS PRICE** (Mil.) SUBS (Actual) PRICE/ SUB.** * CASH FLOW MULT Jul-97 Genesis Cbl McDnld Invest Jackson Co. GA $45 21,000 $2,035 8.9 Jul-97 Fanch Comm Leonard Comm Hendricks IN $6 5,000 $1,328 7.7 Jul-97 G Force LLC InterMeda Kauai HI $24 $12,000 $2,065 8.6 Jul-97 G Force LLC Rifkin & Assoc Kauai HI $14 8,000 $1,744 8.7 Jul-97 Intermedia IV TCI KY $854.1 425,000 $2,010 11.0 Jul-97 InterMedia Ptnrs TCI KY $946 425,000 $2,226 10.1 Jul-97 Triax Midwest Triax Assoc Roselawn IN $50 33,000 $1,509 7.3 Jul-97 (c) TCI/TCA JV TCA Cable TX, LA, NM $285 155,000 $1,839 8.7 Jul-97 (c) TCI/TCA JV TCI TX, LA $310 150,000 $2,068 9.2 Aug-97 Mediacom Cablevision 10 States $315 265,000 $1,189 8.9 Aug-97 Jones Inter Jones Fund Albuquerque NM $223 113,000 $1,977 8.6 Aug-97 FrntrVsn Cox Comm Central OH $144 85,000 $1,694 9.0 Aug-97 Genesis Milestone Hoke Co. NC $2 2,000 $1,145 7.0 Aug-97 Insight Comm Cox Comm Lafayette IL $77 38,000 $2,018 9.6 Aug-97 Charter Sonic Logan UT, CA $183 117,000 $1,562 8.0 Aug-97 Cox Comm Insight Comm Phoenix AZ $77 36,000 $2,131 9.1 Aug-97 Insight Comm Cablevision Rockford IL $97 65,000 $1,492 9.5 Sept-97 Post Newsweek* TCA Cable* Blackwell OK $28 17,000 $1,679 8.9 Sept-97 Time Warner* TCI* FL $360 200,000 $1,800 10.0 Sept-97 Time Warner* TCI* HI, OH, NY $270 133,000 $2,030 10.2 Sept-97 TCI* Time Warner* IL $144 72,000 $2,000 10.3 Sept-97 TCI* Time Warner* IL, NJ, PA $360 170,000 $2,118 10.3 Sept-97 TCA Cable* Post Newsweek* Lufkin TX $28 16,000 $1,819 8.9 Sept-97 Time Warner* TCI* ME, WI $144 77,000 $1,870 9.1 Sept-97 Bresnan/TCI JV TCI MN, MI, NE, WI $800 445,000 $1,798 8.6 YEAR BUYER SELLER SYSTEMS PRICE** (Mil.) SUBS (Actual) PRICE/ SUB.** * CASH FLOW MULT Sept-97 Time Warner* TCI* NY $80 62,000 $1,290 6.2 Sept-97 (c) KC Cable TCI Overland KS $258 93,000 $2,777 12.3 Sept-97 TCI* Time Warner* PA, WY, MO $80 55,000 $1,455 8.1 Sept-97 TCI* Time Warner* Portland OR $270 126,000 $2,143 10.2 Sept-97 TCI* Time Warner* TX $203 117,000 $1,735 8.7 Sept-97 Time Warner* TCI* TX $203 126,000 $1,607 8.2 Sept-97 TCI/TW JV TCI TX $1,326 520,000 $2,550 9.1 Sept-97 TCI/TW JV TW TX $1,176 510,000 $2,306 12.5 Sept-97 Prime Cable SBC Corp VA, MD $637 268,000 $2,377 8.2 Oct-97 Helicon Corp Booth Comm Anderson SC $31 16,000 $1,934 9.6 Oct-97 Harron Comm Auburn Cable Auburn NY $28 14,000 $1,958 10.2 Oct-97 Helicon Corp Booth Comm Boone NC $35 19,000 $1,852 9.5 Oct-97 Comcast Jones Fund 14 Broward FL $140 55,000 $2,545 10.3 Oct-97 Helicon Corp Calhoun TV Calhoun TN $1 1,000 $1,285 6.6 Oct-97 Optel Phonoscope Houston TX $37 34,000 $1,074 8.8 Oct-97 TWE/AN Time Warner NY, FL, NC $1,327 640,000 $2,073 9.4 Nov-97 CableOne* Time Warner* Anniston AL $65 36,000 $1,814 9.5 Nov-97 Avalon Ptrs Pegasus CT, NH $30 15,000 $1,954 9.0 Nov-97 Renaissance Time Warner Jackson , TN $291 125,000 $2,328 9.8 Nov-97 Marcus Cable McDonald Inv Mountain Brook, AL $62 23,000 $2,680 9.8 Nov-97 Fanch Comm Spring Green Spring Green , WI $10 9,000 $1,051 7.3 Nov-97 CableOne Jones Fund 14 Surfside SC $52 25,000 $2,060 10.3 Dec-97 (c) TCI* Insight Comm* Brigham UT $125 58,000 $2,160 9.2 Dec-97 (c) Insight Comm* TCI* Evansville IN $131 63,000 $2,098 9.7 Dec-97 TCI* MediaOne* Chicago IL $1,284 542,000 $2,368 10.6 Dec-97 Comcast Marcus Cable DE, MD $66 27,000 $2,472 9.9 Dec-97 TCI* Century Comm* Fairfield CA $191 90,000 $2,121 9.7 YEAR BUYER SELLER SYSTEMS PRICE** (Mil.) SUBS (Actual) PRICE/ SUB.** * CASH FLOW MULT Dec-97 TCI/Centurt JV TCI LA Co. Ventura CA $455 245,000 $1,857 9.0 Dec-97 (c) Insight/TCI JV TCI Richmond IN $370 160,000 $2,313 9.6 Dec-97 (c) Insight/TCI JV Insight Comm Jefferson IN $377 160,000 $2,359 9.8 Dec-97 Century Comm* TCI* S.Fernando CA $167 90,000 $1,858 9.0 Dec-97 MediaOne* TCI* Southeast, FL, GA $1,110 508,000 $2,186 10.7 Dec-97 TCI/Century JV Century Comm Sherman Oaks CA $1,342 500,000 $2,684 10.9 Dec-97 (c) Multimedia* TCI* Topeka KS $201 128,000 $1,569 8.8 Dec-97 (c) TCI* MultiMedia* IL, IN $189 93,000 $2,030 9.5 Jan-98 TW Fanch Cablevision AllenTwp OH $9 7,000 $1,320 8.1 Jan-98 Cablevision* TCI* Bradford CT $75 60,000 $1,250 6.6 Jan-98 Rapid Comm Rural MO Brandson MO $12 11,000 $1,122 7.8 Jan-98 Peak\TCI JV Halcyon Dequeen AR $38 27,000 $1,407 9.0 Jan-98 Adelphia Sandler Media Hancock MD $24 16,000 $1,476 7.9 Jan-98 Cablevision TCI Hartford CT $380 173,000 $2,197 10.0 Jan-98 PEAK\TCI JV TCI Henryetta OK $147 87,000 $1,690 9.9 Jan-98 TCI* Cablevision* Kalamazoo MI $75 50,000 $1,500 7.0 Jan-98 Gans King George King George VA $6 4,000 $1,710 8.6 Jan-98 Northland InterMedia Toccoa GA $93 54,000 $1,710 8.8 Jan-98 Adelphia Cablevision Wellsville NY $12 12,000 $943 5.4 Jan-98 Adams CATV Cablevision Windsor NY $5 4,000 $1,188 6.8 Feb-98 Bresnan Rifkin Bridgeport MI $17 11,000 $1,545 7.4 Feb-98 E. Cleveland TBA Inc E Cleveland OH $6 4,000 $1,771 8.3 Feb-98 Blackstone Galaxy Media Kemmerer WY $5 4,000 $1,300 8.0 Feb-98 Harron Comm Community TV Laconia NH $113 57,000 $1,980 9.6 Mar-98 TMC Holdings Marcus Cable Waterbury CT $150 63,000 $2,381 10.0 Mar-98 CableOne Marcus TX, OK, MS, LA $151 72,000 $2,112 9.6 YEAR BUYER SELLER SYSTEMS PRICE** (Mil.) SUBS (Actual) PRICE/ SUB.** * CASH FLOW MULT Mar-98 Classic Comm CableOne TX, OK, KS, MO $44 29,000 $1,523 8.3 Mar-98 Frontiervision N.Oakland Sumpter MI $14 8,000 $1,743 7.7 Mar-98 Frontiervision TCI Port Clinton OH $10 7,000 $1,429 6.6 Mar-98 CND Acquisition King Kable Andrews NC $2 2,000 $750 6.9 Mar-98 Upsala Coop. Midcontinent Grey Eagle MN $.5 500 $1,000 8.1 Mar-98 Galaxy Cablevision USA Cablevision Brooks/Colquitt Cts. GA $.1 500 $313 2.8 Apr-98 Vulcan Ventures Marcus TX $2,775 1,100,000 $2,523 11.1 Apr-98 Jones Intercable Jones Palmdale CA $138 64,000 $2,176 10.4 Apr-98 (c) Time Warner* Cablevision* Rensselaer NY $57 30,000 $1,944 9.2 Apr-98 (c) Cablevision* Time Warner* Litchfield CT $49 27,000 $1,835 9.2 Apr-98 CableOne Bresnan Comm Grenada MS $11 7,000 $1,564 7.3 Apr-98 Jones InterCable Jones Littlerock CA $11 6,000 $1,881 8.8 Apr-98 TCI Jones Fund Chicago IL $597 255,000 $2,340 9.8 Apr-98 TCI/Cox JV TCI Tulsa OK $285 150,000 $1,902 8.2 Apr-98 TCI/Cox JV Cox Comm. Oklahoma City OK $285 120,000 $2,378 11.6 Apr-98 Triax Marcus Cable Ottawa IL $66 33,000 $2,018 9.0 Apr-98 Vista Comm Smyrna Cable TV Smyrna GA $62 27,000 $2,351 9.2 Apr-98 TW Fanch TCI MD, OH, VA, WV $274 148,000 $1,858 9.2 May- 98 Cox Comm Community Cable Las Vegas NV $1,137 319,000 $3,564 13.0 May- 98 Millennium InterMedia Partners Arundel MD $130 54,000 $2,399 9.3 May- 98 Amer Cable Ent Booth American Victorville CA $74 32,000 $2,300 9.3 May- 98 N. Willamette Northland Comm Woodburn OR $7 4,000 $1,605 6.5 May- 98 Cox Comm TW-Douglas Cable Omaha NE $6 5,000 $1,224 7.9 May- 98 Jones Bresnan GA $50 24,000 $2,114 8.8 Jun-98 Savage Comm. Midcontinent East Gull Lake MN $1.1 1,000 $1,100 8.7 YEAR BUYER SELLER SYSTEMS PRICE** (Mil.) SUBS (Actual) PRICE/ SUB.** * CASH FLOW MULT Jun-98 MediaOne Time Warner Dearborn, Wayne MI $60 30,400 $1,974 9.7 Jun-98 Insight Coaxial Comm. Columbus OH $183 91,000 $2,011 9.5 Jun-98 AT&T TCI Denver $44,100 15,100,000 $2,923 13.7 Jun-98 Avalon Cable Cable Michigan MI $435 350,000 $2,071 10.2 Jun-98 Avalon Cable Amrac Hadley MA $9 5,000 $1,728 8.8 Grand Total $70,326,800 27,383,400 Total Consummated $1,982,000 1,087,000 NOTES: * System swaps. ** The transaction prices are from Paul Kagan Assocs. The transaction price is dependent upon the terms of each transaction and may or may not include debt. *** The calculations of Price/Basic Subscriber are from Paul Kagan Assocs. These calculations are subject to rounding and reporting inconsistencies. (c) Indicates a "consummated transaction." SOURCES: Paul Kagan Associates, Inc., Announced/Proposed Cable System Sales, Cable TV Investor, Jul. 9, 1997, at 10; Aug. 22, 1997, at 8; Sept. 10, 1997, at 4; Oct. 9, 1997, at 14; Nov. 21, 1997, at 9; Dec. 29, 1997, at 11; Jan. 30, 1998, at 8; Feb. 24, 1998, at 8; Mar. 13, 1998, at 10; Apr. 14, 1998, at 11; May 26, 1998, at 5; Jun. 30, 1998, at 7; Aug. 10, 1998, at 10; Sept. 11, 1998, at 5. Communications Daily, Mass Media ,Nov. 2, 1998; Communications Daily, Mass Media ,Nov. 3, 1998; TCI Press Releases: TCIC and TCA Finalize Partnership, Feb. 2, 1998, available at http://www.tci.com/tci.com/press/980202.html; TCIC Completes Transaction with Multimedia to Exchange Cable Systems in Illinois, Indiana and Kansas, Aug. 31, 1998, available at http://www.tci.com/tci.com/press/980831.html; TCIC Completes Contribution of Overland Park, Kansas Cable System to TCIC/Time Warner Partnership, Aug. 31, 1998, available at http://www.tci.com/tci.com/press/980831a.html. Appendix D Table D-1 MSO Ownership in National Video Programming Services Programming Service Launch Date MSO Ownership (%) Action Pay-Per-View Sept-90 TCI (35) AMC (American Movie Classics) Oct-84 Cablevision (75) Animal Planet Oct-96 TCI (49), Cox (24.6) BBC America Mar-98 TCI (24.6), Cox (12.3) BET (Black Entertainment Television) Jan-80 TCI (35) BET on Jazz Jan-96 TCI (35) BET Movies Feb-97 TCI (81) The Box Worldwide Dec-85 TCI (78) Bravo Feb-80 Cablevision (75) Canales ¤ (1) (Digital package of 8 video channels) Aug-98 TCI (100) Cartoon Network Oct-92 Time Warner (100) CBS Eye on People Mar-97 TCI (24.6), Cox (12.3) Cinemax Aug-80 Time Warner (100) CNN Jun-80 Time Warner (100) CNNfn (The Financial Network) Dec-95 Time Warner (100) CNN Headline News Jan-82 Time Warner (100) CNN International Jan-95 Time Warner (100) CNN/SI Dec-96 Time Warner (100) Comedy Central Apr-91 Time Warner (50) Court TV Jul-91 TCI (50), Time Warner (50) Programming Service Launch Date MSO Ownership (%) Discovery Channel Jun-85 TCI (49), Cox (24.6) Discovery Civilization Oct-96 TCI (49), Cox (24.6) Discovery Health Jun-98 TCI (49), Cox (24.6) Discovery Home & Leisure Oct-96 TCI (49), Cox (24.6) Discovery Kids Oct-96 TCI (49), Cox (24.6) Discovery Science Oct-96 TCI (49), Cox (24.6) E! Entertainment Jun-90 Comcast (39.6), MediaOne (10.4), TCI (10.4) Encore Apr-91 TCI (100) Encore Love Stories Jul-94 TCI (100) Encore Westerns Jul-94 TCI (100) Encore Mysteries Jul-94 TCI (100) Encore Action Sept-94 TCI (100) Encore True Stories and Drama Sept-94 TCI (100) Encore WAM! America's Youth Network Sept-94 TCI (100) FiT TV Dec-93 TCI (50) Food Network Nov-93 MediaOne (5), Cox (1), Time Warner (1) Fox Sports Americas (formerly Prime Deportiva) Dec-93 TCI (25) Fox Sports Direct 1989 TCI (50) Fox Sports Net 1996 TCI (25), Cablevison (37.5) Fox Sports World 1997 TCI (50) FX Oct-94 TCI (50) GEMS International Television Apr-93 Cox (50) Golf Channel Jan-95 MediaOne (14.4), Comcast (43.3) Great American Country Dec-95 Jones (100) Programming Service Launch Date MSO Ownership (%) HBO (Home Box Office) Nov-72 Time Warner (100) HBO 2 Dec-75 Time Warner (100) HBO 3 Oct-93 Time Warner (100) HBO Family Dec-96 Time Warner (100) Home Shopping Network Jul-85 TCI (18.6), MediaOne (<1) Home Shopping (Spree!) Sep-86 TCI (18.6), MediaOne (<1) Independent Film Channel Sep-94 Cablevision (75) International Channel Jul-90 TCI (90) Kaleidoscope Sep-90 TCI (12) Knowledge TV (formerly Mind Extension University) Nov-87 Jones (97) MoreMAX (formerly Cinemax2) Aug-91 Time Warner (100) MuchMusic USA Jul-94 Cablevision (75) Odyssey Channel Oct-93 TCI (32.5) Outdoor Life Network Jul-95 Cox (33.3), TCI (16.7), Comcast (8.3), MediaOne (8.3) Ovation: The Arts Network Apr-96 Time Warner (4.2) Prevue Channel Jan-88 TCI (44) PIN (Product Information Network) Apr-94 Cox (45) QVC Nov-86 Comcast (57), TCI (43) Romance Classics Jan-97 Cablevision (75) Sci-Fi Channel Sept-92 TCI (18.6), MediaOne (<1) Sneak Prevue May-91 TCI (12) Speedvision Dec-95 Cox (33.3), TCI (16.7), Comcast (8.3), MediaOne (8.3) Programming Service Launch Date MSO Ownership (%) Starz! Feb-94 TCI (100) Starz!2 Mar-96 TCI (100) Style Oct-98 Comcast (39.6), MediaOne (10.4), TCI (10.4) TBS Dec-76 Time Warner (100) Telemundo Jan-87 TCI (50) TLC (The Learning Channel) Nov-80 TCI (49), Cox (24.6) TNT (Turner Network Television) Oct-88 Time Warner (100) Travel Channel Feb-87 TCI (49), Cox (24.6) Turner Classic Movies Apr-94 Time Warner (100) USA Network Apr-80 TCI (18.6), MediaOne (<1) Viewers Choice 1-10 and Hot Choice (11 multiplexed channels) Nov-85 Cox (20), Time Warner (17), MediaOne (10), Comcast (10), TCI (10) Wingspan: Air & Space Channel Apr-98 TCI (49), Cox (24.6) Notes: (1) Canales ¤, TCI Liberty's digital package of Spanish-language channels, consists of Discovery en Espa¤ol, Fox Sports Americas, CNN en Espa¤ol, CBS Telenoticias, CineLatino, BoxTejano, BoxExitos, Canal 9 and eight channels of DMX Latino-formatted digital music. TCI has a 10% ownership interest in Time Warner, Inc. This investment includes all of Time Warner Inc.'s subsidiaries, including a 10% ownership interest in Time Warner Cable. This also includes a 10% ownership interest in Time Warner/Turner programming services including, but not limited to, CNN, Cartoon Network, Headline News, TNT, Turner Classic Movies, TBS Superstation, CNNfn, CNN/SI, HBO, Cinemax, Comedy Channel and the WB Television Network. MediaOne has a 25% ownership interest in Time Warner Entertainment, L.P., which includes a 25% ownership interest in Time Warner Cable. Sources: National Cable Television Assoc, National Video Services, Cable Television Developments, Spring 1998, at 27-97. Paul Kagan Assoc., Inc., Libery Media Valuation, Cable Programming Investor, July 7, 1998 3-5. Libery Media Group Reports 2nd Quarter Results, website http://www.tci.com/tci.com/press/980813b.html on Aug. 21, 1998. Liberty Media Assets as of 5/15/98, website http://www.tci.com/libertymedia.com/liberty.pgs/libertyfinancial.html on Aug. 21, 1998. Eben Shapiro and John Lippman, Murdoch Sells TV Guide to an Affiliate of TCI, Wall Street Journal, Jun. 12, 1998, at B1. Time Warner, Inc., 1997 Annual Report. Donaldson, Lufkin & Jenrette, Equity and Research: Broadcasting and Cable, Table 15: U S West Media Group Valuation of Non-Consolidated/Non-Domestic Cable Investors, March 10, 1998, at 35. U S West, Inc., Form 10-K/A for the fiscal year ended Dec. 31, 1997. Comcast Corp., Form 10-K for the fiscal year ended Dec. 31, 1997. Comcast Content, at http://www.comcast.com/content/qvc.htm on Aug. 21, 1998. Comcast Other Investments, at http://www.comcast.com/other/index.htm on Aug. 21, 1998. Cox Strategtic Investments, at http://www.cox.com/financials/investments.html on Aug. 21, 1998. Cablevisions System Corp., Form 10-K for the fiscal year ended Dec. 31, 1997. Adelphia Communications Corp., Form 10-K/A for the fiscal year ended Dec. 31, 1997. Jones Growth Partners II, L.P., Form 10-K for the fiscal year ended Dec. 31, 1997. Table D-2 National Video Programming Services Not Affiliated With a Cable Operator Programming Service Launch Date Adam & Eve Channel Feb-94 Adultvision Jul-95 All News Channel Nov-89 America's Health Network Mar-96 America's Voice Dec-93 ANA Television Network Dec-91 A&E (Arts & Entertainment) Feb-84 Asian American Satellite TV Jan-92 B-Movie Channel May-98 Bloomberg Information Television Jan-95 CBS TeleNoticias 1997 CNET: The Computer Network Jan-95 C-SPAN (1) Mar-79 C-SPAN2 (1) Jun-86 Cable Video Store Apr-86 Canal de Noticias NBC Mar-93 Canal Sur Aug-91 CelticVision Mar-95 Channel America Television Network Jun-88 Channel Earth Mar-97 Children's Cable Network May-95 Cine Latino Dec-94 Classic Arts Showcase May-94 Programming Service Launch Date CMT (Country Music Television) Mar-83 CNBC Apr-89 Consumer Resource Network Dec-94 Crime Channel Jul-93 Deep Dish TV Jan-86 Disney Channel Apr-83 Do-it-Yourself Jan-98 Dream TV Network Nov-96 Ecology Channel Nov-94 Employment Channel Feb-92 The Erotic Network (TEN) Aug-98 ESPN Sep-79 ESPN2 Oct-93 ESPN Classic Sports (formerly Classic Sports Network) May-95 ESPNEWS Nov-96 Ethnic-American Broadcasting Co. 1992 EWTN: Global Catholic Network Aug-81 Fashion Network Jul-96 Filipino Channel Apr-91 Flix Aug-92 Fox Family Channel (formerly The Family Channel) Apr-77 Foxnet Jul-91 Fox News Channel Oct-96 FXM: Movies from Fox Oct-94 Galavision Oct-79 Game Show Network Dec-94 Gay Entertainment Television Nov 95 Programming Service Launch Date Goodlife Television Network (formerly Nostalgia Channel) Jun-98 History Channel Jan-95 Home & Garden Television Dec-94 HTV Aug-95 INSP (Inspirational Nework) Apr-78 Jewish Television Network 1981 Ladbroke Racing Channel Nov-84 Las Vegas Television Network Nov-91 Lifetime Television Feb-84 Lifetime Movie Network Jun-98 Lottery Channel Nov-95 TMC (The Movie Channel) Dec-79 Military Channel Jul-98 Mor Music TV Aug-92 MBC Gospel Network Nov-98 MSNBC Jul-96 MTV: Music Television Aug-81 MTV Networks Latin America (formerly MTV Latino) Oct-93 M2: Music Television Aug-96 Music Zone Apr-95 My Pet TV Sep-96 NASA Television Jul-91 National & International Singles Television Network Apr-95 NET - Political NewsTalk Network Dec-93 Network One Dec-93 Newsworld International Sep-94 Programming Service Launch Date Nickelodeon/Nick at Nite Apr-79 Nick at Nite's TV Land Apr-96 Oasis TV Sept-97 Outdoor Channel Apr-93 Planet Central Television May-95 Playboy TV Nov-82 Praise Television Dec-96 Recovery Network Feb-97 SCOLA Aug-87 Shop at Home Jun-86 Showtime Jul-76 SingleVision Jun-94 Soap Channel Jul-98 Spice May-89 Spice Hot 1998 Student Film Network Nov-94 Sun TV Aug-96 Sundance Channel Feb-96 Telemundo Jan-87 TNN: The Nashville Network Mar-83 Toon Disney Apr-98 Total Communications Network Nov-95 Trinity Broadcasting Network Apr-78 TRIO Sep-94 Tropical Television Network Aug-96 TV 5 - La Television Internationale Jan-98 Programming Service Launch Date TV Asia Apr-93 TV Japan Jul-91 TVN Digital Cable (Comprised of digital multiplex of 32 channels as well as 3 analog channels) Feb-98 U Network Oct-89 Univision Sep-76 ValueVision Oct-91 VH-1 Jan-85 Via TV Network Aug-93 Video Catalog Channel Oct-91 Weather Channel May-82 WorldJazz Jul-95 Worship Network Sep-92 ZDTV: Your Computer Channel May-98 Z Music Mar-93 Notes: (1) Cable affiliates provide 95% of funding for C-SPAN and C-SPAN2, but have no ownership or program control interests. DBS licensees provide the other 5% of funding and also have no ownership or program control interests. Sources: National Cable Television Assoc, National Video Services, Cable Television Developments, Spring 1998, at 27-97. TABLE D-3 Regional Video Programming Services Programming Service Launch Date MSO Ownerhsip (%) Arabic Channel Apr-91 Automotive Television Network (ATN) Sep-95 BAYTV Jul-94 TCI (49) Cable TV Network of New Jersey Jul-93 California Channel Feb-91 Casa Club TV Jul-97 ChicagoLand Television News (CLTV) Jan-93 CN8 - The Comcast Network 1996 Comcast (100) Comcast SportsNet Oct-97 Comcast (46) County Telvision Network San Diego Jul-96 Ecumenical Television Channel 1983 Empire Sports Network Dec-90 Florida's News Channel Sep-98 Fox Sports Arizona Sep-96 TCI (50) Fox Sports Bay Area Apr-90 TCI (35) Fox Sports Chicago Jan-84 TCI (35), Cablevision (45) Fox Sports Cincinnati 1989 TCI (20), Cablevision (45) Fox Sports Detroit Sep-97 TCI (50) Fox Sports Intermountain West 1990 TCI (50) Fox Sports Midwest 1989 TCI (50) Fox Sports New England Nov-81 TCI (10), Cablevision (22.5), MediaOne (50) Fox Sports New York 1982 TCI (18), Cablevision (41.5) Programming Service Launch Date MSO Ownerhsip (%) Fox Sports Northwest Nov-88 TCI (50) Fox Sports Ohio Feb-89 TCI (20), Cablevision (45) Fox Sports Pacific Unknown Cablevision (45) Fox Sports Pittsburgh Apr-86 TCI (50) Fox Sports Rocky Mountain Nov-88 TCI (50) Fox Sports South Aug-90 TCI (44) Fox Sports Southwest Jan-83 TCI (50) Fox Sports West Oct-85 TCI (50) Fox Sports West 2 Jan-97 TCI (50) Hip Hop Network Jan-97 Home Team Sports (HTS) Apr-84 TCI (17) International Television Broadcasting (ITV) Apr-86 Madison Square Garden Network (MSG) Oct-69 TCI (18), Cablevision (41.5) MSG Metro Guide Aug-98 Cablevision (100) MSG Traffic and Weather Aug-98 Cablevision (100) MSG Metro Learning Channel Aug-98 Cablevision (100) MediaOne Dec-95 MediaOne (100) Midwest Sports Channel Mar-89 Neighborhood News L.I. Unknown Cablevision (75) New England Cable News Mar-92 MediaOne (50) New England Sports Network (NESN) Mar-84 New York 1 News Sep-92 Time Warner News 12 Connecticut Jun-95 Cablevision (75) News 12 Long Island Dec-86 Cablevision (75) News 12 New Jersey Mar-96 Cablevision (75) News 12 Westchester Nov-95 Cablevision (75) Programming Service Launch Date MSO Ownerhsip (%) Newschannel 8 Oct-91 Nippon Golden Network Jan-82 NorthWest Cable News Dec-95 Orange County NewsChannel Sep-90 PASS Sports (Pro-Am Sports System) Apr-84 Pennsylvania Cable Network (PCN) Sep-79 Pittsburgh Cable News Channel (PCNC) Jan-94 PRISM Sep-76 Six News Now Jul-95 South Florida Newschannel 1998 SportsChannel Florida Dec-87 TCI (6), Cablevisoin (13.5) SportsChannel New York 1976 Sunshine Network Mar-88 TCI (27), MediaOne (7.5), Comcast (16), Cox (5.3) Sources: National Cable Television Assoc, Regional Video Services, Cable Television Developments, Spring 1998, at 98-116. Liberty Media Press Release, Cablevision's Rainbow Media and Fox/Liberty Complete Transaction to Create Sports Partnership, Dec. 18, 1997, at 1. R. Thomas Umstead, ESPN Lands $600M NHL Deal, Multichannel News, Aug. 31, 1998, at 10. R. Thomas Umstead, Ops Eye Low-Cost Local Heroes, Multichannel News, May 4, 1998, at 74. See also Table D-1 Sources. TABLE D-4 Planned Programming Services Programming Service Planned Launch Date, If Announced ABZ Not Announced American Legal Network Not Announced American Pop 4th Qtr 1998 American West Network Not Announced Annenburg/CPB Channel Not Announced Anthropology Programming and Entertainment Not Announced Anti-Aging Network Not Announced Arts & Antiques Network Not Announced Auto Channel 1999 Baby TV 1998 Beauty Channel Not Announced Benefit Network Not Announced Boating Channel Not Announced Booknet Mid-1999 Career & Education Opportunity Channel Not Announced Catalogue TV Not Announced CEO Channel Not Announced Channel 500 Not Announced Collectors Channel Not Announced Comedy.net Not Announced Documentary Channel 2nd Qtr. 1999 Enrichment Channel Not Announced Football Channel Network Not Announced Gaming Entertainment Television 2nd Qtr. 1999 Programming Service Expected Launch Date Genesis Network Not Announced GETv Network Not Announced Global Village Network Not Announced Hobby Craft Communications 2nd Qtr. 1999 Home Improvement TV Network Not Announced Jim Henson Network Not Announced Locomotion 4th Qtr. 1998 M1 Not Announced Martial Arts Action Network 1999 MBC Movie Network Not Announced Men's Entertainment Network (MEN) 3rd Qtr. 1999 Museum Channel Not Announced Native American Nations Program Network Not Announced Nickelodeon Game & Sports January 1999 Nick Too January 1999 Noggin January 1999 Orb TV Not Announced Outlet Mall Network Not Announced Oxygen January 2000 Parents Channel Not Announced Performance Showcase Not Announced Planet Central Television Not Announced Premiere Horse Network Not Announced Puppy Channel Not Announced RadioTV Network Mid-1999 Programming Service Expected Launch Date Real Estate Network Not Announced Seminar TV Network Not Announced Sewing and Needle Arts Network Not Announced Space Network Not Announced Spanish Shopping Network 4th Qtr 1998 Technology Channel Not Announced Television Games Network Not Announced Texas Cable News January 1999 Theater Channel Not Announced Therapy Channel Network Not Announced Tri-State Media Network 3rd Qtr. 1999 URU TV/The Earthcast Not Announced Weatherscan 1998 WeB Not Announced World Cinema 4th Qtr 1998 Youth Sports Broadcasting Channel Not Announced Sources: National Cable Television Assoc., Planned Services, Cable Television Developments, Spring 1998, at 126- 142. Cablevision, Database: Announced Services, Sept. 21, 1998 at 49. Linda Moss, DIY Slates $15M to Launch Digital Net, Multichannel News, May 25, 1998 at 22. New Network Handbook--Programming '98, Cablevision, Mar. 16, 1998, at 41-53. TABLE D-5 MSO Ownership in National Programming, MSOs Ranked in Order of Number of Subscribers Services Subs. (Mil.) TCI Time Warner Media One Comcast Cox Cable- vision Systems Jones Cable Action Pay- Per-View 8.0 35% AMC 68.0 75% Animal Planet 40.7 49% 24.6% BBC America * 24.6% 12.3% BET 54.2 35% BET on Jazz 3.5 35% BET Movies 3.5 81% The Box Worldwide 26.8 78% Bravo 35.0 75% Canales ¤ * 100% Cartoon Network 51.3 100% CBS Eye on People 11.0 24.6% 12.3% Cinemax 32.0 100% Cinemax2 (1) 100% CNN 73.7 100% CNNfn 2.4 100% CNN Headline News 68.6 100% CNN International 2.8 100% CNN/SI .6 100% Services Subs. (Mil.) TCI Time Warner Media One Comcast Cox Cable- vision Systems Jones Cable Comedy Central 51.1 50% Court TV 34.1 50% 50% Discovery Channel 73.7 49% 24.6% Discovery Civilization * 49% 24.6% Discovery Health * 49% 24.6% Discovery Home & Leisure * 49% 24.6% Discovery Kids * 49% 24.6% Discovery Science * 49% 24.6% E! 50.0 10.4% 10.4% 39.6% Encore 10.0 100% Encore Love Stories 12.3 100% Encore Westerns (2) 100% Encore Mysteries (2) 100% Encore Action (2) 100% Encore True Stories and Drama (2) 100% Encore WAM! (2) 100% FiT TV 11.2 50% Food Network 33.1 1% 5% 1% Services Subs. (Mil.) TCI Time Warner Media One Comcast Cox Cable- vision Systems Jones Cable Fox Sports Americas 9.0 25% Fox Sports Direct 5.2 50% Fox Sports Net 57.0 25% 37.5% Fox Sports World .4 50% FX 35.8 50% GEMS International Television 11.0 50% Golf Channel 17.3 14.4% 43.3% Great American Country 3.0 100% HBO (1) 100% HBO 2 (1) 100% HBO 3 (1) 100% HBO Family (1) 100% Home Shopping Network 53.2 18.6% <1% Home Shopping (Spree!) 12.4 18.6% <1% Independent Film Channel 15.0 75% International Channel 8.0 90% Kaleidoscope 15.0 12% Services Subs. (Mil.) TCI Time Warner Media One Comcast Cox Cable- vision Systems Jones Cable Knowledge TV 26.0 97% MuchMusic 18.5 75% Odyssey 30.1 32.5% Outdoor Life 13.5 16.7% 8.3% 8.3% 33.3% Ovation 5.2 4.2% Prevue Channel 50.8 44% Product Information Network 8.0 45% QVC 66.6 43% 57% Romance Classics 14.0 75% Sci-Fi Channel 49.6 18.6% <1% Sneak Preview 36.0 12% Speedvision 14.5 16.7% 8.3% 8.3% 33.3% Starz! 7.5 100% Starz!2 * 100% Style * 10.4% 10.4% 39.6% TBS 74.4 100% Telemundo 17.6 50% TLC 65.1 49% 24.6% TNT 73.1 100% Services Subs. (Mil.) TCI Time Warner Media One Comcast Cox Cable- vision Systems Jones Cable Travel Channel 18.4 49% 24.6% Turner Classic Movies 28.4 100% USA Network 73.7 18.6% <1% Viewers Choice 1-10 19.0 10% 17% 10% 10% 20% Wingspan * 49% 24.6% Notes: In addition to cable, other services such as MMDS (wireless cable), SMATV (satellite master antenna television), satellite, including HSD (home satellite dish) and DBS (direct broadcast satellite), broadcast television and LPTV (low power television) may distribute these signals. Subscriber figures may include these noncable services. * Indicates that subscribership count is unknown or not available. (1) Subscribership of 32.0 million includes all Cinemax and HBO channels. (2) Subscribership of 12.3 million includes all of Encore's six Thematic Multiplex channels. Sources: Sources for subscriber counts: Paul Kagan Assocs., Inc., June 30 Network Census, Cable Program Investor, Aug. 14, 1998, at 11. National Cable Television Assoc, National Video Services, Cable Television Developments, Spring 1998, at 28-97. Liberty Media Assets as of 5/15/98, at http://www.tci.com/libertymedia.com/liberty.pgs/libertyfinancial.html on Aug. 21, 1998. Sources for ownership percentages: See Table D-1 sources. TABLE D-6 Top 50 Programming Services by Subscribership Rank Programming Network (Top 50) Number of Subscribers (Millions) MSO Ownership Interest in Network (%) 1 TBS 74.4 Time Warner (100) 2 ESPN 73.8 None 3 Discovery Channel 73.7 TCI (49), Cox (24.6) 4 USA Network 73.7 TCI (18.6) 5 CNN 73.7 Time Warner (100) 6 C-SPAN 73.3 None 7 TNT 73.1 Time Warner (100) 8 Nickelodeon/Nick at Nite 72.6 None 9 Fox Family Channel 71.8 None 10 A&E 71.7 None 11 TNN (The Nashville Network) 71.5 None 12 Lifetime Television 71.5 None 13 Weather Channel 70.2 None 14 MTV 69.4 None 15 CNN Headline News 68.6 TIme Warner (100) 16 AMC 68.0 Cablevision (75) 17 QVC 66.6 Comcast (57), TCI (43) 18 CNBC 65.6 None 19 TLC (The Learning Channel) 65.1 TCI (49), Cox (24.6) 20 VH1 62.2 None 21 ESPN2 58.5 None 22 BET 54.2 TCI (35) Rank Programming Network (Top 50) Number of Subscribers (Millions) MSO Ownership Interest in Network (%) 23 Home Shopping Network 53.2 TCI (18.6) 24 Cartoon Network 51.3 Time Warner (100) 25 C-SPAN2 51.1 None 26 Comedy Central 51.1 Time Warner (50) 27 Prevue Channel 50.8 TCI (12) 28 E! Entertainment 50.0 Comcast (39.6), Media One (10.4), TCI (10.4) 29 Sci-Fi Channel 49.6 TCI (18.6) 30 History Channel 49.6 None 31 CMT (Country Music Television) 42.2 None 32 Disney Channel 41.9 None 33 MSNBC 41.0 None 34 Animal Planet 40.7 TCI (49), Cox (24.6) 35 Sneak Prevue 36.0 TCI (12) 36 FX 35.8 TCI (50) 37 Bravo 35.0 Cablevision (75) 38 Court TV 34.1 TCI (50), Time Warner (50) 39 Food Network 33.1 Media One (5), Cox (1), Time Warner (1) 40 Fox News Channel 32.0 None 41 Odyssey Channel 30.1 TCI (32.5) 42 Nick at Night's TV Land 29.1 None 43 Turner Classic Movies 28.4 Time Warner (100) 44 Box Worldwide 26.8 TCI (78) 45 Knowledge TV 26.0 Jones (97) 46 Travel Channel 18.4 TCI (49), Cox (24.6) Rank Programming Network (Top 50) Number of Subscribers (Millions) MSO Ownership Interest in Network (%) 47 Golf Channel 17.3 MediaOne (14.4) 48 ESPN Classic Sports 15.0 None 49 Independent Film Channel 15.0 Cablevision (75) 50 Game Show Network 14.5 None Notes: In addition to cable, other services such as MMDS (wireless cable), SMATV (satellite master antenna television), satellite, including HSD (home satellite dish) and DBS (direct broadcast satellite), broadcast television and LPTV (low power television) may distribute these signals. Subscriber figures may include these noncable services. Superstations included in the source data are not included in this ranking. Source: Paul Kagan Assocs., Inc., June 30 Network Census, Cable Program Investor, Aug. 14, 1998, at 11. TABLE D-7 Top 15 Programming Services by Prime Time Rating Rank Programming Service MSO with Ownership Interest (%) 1 TNT Time Warner (100) 2 USA Network TCI (18.6) 3 Nickelodeon/Nick at Nite None 4 TBS Time Warner (100) 5 Lifetime Television None 6 Cartoon Network Time Warner (100) 7 ESPN None 8 Fox Family Channel None 9 A&E None 10 Discovery Channel TCI (49), Cox (24.6) 11 TNN (The Nashville Network) None 12 TLC (The Learning Channel) TCI (49), Cox (24.6) 13 CNN Time Warner (100) 14 FX TCI (50) 15 Comedy Central Time Warner (50) Notes: Superstations included in the source data are not included in this ranking. Source: Paul Kagan Assocs., Inc., Second Quarter 1998 Prime-Time Ratings, Cable Program Investor, Aug. 14, 1998, at 6. APPENDIX E Program Access Matters Resolved 1. In a program access complaint dismissed in 1998, EchoStar Communications Corporation ("EchoStar") alleged that Rainbow Media Holdings, Inc. and Rainbow Programming Holdings, Inc. (collectively "Rainbow") discriminated in the prices, terms and conditions of programming offered to EchoStar, unreasonably refused to sell its programming to EchoStar, and engaged in unfair methods of competition or unfair acts and practices. EchoStar subsequently requested that the program access complaint be dismissed with prejudice, indicating that it and Rainbow amicably settled the issues in its complaint. Accordingly, the Cable Services Bureau ("Bureau") dismissed the proceeding with prejudice. 2. In a program access complaint decided in 1998, EchoStar alleged that FX Networks, LLC ("FX") and Fox/Liberty Networks, LLC ("Fox/Liberty") refused to provide its programming to EchoStar because of prohibited exclusive contracts that FX had with cable operators across the country. EchoStar alleged that FX's refusal to deal with EchoStar regarding such programming violated the Commission's prohibition on exclusive contracts, and constituted an unreasonable refusal to sell in violation of Section 628(c) of the Communications Act and Section 76.1002(b) of the Commission's rules and an unfair practice in violation of Section 628(b) of the Act and Section 76.1001 of the Commission's rules. In response, FX argued that its exclusive contracts were lawful when entered into because FX was not a vertically integrated programmer at the time, and that its subsequent vertical integration did not negate the validity of these agreements. The Bureau found that FX unreasonably refused to sell its programming to Echostar in violation of Section 628(c) of the Communications Act and Section 76.1002(b) of the Commission's rules. In granting the complaint, the Bureau stated that FX's once valid exclusive contracts did not in themselves justify its refusal to sell to Echostar. 3. In a similar program access matter, Corporate Media Partners, d/b/a Americast ("Americast"), and its telephone company partners, Ameritech Media Ventures, Inc., BellSouth Interactive Media Services, Inc., GTE Media Ventures Incorporated, and SNET Personal Vision, Inc., filed a complaint against FX, Fox/Liberty and Tele-Communications, Inc. ("TCI"). As with the Echostar complaint described above, Ameritech alleged that FX had refused to provide its programming to EchoStar because of prohibited exclusive contracts that FX had with cable operators across the country. FX acknowledged that the facts and circumstances surrounding Americast's complaint were materially indistinguishable from those examined by the Commission in the EchoStar proceeding, and offered no additional legal justification for its conduct. Consistent with the EchoStar proceeding, the Bureau found that FX unreasonably refused to sell its programming to Americast in violation of Section 628(c) of the Communications Act and Section 76.1002(b) of the Commission's rules. 4. Outdoor Life Network, L.L.C. ("Outdoor Life") and Speedvision Network, L.L.C. ("Speedvision"), two cable programming vendors (collectively, "the Networks"), filed a Petition for Exclusivity seeking approval to enter into exclusive distribution agreements with MVPDs in 17 Nielsen Designated Market Areas and in the State of Connecticut. Section 628(c)(2)(D) of the Communications Act provides that, in areas served by a cable operator, exclusive contracts for satellite cable programming between vertically integrated programming vendors and cable operators are prohibited unless the Commission determines that such exclusivity is in the public interest. The Bureau denied the Petition on the grounds that the exclusive arrangement proposed by the Networks was not in the public interest. The Bureau stated that the proposed exclusivity would withhold programming services with nationwide appeal from emerging competitors to cable, such as cable overbuilders, MMDS, and telephone companies, thereby directly constraining competition in the local distribution markets at issue as well as the national distribution market. The Bureau also found that no countervailing public interest benefits would be derived from allowing enforcement of the proposed exclusivity. 5. Turner Vision, Inc., Satellite Receivers Ltd., Consumer Satellite Systems, Inc. and Programmers Clearing House, Inc. ("Complainants") alleged in a program access complaint that CNN had engaged in price discrimination and unfair practices because CNN charged substantially lower rates for Cable News Network and Headline News to Complainants' competitors than it charged to Complainants. CNN filed a consolidated answer requesting dismissal, stating that its price differentials were justified and that Complainants did not demonstrate price discrimination between themselves and similarly situated MVPDs. The Bureau found that although CNN justified a significant portion of the price differential, it had engaged in unlawful price discrimination and violated Section 628(c) of the Communications Act and Section 76.1002(b) of the Commission's rules for failure to justify the entire amount of the disputed price differential. 6. Ameritech alleged in a program access complaint that MediaOne, Inc. ("MediaOne") and Time Warner Cable ("Time Warner") violated Section 628(b) of the Communications Act and Section 76.1001 of the Commission's rules by entering into exclusivity agreements whereby Time Warner and MediaOne would obtain exclusive rights to carry Classic Sports Network in various communities located in Illinois and Michigan. Subsequently, Ameritech filed Joint Stipulations of Dismissal with both Time Warner and MediaOne, stating that the issues raised by Ameritech's complaint relating to the affected communities had been resolved. In terminating this proceeding, the Bureau noted that it encourages resolution of program access disputes through negotiations between the parties in an effort to avoid time- consuming, complex adjudication. 7. DIRECTV filed a program access complaint against Comcast Corporation ("Comcast"), Comcast-Spectacor, L.P., and Comcast SportsNet ("SportsNet") (collectively referred to as "Defendants"). Comcast delivers SportsNet programming terrestrially, and had denied DIRECTV access to that programming. The three interrelated matters disputed in this proceeding were as follows; (1) is the programming in question "satellite cable programming" so that Comcast's conduct is actionable under Section 628(c) of the program access rules, (2) does the Commission have the authority to take action against evasions of the program access rules and, if so, is Comcast's conduct actionable as an evasion, and (3) does Comcast's conduct involve unfair or anti-competitive action to deprive DIRECTV of "satellite cable programming" under Section 628(b)? In denying DIRECTV's complaint, the Bureau found that the correct reading of Section 628(c) is that the provisions in question apply to satellite cable programming, not programming that was "previously" satellite-delivered or the "equivalent" of satellite cable programming. In addition, the Bureau did not find evidence that Defendants intended to evade the rules or that, standing alone, Comcast's decision to deliver Comcast SportsNet terrestrially and to deny that programming to DIRECTV was "unfair" under Section 628(b). 8. EchoStar filed a program access complaint against Fox/Liberty Networks LLC, Fox Sports Net LLC and Fox Sports Direct (collectively "Fox"). EchoStar alleges that Fox had engaged in unlawful discrimination against EchoStar in the prices, terms and conditions that Fox imposed upon EchoStar for making available the regional sports programming that it controls. Fox filed an answer denying discrimination and requesting that the Commission dismiss the Complaint with prejudice. Pursuant to Section 76.1003(r)(1) of the Commission's rules, Echostar had one year from the date of entering into the contract with Liberty Satellite Sports, Inc./Fox Sports Direct to file a program access complaint with the Commission. The Bureau dismissed Echostar's complaint with prejudice, finding that it was barred by the one year limitations period. APPENDIX F INQUIRY CONCERNING CABLE TELEVISION PROGRAMMING COSTS Report of the Cable Services Bureau I. Introduction and Summary of Findings 1. In an effort to identify the sources of recent cable television programming cost increases, the Cable Services Bureau ("the Bureau") commenced an inquiry designed to shed light on discrete subcategories of programming costs, as well as on other matters related to cable operators' costs and revenues ("the Inquiry"). The Inquiry was prompted by the Commission's 1997 Annual Report on Video Competition ("Competition Report") and its 1997 Report on Cable Industry Prices ("Price Survey"). The Price Survey indicated that monthly subscriber rates charged by noncompetitive cable systems increased, on average, by 8.5% during the year ended July 1, 1997, following increases of approximately 8.8% during the previous year. These increases come at a time when general inflation, as measured by the Consumer Price Index ("CPI"), is relatively mild. The CPI rose by 2.23% and 2.95%, respectively, during the two-year period under review. A chart comparing the trend of the general CPI since 1990 with the trend of the Cable CPI for the same period is attached as Chart 1. More recently, cable rates continue to rise approximately four times the rate of inflation. According to the Bureau of Labor Statistics, between June 1997 and June 1998, cable rates rose 7.3%, considerably more than the 1.7% increase in the CPI during the same period. 2. The Inquiry generally confirmed the Price Survey findings regarding the relative effect on cable rates of programming costs, channel additions, and infrastructure upgrades under Commission rules. Programming costs include license fees, retransmission consent and copyright fees, and markups associated with programming cost increases; all of which are recoverable by cable operators under Commission rules. With respect to channel additions, Commission rules prior to December 31, 1997 provided an incentive to operators to increase their program offerings by permitting operators to increase rates by either of two methods. Infrastructure upgrade costs may be recovered through cost-of-service filings or, with respect to two of the MSOs participating in the Inquiry, pursuant to social contracts those MSOs have executed. The Price Survey found that, after the allowed inflation adjustments, programming costs were the most significant factor contributing to reported rate increases. These results are shown in Chart 2. Although much attention has been focused on increases in the cost of sports programming, the Inquiry found that during the two-year period under review only a relatively minor portion of rate increases (5.3%) can be attributed to sports programming increases. Chart 3 illustrates the degree to which certain subcategories of programming costs contributed to rate increases. 3. For the Multiple System Operators ("MSOs") responding to the Inquiry, the rate of increase in programming costs was significant during the two-year period under review. Between July 1, 1996 and July 1, 1997, the responding MSOs increased their average expenditures for programming by 20.2%. That increase in programming costs reflects both the increases in the cost of existing programming (i.e., the programming that was offered on July 1, 1996) as well as the full cost of new programming services the operator may have added during the ensuing year. Some portion of the increase in programming expenditures is also attributable to changes in the mix of programming offered since operators frequently change their programming lineup, and to subscriber growth since programming costs are usually established on a per-subscriber basis. Programming costs for the responding MSOs (for regulated services) were equal to approximately 24% of regulated revenues for the 12-month period ending July 1, 1997. Thus, on average, about one-quarter of an operator's regulated revenues goes to pay for programming. 4. The Inquiry also sought information on revenues, including advertising revenues. Advertising revenues for the MSOs responding to the Inquiry grew steadily during the period under review. The Inquiry results indicate that advertising revenues increased by nearly 29% in the 12-month period ending July 1, 1997, and that advertising revenue equaled about 8% of regulated revenues at the end of this period. Several Inquiry participants noted that some portion of this growth was attributable to factors such as system upgrades, additional channels, subscriber growth, clustering, and system acquisitions. The average advertising revenue earned by Inquiry participants in 1996 and 1997 is shown in Chart 4. 5. The Cable Television Consumer Protection and Competition Act of 1992 ("the 1992 Cable Act") required the Commission to ensure that rates were reasonable and "that cable operators continue to expand, where economically justified, their capacity and the programs offered over their cable systems." In the first two years after the Act -- 1993 and 1994 -- the Commission successfully sought to check the rapid increases in cable rates that were occurring prior to passage of the Act, as evidenced from the downward trend of cable rates for those two years shown in Chart 1. For the period from 1995 through 1997, the Commission adopted rules, related to channel additions, designed to provide an incentive to cable operators to expand the capacities of their systems and increase their programming services. During this period, operators completed system upgrades and expanded their program offerings. The cost of this expansion was significant, resulting in increases consistently several times higher than inflation. This incentive for expansion of services appears to have significantly contributed to the rate increases that took place during the period under study. The channel addition rules expired at the end of 1997 and are no longer available. The 1996 Act eliminates most rate regulation of cable operators after March 1999. 6. While the 1992 Cable Act was intended both to restrain rates and stimulate growth, it is competition that most effectively will ensure both reasonable rates and improved services. Competition has been and continues to be very slow in coming to the video distribution industry. As of June 1997, the cable industry still controlled 87% of subscribers to multichannel video programming distributors ("MVPDs") and, for most of these subscribers, there is no product which substitutes directly for cable wireline MVPD service. Cable television continues to be the primary delivery technology for the distribution of multichannel video programming and continues to occupy a dominant position in the MVPD marketplace. Subscribers served by cable wireline MVPD service rarely have a choice of wireline providers. The Commission has taken a series of steps to foster increased competition in the cable industry. It has adopted mechanisms to improve the effectiveness of our program access rules. It has preempted local rules and regulations which prohibited or unnecessarily restricted the ability of homeowners to install satellite dishes or other antennae on their property. It has given alternative video distributors access to wiring installed by cable operators in multiple dwelling units ("MDUs"). However, the Commission's statutory authority does not extend to certain additional areas which potentially could foster additional competition. For example, satellite providers are effectively prohibited from carrying local network broadcast signals under the Satellite Home Viewer Act. Also, there are limits on our authority to mandate access to programming when the programming in question is delivered terrestrially rather than by satellite. Finally, the Commission's impact on competition in MDUs is limited because the Commission's inside wiring regulations extend only to circumstances where the incumbent video services provider no longer has a legal right to remain in the building. The measures the Commission has taken have helped to promote competition, but competition remains the exception, not the rule. II. Methodology of the Inquiry 7. To conduct the Inquiry, the Bureau prepared a questionnaire and distributed it to the six largest (in terms of subscriber size) cable television industry MSOs. Participation in the Inquiry was voluntary. The Bureau sought to build on information that was gathered in the Price Survey. The questionnaire was designed to assist the Bureau in examining certain specific operator costs, in particular their expenditures for programming services, the effects of system upgrades on rates, and operators' major sources of non-subscriber revenues. The six MSOs selected for participation were: Cablevision Systems Corporation; Comcast Corporation; Cox Communications, Inc.; MediaOne, Inc; TCI Communications, Inc.; and Time Warner Cable. Collectively, these six MSOs serve approximately 67% of all cable subscribers. While all six MSOs responded to varying degrees, not all respondents provided complete information on every question. The participants provided several reasons for not responding fully. These include the unavailability of the requested data, the inability of the MSO to compile the data in the requested format, and/or the MSO's unwillingness to share the requested data because of its proprietary or commercially sensitive nature. At least four respondents, however, provided consistent information across a majority of questions. The results of the Inquiry, therefore, are based largely on four responses. For those questions where more than four MSOs provided consistent data, the results are footnoted. 8. The Bureau also received an unsolicited letter from Summit Communications ("Summit"), a small operator that serves 42,000 subscribers from 25 headends in the Pacific Northwest. Summit offers its views on programming costs and advertising revenues. 9. The questionnaire asked the MSOs to provide information as of a particular date on an average or aggregate basis for all of their systems, whether or not the systems were regulated by the Commission or by a local franchising authority, or were unregulated. The dates selected for the questionnaire (July 1, 1996, and July 1, 1997) correspond with the dates used in the 1997 Price Survey. The results, which are shown in Tables 1 and 2, are based on averages of the data provided by four MSOs. Each table, however, is based on a different set of four respondents. Where there were fewer than four responses to a particular question or part of a question, averages were not calculated or reported, with the exception of data on channel additions which are based on three responses. Some MSOs provided data in answer to certain questions (such as those pertaining to average rates) for sampled systems only, rather than all systems. Those MSOs used the same sample set as the sample selected by the Commission for the Price Survey. Unlike the Price Survey, however, the Inquiry is not based on a random sample. The results, therefore, should not be interpreted as being representative of the entire industry. A further shortcoming of the data from a statistical standpoint is that the mix of respondents is not the same in Tables 1 and 2 so that comparisons between the two tables cannot be made. 10. The focus of the Inquiry and of this Report is primarily on programming costs. Several additional areas, however, were included in the Inquiry questionnaire and are considered in this Report, including other factors contributing to rate increases, the effects of affiliation between programmers and operators on programming costs, and the sources and trends of certain categories of operators' revenues and expenditures. 11. In the Price Survey, the Commission identified the main factors that contributed to changes in cable rates between July 1, 1995 and July 1, 1997. The Price Survey indicated that for the noncompetitive segment of the cable industry, which accounts for the bulk of the industry, 34% of total permitted rate increases during the 12-month period ending July 1, 1997, were attributable to inflation adjustments; 29% of total rate increases were attributable to programming cost increases; 13% were attributable to channel additions; 11% to system upgrades; 8% to higher equipment costs; and 5% to "other" cost increases. Chart 2 provides a graphic display of this breakdown. Through the Inquiry, the Bureau sought additional detailed information on three of these factors: programming costs, channel additions, and system upgrades. The Bureau also sought information on expenditures for programming services with affiliated versus unaffiliated programmers, and information on non-subscriber revenues. The major findings of the Inquiry are summarized below. III. Findings 12. The results of the Inquiry tracked the findings of the Price Survey Report for those aggregate measures where the two surveys overlapped. For example, the 1997 Price Survey found that, on average, the noncompetitive group of cable operators charged $28.83 per month for programming services (BST and CPST) and equipment as of July 1, 1997. As shown in Table 2, the Inquiry participants (based on four responses) charged $28.62, on average, for the same services as of the same date. A. Programming costs 13. The Commission's rules allow operators to pass through new programming costs, which are defined as "external costs," since operators have little or no control over these costs. When the Commission adopted its rate regulations, it noted that programming costs had increased at a rate "far exceeding the rate of inflation." Acknowledging that the pass-through of new programming costs could have adverse effects on subscriber rates, the Commission concluded that excessive rate increases due to programming cost increases could cause operators to lose subscribers and that this threat would temper the level of programming-induced rate increases. The Commission added that it would monitor the impact of external cost treatment of programming costs. 14. Special rules govern an operator's recovery of the costs of programming purchased from entities that are affiliated with the operator. An operator may adjust its rates to reflect increases in the costs of such programming only to the extent that the license fees charged to the operator by the affiliated programmer reflect either (1) the prevailing company prices offered by the programmer to unaffiliated entities or (2) the fair market value of the programming. 1. Recent trends in cable operators' expenditures for programming services 15. The Inquiry found that, in 1996, the four MSOs responding to this question incurred an average of $397.8 million in aggregate expenditures for regulated programming. This category of expenditures increased by 20.2% in 1997, rising to $478.1 million. The 20.2% increase between 1996 and 1997 includes both cost increases incurred on existing programming services offered in 1996, as well as the cost of programming services the operators added during the year. Inquiry participants reported that subscriber growth, system acquisitions, and changes in the mix of programming offered (for example, moving a premium service to the basic tier), also contributed to the reported increases in aggregate programming expenditures. Had the increase in programming costs been reported on a per-channel, per- subscriber basis, it would have been significantly less than the aggregate expenditure increase of 20.2%. Programming expenditures as a percent of average regulated revenues were calculated using the responses from the same four MSOs who provided information on both programming expenditures and regulated revenues. For those four MSOs, programming expenditures as a percent of average regulated revenues equaled 22.4% in 1996 and 23.6% in 1997. 16. The same four MSOs also reported their expenditures for each major subcategory of programming -- sports, news, children's programming, and general entertainment programming (referred to in the questionnaire as "all other"). The average aggregate expenditures for each subcategory of programming are shown in Table 1. On average, sports programming accounted for 26.7% of total expenditures for regulated programming in 1997 (or $127.6 million); news programming accounted for 11.2% (or $53.3 million) of the total; children's programming accounted for 11.5% (or $55.1 million); and the "all other" category accounted for 50.6% (or $242.1 million) of total programming expenditures. As shown in Table 1, average aggregate expenditures for the four subcategories of programming -- sports, news, children's, and "all other" increased by 16.3%, 25.8%, 24.6% and 19.9%, respectively, between 1996 and 1997. The results show, therefore, that between 1996 and 1997 sports programming had the lowest rate of increase in aggregate expenditures of the four subcategories of programming. 17. One MSO pointed out that although "sports programming costs get the headlines, huge increases in expenditures by cable programming networks are the rule." The MSO states that cable programming network expenditures to produce basic cable programming increased eight-fold, from $482 million to $4 billion, from 1986 to 1998. 18. Summit states that small operators lack the market power to negotiate favorable programming rates and cannot obtain volume discounts. Summit alleges that some programmers refuse to negotiate with the National Cable Television Cooperative, which purchases programming on behalf of its small-operator members. As a result, according to Summit, small operators have little control over their programming costs. 2. Programming costs as a factor contributing to recent rate increases 19. In their public statements, operators have identified programming costs, and the costs of sports programming in particular, as one of the major reasons for recent rate increases. In addition, at least one industry study has concluded that sports and entertainment programming costs have escalated subsequent to the period under review at a rate that far exceeds the general rate of inflation. In the case of sports programming, news accounts within the past year of bidding wars and unprecedented fees for sports broadcast rights lend credence to the proposition that sports programming costs are indeed escalating rapidly. These more recent cost increases are not reflected in the Inquiry responses. 20. The Inquiry results, therefore, do not reflect any license fee increases owing to sports distribution rights agreements announced in late 1997 and 1998. In response to a question on this issue, a majority of the participating MSOs anticipated an increase in their sports programming costs in the coming year. Press reports indicate that ESPN has already increased its license fees for some operators by up to 20%. The Inquiry participants profess that their ability to "pass-through" these increased costs will depend on the willingness of subscribers to pay the resulting higher charges. 21. The Price Survey found that cable operators in the noncompetitive group attributed 29% of their rate increases during the year ending July 1, 1997, to aggregate programming cost increases. The Inquiry found that four large MSOs, on average, attributed 28.2% of their rate increases over the same period to aggregate programming cost increases. 22. The Inquiry participants attributed virtually all of their programming expenditure increases (97.1% in 1997) to increases in the license fees charged by cable programming networks. The remaining 2.9% was attributed primarily to allowable markups on programming costs. We asked Inquiry participants to provide a breakdown of their expenditures on license fees into the four programming subcategories -- sports, children's, news, and "all other" -- and, in addition, to allocate the amount of their increase in average monthly rates that was attributable to each of these four subcategories. Four MSOs provided this breakdown. These MSOs experienced a $2.45 change in their monthly rates for the year ending July 1, 1997. Of this amount, the MSOs attributed $0.69 or 28.2% to increases in programming costs. Of this $0.69, they attributed $0.67 to changes in license fees, and, of that amount, $0.13 (or 19.4%), $0.08 (or 11.9%), $0.03 (or 4.5%), and $0.43 (or 64.2%), respectively, to the subcategories of sports, news, children's, and "all other" programming. Table 2 and Chart 3 show this breakdown for the year ending July 1, 1997. 23. Applying these amounts to the total increase in rates between July 1, 1996, and July 1, 1997, we found that the increase in aggregate expenditures for sports programming license fees accounted for 5.3% of the total increase in rates over that period ($0.13 divided by $2.45 equals 5.3%). On the same basis, increases in expenditures for news and children's programming accounted for 1.2% and 3.2%, respectively, of the total increase in rates for that period. The "all other," or general entertainment, category accounted for 17.6% of the total increase in rates. 24. On average, for the year ending July 1, 1997, the Inquiry participants reported that 10.4% of the total increase in license fees was attributable to affiliated programming. These same MSOs reported that, for the same period, affiliated programming networks accounted for 12% of all programming networks on their regulated tiers. Increases from unaffiliated programmers accounted for the remaining 89.6% of the total increase in license fees, while unaffiliated programming networks accounted for 88% of all programming networks carried. The four MSOs responding to this question included a mix of operators with widely varying degrees of affiliation. For the year ending July 1, 1997, for example, the most vertically integrated operator reported that approximately 23% of its average regulated channels provided programming from affiliated programmers. This operator also attributed approximately 29% of its programming cost increases to affiliated programmers for the same time period. The least vertically integrated operator, by contrast, reported that approximately 4% of its average regulated channels provided programming from affiliated programmers. For the same time period, that operator attributed approximately 4% of its programming cost increases to affiliated programmers. B. Channel additions 25. The Commission's channel addition rules allow operators to recover programming costs and other costs incurred when operators add channels to their systems. Until December 31, 1997, operators were permitted to increase their rates using either of two methods to account for the addition of channels to CPSTs and single-tier systems after May 15, 1994. The two methods of rate adjustment were the per-channel adjustment factor and the Operator's Cap. Neither method is currently available to operators. By its own terms, the rule authorizing these methods expired on December 31, 1997. During the period both methods were in effect, operators were required to elect their preferred method the first time they adjusted rates after December 31, 1994, to reflect a channel addition that occurred on or after May 15, 1994. They were required to use the elected methodology for all channel additions through December 31, 1997. Neither method was intended to offer a precise measure of the actual cost increase experienced by an operator when it added channels. The Operator's Cap, in fact, gave operators the opportunity in some cases to adjust their rates by more than the actual cost associated with channel additions. 26. The Price Survey indicated that rate adjustments due to channel additions accounted for 13% of overall rate increases for the 12-month period ending July 1, 1997. The Inquiry participants attributed 14.4% (based on three responses) of the increase in rates between July 1, 1996 and July 1, 1997, to channel additions. The participants' channel addition rate adjustments were based primarily on the now-expired Operator's Cap method. C. System Upgrades 27. Upgrade costs may be recovered through a streamlined cost-of-service filing in which the operator documents the actual costs of the upgrade. In some cases, operators have undertaken upgrades as part of a social contract. The Commission's Social Contracts with Time Warner Cable and MediaOne (formerly Continental Cablevision, Inc.) allow those two operators to increase monthly rates by $1.00 per subscriber each year for five years. The total rate increase over the five-year period is intended to compensate the operators for their upgrade costs. 28. The 1997 Price Survey indicated that 11% of rate increases during the 12-month period ending July 1, 1997, were attributable to infrastructure upgrades. The Inquiry found that upgrades, in general, comprised a higher proportion -- 18% -- of average monthly rate increases than the proportion indicated by the Price Survey for the same period. MSOs with social contracts reported substantial upgrades pursuant to their social contracts with the Commission. One such MSO adds, however, that its upgrade costs have substantially exceeded its upgrade-related rate increases. Three MSOs reported that although they have completed system upgrades and, in some cases, have expended considerable sums to do so, they have not sought to recover their upgrade costs in regulated subscriber rates. One MSO states that it has used borrowed funds as well as revenues from advertising and other non-regulated sources to finance over $3.5 billion in upgrades. Another MSO states that, in addition to rates for regulated services, it has drawn on advertising revenues, home shopping commissions, and launch and marketing fees to finance its upgrades. D. Revenues 29. Operators earn revenues not only on regulated subscriber services but also from unregulated subscriber services (such as premium and pay-per-view channels) and non-subscriber sources, such as launch fees and sales commissions paid by programmers and from local advertising. The 1992 Cable Act required the Commission to evaluate a number of factors when it established regulations to ensure that cable television rates are reasonable. Among other things, the Act required the Commission to consider "the revenues (if any) received by a cable operator from advertising from programming that is carried as part of the service for which a rate is being established, and changes in such revenues, or from other consideration obtained in connection with the cable programming services concerned." 30. Operators that increase their rates to recover increased programming costs must adjust their permitted rates, on a channel-by-channel basis, to account for any revenues received from programmers, such as sales commissions. Offsetting is designed to permit operators to recover only their net programming costs. The Commission determined that off-setting "best balances the interest of the cable operator in being compensated for adding new programming and the interest of subscribers in receiving reasonable rates." Under the channel-by-channel offsetting method, operators are not required to use revenues derived from programming on one channel to offset the costs of programming carried on another channel. If a programmer does not charge the operator for carriage, as is generally the case with home shopping channels, then the operator is not required to use the revenues derived from that programming as an offset to the costs of other programming. As a practical matter, therefore, sales commission revenues are not applied against operators' increased programming costs to reduce the rate increase associated with those costs. 1. Advertising Revenues 31. The Commission does not require operators to apply advertising revenues as a general offset to rate increases under the benchmark/price cap method. Advertising revenues are considered in cost-of- service rate filings, but the majority of cable systems use the benchmark/price cap method and are not required to apply advertising revenues against programming costs. 32. Average advertising revenues earned by Inquiry participants grew by 28.9% between 1996 and 1997, from $130.6 million to $168.4 million, as shown in Chart 4. Participants reported that at least some of this growth is due to system acquisitions and to subscriber growth. As a percent of average regulated revenues, Inquiry participants' average local advertising revenues have increased from 7.4% in 1996 to 8.3% in 1997, as shown in Table 1. 33. The participating MSOs report that despite the recent growth in advertising revenues, this source of revenue is still relatively small and is not reliable. One MSO states that gross profit margins have declined as programming costs have increased because revenues from advertising and other sources have not kept pace with programming cost increases. Several MSOs note that it is not feasible for operators to increase advertising rates in step with programming cost increases because they face competition for advertising sales from many other local media outlets, including local radio and TV stations, newspapers, and direct mail. One MSO adds that operators' ability to sell advertising time is further constrained by their inability to deliver a large audience share, since cable system subscribers are located in contained geographic areas. Another MSO points out that increased advertising fees must be justified by increased program ratings. Several operators note that the generation of advertising revenues entails costs, including the costs of selling advertising time and inserting advertising into cable programming, which are not recoverable under the Commission's rules as external costs. Summit states that small operators, in particular, are unable to recoup programming cost increases from advertising revenues, noting that on 24 of its 25 systems, the costs of selling and inserting advertisements outweigh the value of the advertising. Summit states that its total advertising revenue in 1997 was $19,937, or 13 cents per subscriber per month. Summit adds that programmers use the advertising availabilities not used by Summit. However, they refuse to share any of the resulting revenues with Summit, despite Summit's requests that they do so. 2. Launch Fees 34. Launch fees are paid by a programmer to an operator, usually on a per-subscriber basis, as an incentive for the operator to add the programmer's service. Operators that had used the Operator's Cap method for channel additions were required to use launch fee revenues received from any programmer first to offset the permitted per-channel Operator's Cap rate increase for that programming service. Any remaining launch fee revenues were then required to be used to offset programming costs. The Bureau determined that no offsetting was required if the payment was used to cover "verifiable and reasonable promotional expenses" incurred by an operator to market the new programming. The Bureau later clarified that the channel-by-channel standard for offsetting would be applied on a programmer-specific basis where a single cable channel is shared by different programming services. 35. Only two Inquiry participants provided information on revenues from launch fees, and for those two MSOs launch fees amounted to a tiny fraction of total regulated revenues. One MSO reported that launch fees are an unreliable source of revenue, and that this source of revenue may disappear in the future as more channel capacity becomes available with the introduction of digital capability. 3. Sales Commissions 36. Sales commissions are revenues from programming, such as home shopping channels, that programmers pay cable operators in exchange for carriage. Operators must use sales commission revenues to offset, on a channel-by-channel basis, the cost of the programming from which such revenues are derived. As a practical matter, the rate benefit derived from such offsets, if any, is minimal, because home shopping programmers typically do not charge operators license fees to carry their programming. 37. The Inquiry results indicate that revenues from commissions received from home shopping networks averaged $18.2 million and $19.8 million in 1996 and 1997, respectively, as shown in Table 1. IV. Analysis A. Effectiveness of Regulations Governing External Costs 38. The 1992 Cable Act directed the Commission to prescribe regulations that protect subscribers from having to pay unreasonable rates. The Act also sought to promote the expansion of cable system capacity and program offerings. The Commission attempted to strike a balance between these two goals first by implementing a rate rollback to ensure that regulated rates approximated the rates that would be charged in the presence of effective competition, and then by adopting a price cap regime to govern future rate increases due to increasing costs. Finding that these measures alone were insufficient to encourage operators to expand their program offerings, the Commission subsequently adopted incentives for operators to expand their channel capacity and provide additional programming. 39. The Commission's rules governing regulation of cable television rates were designed to promote investment in high-quality programming, infrastructure upgrades, and advanced services while at the same time maintaining reasonable rates for subscribers. The average channel capacity of cable systems has increased steadily over the period of regulation, and the number of national cable programming networks has undergone a period of rapid growth. But the cost, in terms of increases in cable rates, has been high. During the two-year period under review, rates grew by more than 8% per year. On a per-channel basis, cable rates initially declined under rate regulation, but, more recently, have increased, though at a much slower rate than overall cable rates. The average monthly rate increase on a per-channel basis was 1.7% for the year ending July 1, 1996, and 3.3% for the year ending July 1, 1997. B. Effect of Programming Costs on Rates 40. In adopting the initial rate regulations, the Commission stated that it would monitor the impact of external cost treatment of programming costs and would impose a cap or other restriction on rate increases due to programming cost increases if "precipitous" rate increases or other harmful effects resulted from external cost treatment of these costs. Operators have argued that, short of dropping programming services altogether, they cannot control programming costs. 41. The impact of programming cost increases on the level of cable rate increases could have been mitigated in several ways. Operators could have been required to offset programming cost increases with local advertising revenues, either on a channel-by-channel basis (as offsets for launch fees and commissions currently are applied) or on a tier-by-tier basis. Such a requirement would have been administratively complex, however, as it would have required operators and regulators to quantify advertising revenues as well as costs incurred to generate those revenues, on a channel-by-channel or tier-by- tier basis. The Commission also could have limited programming cost and/or other external cost pass- throughs by other means. For example, the 7.5% markup on programming costs could have been eliminated. Alternatively, or in addition, external costs could have been capped, perhaps at the level of inflation, with or without an additional allowance for profit. Adoption of this type of cap on programming cost pass- throughs could have prompted operators to use advertising revenues to pay for a portion of programming costs, but would not have required operators or regulators to account for advertising costs and revenues on a channel-by-channel or tier-by-tier basis. The Commission previously considered such a cap on external cost pass-throughs, but declined to adopt it out of a concern for the continued growth of programming. C. Effect of Affiliation on Programming Costs 42. Information provided by the Inquiry participants did not permit an in depth analysis of the effects of affiliation on programming costs and subscriber rates. Our rules require that license fees charged by programmers to their affiliated operators must reflect either the same rates as those charged to unaffiliated operators or the fair market value of the programming. Data from the Inquiry show that, on average, the ratios of affiliated programming networks to all programming networks (12%), and expenditures on affiliated programming to total programming expenditures (10.4%), are roughly similar. Without examining programmers' costs and pricing practices, which was beyond the scope of this Inquiry, it is impossible to evaluate the effects of affiliation on rates. Nevertheless, the data that we did collect do not suggest that cable operators' programming costs are either systematically higher or systematically lower for affiliated channels than for unaffiliated channels. D. Revenues 43. Under the Commission's rules, advertising revenues are accounted for in rates only through the cost-of-service rate method, which is used infrequently. Advertising revenues earned by Inquiry participants, other operators, and programmers have grown steadily in recent years. The Inquiry indicates that advertising revenues are not a major source of revenue for operators at this time, since they are equal to about 8% of regulated revenues as of June 30, 1997. Revenues from sales commissions and launch fees appear to be relatively insignificant compared to overall revenues, and there appears to have been little or no growth in these revenues in recent years. V. Conclusion 44. While rate increases for the most part have been accompanied by upgrades in system infrastructure, rate increases consistently several times the rate of inflation have engendered numerous critics of the rate-setting policies of cable operators and of the Commission's rate regulations permitting such increases. Infrastructure upgrades have enabled many cable subscribers to receive service from state-of-the- art systems capable of offering many more channels of service through fiber-optic cable and advanced system architectures. The introduction of digital service enables subscribers to receive more channels. Many subscribers now receive better signal quality and experience fewer outages. Operators are now able to offer new non-video services such as Internet access in competition with other providers, and are inaugurating local and long-distance telephone services in selected areas. Because cable rates are significantly higher than they were two and three years ago, it matters little that the Cable CPI as shown in Chart 1 is currently moving along a trend that is below a projection of the Cable CPI based on rates prior to regulation in the early 1990's. 45. The Commission's external cost rules, which allow a direct pass-through of programming costs, and the channel addition rules, which provided an incentive for growth, both contributed to the combination of factors resulting in rate increases far in excess of inflation. The Commission was directed by the 1992 Cable Act to ensure that rates are reasonable and that operators are able to upgrade their infrastructure and expand their services. The rate increases have facilitated the ability of operators to upgrade their infrastructure and to expand their services, but the increases are significant and a concern to subscribers. 46. The Commission's channel addition rules, which were in effect until December 31, 1997, were not intended to serve as a refined measure of the actual costs operators incurred when they added channels to regulated tiers. The Operator's Cap method, in particular, sought to provide an incentive to operators to expand their channel capacity and program offerings. The method allowed rate adjustments in excess of an operator's actual costs. The Inquiry indicated that about 14% of rate increases taken during the period under review were attributed to channel additions and that a majority of these additions were made using the Operator's Cap method. This method of rate adjustment to account for channel additions is no longer available to operators. 47. The greatest opportunity to ensure reasonable rates and broad choice in products and services is the development of a competitive environment. In areas where consumers have had a range of providers to choose from, not only for video services but also for telecommunications services in general, those consumers have benefited from lower prices and improved services. In view of the cable industry's ongoing modernization efforts, the industry stands at a critical juncture, with the potential to become a significant competitor in the broader range of telecommunications services. The Commission should continue to remove barriers to competition within its control and encourage a competitive marketplace. Statement of Chairman William Kennard Re: In the Matter of Annual Assessment of the Status of Competition in Markets for the Delivery of Video Programming, CS Docket 98-102 When Congress passed the Telecommunications Act of 1996, it affirmed the principle that when it comes to innovation and consumer choice, competition is preferable to regulation. Congress envisioned that the removal of market entry barriers would produce robust competition offering a wide array of viewing choices at reasonable prices to millions of American families across the nation. Our annual report shows that, although competition is increasing, the level of competition that consumers are seeking has not yet arrived. Eighty-five percent of all households subscribing to multi-channel video service receive that service from their local cable operator (a two percent decline from the 87 percent we reported a year ago). With this high market share, it is not surprising that cable prices rose more than four times the rate of inflation between June 1997 and June 1998. The drop in local cable operators' dominance of this market is primarily due to the continued growth of DBS systems, and to a lesser degree, the launch of new open video systems and instances where incumbent cable operators have faced head-to-head competition from other cable operators. These cases are immensely important for they teach us an important lesson. That lesson is that competition brings consumer benefits. And, as we continue to move towards a more competitive market, it is my hope that consumers will benefit from lower prices, improved customer service, and additional services. Over the past year, the Commission has taken a number of steps to foster vigorous competition in this field. We improved our program access rules. We pre-empted rules and regulations that prohibited renters and residents in multiple-dwelling units from setting up satellite dishes and antennae in areas under their exclusive control. We ensured that consumers soon will be able to choose to purchase set top boxes from their local retailer instead of leasing their boxes from their cable operator. And we sought updated information on the state of horizontal concentration in the cable industry and how it affects competitiveness. The Commission will continue to take aggressive actions to promote competition. I believe that we could do even more if we were given additional statutory tools. Congress has done much to promote competition in this marketplace, and I believe it would be beneficial for Congress to consider taking additional actions to promote competition. Specifically, I believe that Congress should continue to consider whether to amend the Satellite Home Viewer Act to allow DBS providers to carry local broadcast signals. In my view, it is difficult for DBS to develop as a head-to-head competitor to cable if DBS can't carry many of the channels at the heart of our TV experience. In other words, it's more than a little frustrating to be able to watch a football game a 1,000 miles away, but not be able to tune in to your local news to see if it is going to rain tomorrow. Many consumers have reported this type of frustration with DBS. I believe that removing this prohibition would help promote the further growth of DBS. I would like to work with Congress as they evaluate other statutory proposals to promote competition. For example, the Commission's current impact on competition in MDUs is limited because our authority to allow use of the inside wiring by competitors extends only to circumstances where the incumbent video service provider no longer has a legal right to remain in the building. And, as I said only a month ago when we adopted new OTARD rules, I would like to open a dialogue with Congress regarding the possible extension of the OTARD provisions for renters and others who do not have exclusive use or control of suitable areas for antenna placement. Finally, I would welcome a debate as to whether it would be beneficial to expand the coverage of the program access provisions of the Act. Finally, I share Commissioner Tristani's vision of a competitive marketplace governed by variety and consumer choice on all levels -- a marketplace in which different firms "vie for consumers with different mixes of price, quality and service." And, I join in Commissioner Tristani's praise of efforts to create additional tiers of cable services. As she so eloquently states, "[o]nly when all consumers have the opportunity to meaningfully express their preferences in the marketplace can we declare victory and go home." I couldn't agree more. Separate Statement of Commissioner Ness Re: In the Matter of Annual Assessment of the Status of Competition in Markets for the Delivery of Video Program This, our fifth annual report on the status of competition in the market for the delivery of video programming, finds that competition to cable is slowly but steadily growing. The record evidences a consistent trend showing that more people each year perceive that they have more than one multichannel video provider ("MVPD") from which to choose. As is often the case, readers can interpret the data in this comprehensive report in various ways. In my view, the data tell a positive story about the development of multichannel video competition, particularly from Direct Broadcast Satellite service ("DBS"). From July 1994 to June 1998, DBS subscribership has grown from 70,000 to 7.2 million, which, as of June 1998 represented 9.4% of all MVPD subscribers. In each of the last four years, DBS has experienced impressive growth. Indeed, Paul Kagan reports that 2.2 million of the 3.6 million net new MVPD subscribers in 1998 (or almost two-thirds) are choosing DBS. Last year, our report identified at least three reasons why potential DBS subscribers declined to sign up: high installation costs, significant costs to hook up additional TV sets, and the lack of broadcast television service. Since last year, the cost of installation has plummeted, although it remains expensive to hook up additional sets. Notably, efforts have been made in the last year to address the legislative and technological prerequisites to enable DBS providers to offer local broadcast signals in their respective local markets. Whether it is 'local into local' or consumer education and assistance with installation of rooftop antennas, the key is cooperation between terrestrial broadcasters and DBS providers. Success on this front could make DBS an even better substitute to cable for many Americans. The level of competition in the multichannel video market should not be measured solely by whether cable continues to lose market share. If cable operators use competitive responses to retain customers, so much the better. We should not fault the cable industry for beefing up its service quality, for example, in light of growing competition. Some of the data in this report show that the "pie" is getting slightly larger, as the number of total TV households grows and the numbers of multichannel video subscribers grows. For example, the total number of television homes increased from 97 million in 1996 to 98 million today. The total number of households subscribing to MVPDs increased 4.1% from 73.6 million in 1997 to 76.6 million in 1998. The number of cable subscribers also continued to grow, rising about 2% from 64.2 million in 1997 to 65.4 million in 1998. Some subscribers have chosen to retain basic cable for local service while adding DBS for its national programming and picture clarity. Thus, both the number of cable subscribers and non- cable subscribers have grown and may continue to grow. While I am heartened by the progress made in the development of new competition to cable, some concerns remain. Local cable franchise areas served by a wireline competitor, while growing, are limited. The widespread entry by local exchange carriers (LECs) envisioned by the Congress has not yet developed. Not everyone has access to DBS (it is currently available only throughout the Continental United States), and even with our extension, last fall, of the over-the-air reception device accessibility provisions, many, if not most, residents in multiple dwelling units may not be able to subscribe to DBS. DBS offerings also do not, in general, compete on the basis of price with what is marketed as "basic" cable. For those cable subscribers looking for lower prices, I am hopeful more cable operators will follow the lead of Comcast by offering channel packages at various price points, to the extent such offerings do not impair the launch of new program networks. The next year or two will be especially dynamic as cable operators enter the voice and data market and broadband data offerings are introduced by cable, DBS, local exchange carriers, and potentially MMDS and others. In addition, as a result of our implementation of statutory provisions enabling the retail market for set top devices to develop, new digital products and services are likely to be offered. The state of competition in the video marketplace could be substantially affected by how these related services are offered, and how they are accepted by consumers. Practically speaking, competitive markets are evidenced by the availability of choice -- in other words, do people perceive that they have a realistic choice between providers of multichannel video programming? Choices should be available at various prices, should be available to people in various living environments, must be realistic, and must not be transitory. When markets are fully competitive -- when people have meaningful choices -- the need for government regulation abates and the benefits of competition are manifest: lower prices, new and different service offerings, and better customer service. I am encouraged by the level of competition that has been achieved thus far, and I support efforts by industry and government to attain a fully competitive market for video programming distribution. SEPARATE STATEMENT OF COMMISSIONER MICHAEL POWELL Re: Annual Assessment of the Status of Competition in Markets for the Delivery of Video Programming, CS Docket No. 98-102 Today we transmit the Fifth Annual Report of the FCC to Congress regarding the state of competition in video programming. I wish to offer my view on how to interpret some of the most noteworthy facts contained within this report. First, a word about concentration in the multi-channel video market. I take issue with some of the analysis in this report designed to quantify the extent of concentration in this market. I am not convinced that the product markets are properly defined and I question the value of hypothetical concentration analysis to produce an HHI index. But it really does not matter. By any measure, cable commands the lion's share of the multi-channel video market, though that share continues to steadily decline. Indeed, having started from a position of near total monopoly, it would be surprising if it did not control a large market share only three years since the passage of the 1996 Act. What must be understood is that market share alone does not support the conclusion that a given cable operator is exercising market power to the detriment of consumers. As antitrust scholars well know, monopoly (or near monopoly) is not per se illegal, nor does the presence of a monopolist necessarily mean that there are anti-competitive effects flowing from its dominant position. A multitude of competitive alternatives certainly is always preferred, but the existence of only a few is not sufficient to pronounce anti-competitive harms to consumers. What must be examined is (1) the ability of the monopolist to raise prices substantially in excess of marginal costs, (2) whether a monopolist can restrict output, and (3) whether the lack of competition results in a lack of innovation. When one examines the state of the cable industry, I do not believe one can fairly conclude that consumers are suffering from cable's dominant position. Price Increases: Many of cable's critics quickly point to the increases in cable prices as evidence that there is a lack of competition. Perhaps, but one cannot proclaim that prices are increasing faster than the consumer price index and rest the case. Price increases, of course, are not anti-competitive unless they substantially exceed the private firm's costs. If price increases are largely a consequence of increases in cost, it is incorrect to cite price increases as evidence of competitive harm. In the case of video programming, it is indisputable that programming licensing fees MSO's must pay have increased dramatically (18.4% last year) as have programming costs (20.9% last year). This report squarely acknowledges these facts. Moreover, it is not monopolistic behavior to increase prices to upgrade infrastructure and facilities that will ultimately benefit consumers in the market. In this report, we find that capital expenditures to upgrade cable facilities were up 21% last year. It is particularly dubious to cite price increases to demonstrate lack of competitive discipline when prices have been regulated. Undoubtedly, in areas where there is direct competition to cable, the prices have been lower than non-competitive systems, but not by that much. In 1997, the price difference between competitive and non- competitive systems was $1.57, down from $1.69 the previous year. In short, most competitors are entering the market at similar price points. Output and Value: With a medium such as multi-channel video that is sold in different pricing combinations in different systems across the country, it is risky to examine aggregate price increases across the industry and the full range of pricing packages. It is my understanding that, while aggregate prices have increased, the price per channel has not increased. Cable operators have steadily increased the number of channels and programs available to consumers. In economic terms, they have increased output. They have not restricted output, which is the hallmark of monopolistic behavior. Price per channel measures also more fully incorporate the concept of value. Consumers do not care solely about price. They want a good value the ratio of price to product. More channels, more original programming, higher quality programs are consumer benefits for which many may be willing to pay more. In fact, with this expansion has come continued growth in subscribership suggesting that consumers do value the product. Many respond to this point by rightly pointing out that many consumers do not wish to pay for 500 channels, or greater (more expensive) sports programming, or premium movies. This is true enough. But, there appear to be many low cost alternatives available to those customers and those basic packages have not increased significantly in price. Many cable providers offer a relatively low priced ($12 or less) basic tier of service. One operator, Cox, reported that it offers a 20-channel basic service tier to its customers for $11 per month and that 5% of its subscriber choose to use only this service. Another provider, Comcast, reported that it offers a basic service consisting of local broadcast signals and C-Span for about $9-12 per month. All reports that I have seen indicate that these basic tier prices will remain relatively low. Moreover, they will continue to be regulated even after the March 31, 1999 sunset of upper tier rate regulation. Innovation: Finally, when looking at monopoly behavior to determine if one sees signs of anti- competitive effects, one looks to see if the firms are innovating. Here, it is clear that cable is doing so. Not only have there been steady increases in the quality of programming as discussed above, but also this industry has been investing significant sums to upgrade plant for high speed, two-way capability. This is allowing the industry to begin to offer residential phone service in direct competition with incumbent phone companies a development Congress clearly hoped for in the 1996 Act. Moreover, the rapid innovation of cable plant is accelerating the universally shared desire to bring broadband internet services to homes and residences. Competitors and Barriers to Entry: All this said, I too would love to see greater competition to cable. I believe it will provide some price discipline, but just as importantly, competition will accelerate product innovation. While there are many ways to skin the cat, DBS clearly is shaping up as the singularly most significant competitive alternative to cable. And, it is coming on strong. DBS subscribers increased by 40% last year. Two out of three new subscribers of multi-channel video chose DBS over cable. And, DBS is now very competitively priced, having slashed equipment costs and developed comparable or superior packages of programming. With the flurry of acquisition activity we have seen by the leading DBS providers in recent weeks, DBS's future looks bright. There are clearly many barriers to breaking into this market. The inability to offer local signals, the challenge of getting dishes set up in some areas, and access to programming are just a few of them. But, it is worthy to note that many of the "barriers to entry" are regulatory, rather than a consequence of a monopolist's market power or control of essential facilities. I sincerely hope the Commission, the States and Congress work to lower some of these barriers over the coming year. Overall, I believe that the factual story this report tells is a positive one. The report indicates that there are promising trends in the video programming industry. Despite some entry barriers, we continue to see forays by telephone companies and other utilities, satellite companies and wireless providers into this market. Investment in this arena is strong. I believe this is so not just because the video business is a good one, but also because of the promise of the coming broadband market. Broadband offers the potential for new revenue streams for MVPD providers and, in turn, will provide consumers with new products and new choices. We should be careful not to take actions that would threaten further growth. STATEMENT OF COMMISSIONER GLORIA TRISTANI In the Matter of Annual Assessment of the Status of Competition in Markets for the Delivery of Video Programming, CS Docket No. 98-102 Debates about the status of cable competition often seem a rote exercise. One side asserts that competition has arrived and that market forces now can be relied upon to protect consumers; the other side claims that cable's dominant market power remains intact. One side argues that DBS has emerged as a substitutable, if not superior, video product to cable; the other side dismisses DBS as a high-end option. One side states that consumers are receiving more value (i.e., more and better programming services) for their money; the other side stresses the fact that rates continue to rise at more than four times the rate of inflation. If few minds are ever changed during these debates, it may be because both sides are partly right. They are just focused on different consumers. Those who assert that competition has arrived are focused on a particular category of video consumers: those who want and can afford large programming packages. The cable industry has invested billions of dollars in capacity upgrades -- and plans to invest billions more -- in order to keep these consumers from defecting to DBS and, more importantly, to be able to exploit new revenue opportunitites like high-speed Internet access. As it happens, both reasons underlying cable's expanding capacity (i.e., increased channels and new services) are aimed at similar consumers, who tend to be younger and more well-off than the nation as a whole. Although the cost of upgrades and new services may have caused rates to climb four times faster than the rate of inflation, these consumers may very well feel that the higher prices are justified by the increased value of the delivered product. These consumers can look forward to even better times ahead. On the video side, if the up front costs of DBS continue to decline (and especially if DBS providers are able to provide local broadcast signals), an increasing number of consumers of large programming packages will find DBS and cable to be complete substitutes for each other. On the data side, several entities, including telephone companies and wireless operators, are moving to enter the high-speed data business. It thus appears that these consumers can expect to have multiple service providers competing to serve both their video and data needs. But there is another group of consumers who are not doing so well. These consumers do not want, cannot use or cannot afford large programming packages or high-speed data services. They are happy with plain-old cable service and would have kept a more modest level of service if they had been given that option. But by and large they were not. Instead, they were confronted with a take-it-or-leave-it proposition: pay big rate increases for additional services they do not want and did not ask for, or lose all the cable channels that they have come to rely upon for news and entertainment. And unlike consumers of large programming packages, there was no DBS or DBS-equivalent giving them any real alternative. Not surprisingly, these consumers are unimpressed with the argument that they are actually better off with the additional services because their per channel cost may have gone down. That argument assumes that all channels have equal value when, to these customers, the value added by the new channels is zero. In a truly competitive market, things would be different. In a competitive market, different firms would vie for consumers with different mixes of price, quality and service. The market would sort out what particular combinations of those factors succeed. Some consumers would be willing to put up with poor service in exchange for bargain-basement prices; others would opt for better service at higher prices. Only consumer choice freely expressed -- and not industry or government edict about what consumers "should" value -- can be counted on to reach the right result. It shows how starved we are for competition that anyone could look at the competitive choice provided by DBS and declare victory. I am aware of all the reasons why some say additional choice for consumers will not work -- subscribers would need addressable set-top boxes, new channels would never survive in an a la carte world, and so on. I make just a few observations. First, most of the technical and other objections to more choice for consumers apply to a purely a la carte world. But we should not allow the perfect to become the enemy of the good. Even some choice (e.g., two or three tiers in place of the current take-it-or-leave approach) is better than none. Second, I reject the notion that consumers should be forced to buy additional services that they do not want until they can be made to realize how valuable these services are. We do not do that with magazines, toothpaste or soda pop. For other products, companies use marketing techniques find a way to entice consumers to affirmatively select their product. Cable programming services should be no different. In a market economy, consumers can and must be counted on to determine which products should succeed and which should fail. In the end, it all comes down to trusting the consumer. I am constantly amazed in Washington at the number of people who express complete faith in markets but little faith in living, breathing consumers. I trust consumers to make the right choices about the mix of price, services and quality that is appropriate. Whether or not those choices match the industry's business plans or the expectations of Silicon Valley investors is secondary. Only when all consumers have the opportunity to meaningfully express their preferences in the marketplace can we declare victory and go home. Dissenting Statement of Commissioner Harold Furchtgott-Roth Annual Assessment of the Status of Competition in Markets for the Delivery of Video Programming, CS Docket No. 98-102 For the reasons that follow, I must respectfully dissent from the 1998 "Annual Assessment of the Status of Competition in Markets for the Delivery of Video Programming." I. As an initial matter, I do not believe that the issuance of this Competition Report fulfills our duties under the Communications Act. Instead of examining the state of competition "in the market for the delivery of video programming," 47 USC section 628(g), as the statute prescribes, the Report artificially limits its analysis to the delivery of "multichannel video programming." There are, of course, many forms of video programming that do not come bundled in channels but that are still part of the general video distribution market. Unfortunately, the Report does not take full account of these very real forces in its investigation of competition. For instance, the report considers broadcast service only as a competitor to multichannel video programming distributors ("MVPDs") in advertising, programming acquisition, and programming production, see supra at paras. 95-101, but not as an independent delivery source of video programming. Yet the statutory definition of "video programming" specifically includes broadcast programming. See 47 USC section 602(20) (providing that "the term 'video programming' means programming provided by, or generally comparable to programming provided by, a television broadcast station"). In focusing primarily on what is a submarket of video programming -- the "multichannel" distribution market -- rather than the entire market, the report does not fully meet the requirements of the statute. The language of the statute also makes clear that Congress considered the delivery of video programming to constitute a single "market," see id. section 628(g) (referring to "the market" for video programming delivery), not a conglomeration of "markets," as the very title of this Report suggests in speaking of "[m]arkets" for the delivery of video programming. We should, as a plain statutory matter, have considered the delivery of video programming a single market in this Report. II. In addition to the above-described statutory reasons to view the relevant market participants as more than just MVPDs, economic theory supports that conclusion. A product market is not comprised of perfectly substitutable products. Cf. supra at para. 63 (discussing whether DBS "represents a substitute" for cable). Rather, "[a] product market is a group of goods or services whose availability and prices discipline one another." Crandall & Furchtgott-Roth, Cable TV: Regulation or Competition? at 26 (1996) (emphasis added). For its part, cable television provides a variety of entertainment, information, and even home shopping programming. Similar services may be obtained from local television stations, satellite retransmissions, local sports teams, movie theaters, video rentals, newspapers, magazines, radio stations, and retail shops. Id. In my opinion, monopoly power, where it exists, can be limited -- or "disciplined" -- where "theaters, a large number of broadcast stations, video rentals, live events, and other diversions are readily available." Id. at 105. Thus, in economic terms, the sources that I believe should be considered in analyzing the amount of competition to cable include, at least, broadcast televisions stations, DBS, videotape rentals, motion pictures, even theatrical productions and, at some point in the not too distant future, internet streaming video. From this perspective on the relevant product market, it would not, for instance, appear "unlikely that broadcast television will offer consumers a . . . service in competition with cable," supra at para. 100, but that they already do so. More broadly, when considering the entire video programming market, not just segments of it, one finds that American consumers have more options for the receipt of video programming than ever before. At any time of day, any day of the year, consumers can choose from a wide and ever-widening array of video programming for their entertainment, information, and education. Among other things, they can watch free broadcast television, rent a film, go to the theatre, enjoy DBS sports programming, watch cable news, or order a pay-per-view movie. It takes some impressive intellectual gymnastics to try and find a lack of competition among the providers of these choices in video programming for the American consumer. This general analytical problem of the proper product market manifests itself in the Report in more specific ways too. Section III looks at market share but considers only cable and non-cable MVPDs, not video programming distributors generally. These market share numbers are distorted by the use of what is, in my opinion, an inappropriate denominator. Similarly, in the discussion of concentration levels based on the Herfindahl-Hirschman Index ("HHI"), the Report measures only MVPDs. HHI numbers can be useful in considering concentration levels in product markets but they are rendered meaningless when applied to market segments instead of markets. Likewise, Section IV, in considering instances of competition, assumes that competition only exists when there is more than one (usually facilities-based) MVPD in an area -- which of leads to the conclusion that these instances are more "limited" than if one considered the presence of other video programming deliverers. In my opinion, case studies about "competitive responses" should include, for instance, the relationship between cable and DBS systems. In sum, because the Report slices the relevant product market too thin and thereby paints many actual competitors out of the picture, its conclusions about the state of competition are skewed ab initio. I thus cannot endorse those conclusions. III. The objective facts in the Report -- which, as opposed to the conclusions about competition, I have no quarrel with -- indicate that even in the multichannel-only product market cable today faces a significant amount of competition and that this competition is likely to grow. The percentage of MVPD subscribers that purchase cable (85%) is not, in itself, cause for concern. This market share statistic provides no direct evidence of the availability, or lack thereof, of alternatives to cable, although it is often cited as such. On its face, it only tells us that many people have opted -- perhaps for reasons entirely apart from lack of choice -- for cable companies over other video distributors. The reasons that consumers choose certain video products over others are complicated, based on personal cost- benefit determinations, and cannot be adduced from this number. In short, it simply does not follow from the fact that cable has a preponderance of MVPD customers that cable has an unlawful or inefficient hold on the market. The FCC should not be in the business of trying to drive down the percentage of MVPD subscribers who take cable. Instead, we should create an environment that allows alternative providers to meet market demand for these services by removing regulatory impediments like rate regulation. The fact that cable price increases outpaced the general rate of inflation is not necessarily cause for concern either. The inflation rate measures the average increase in prices of consumer goods and services. Producers of goods and services in various industries of course face widely divergent circumstances in terms of production, labor, overhead costs, etc.; simply put, not all industries face average costs. Given that cable has invested heavily in systems upgrades, see supra at para. 9 (increase of 21% since 1996), that its programming and licensing costs have increased far faster than inflation, see id. (increase of 18.4% and 20.9%, respectively), and that cable is providing more video and non-video services to its customers than ever before, see id., a 7.3% price increase, as compared to a national average of 1.7%, is not particularly strong evidence of anticompetitive behavior. Cable subscribership increased last year. I believe that consumers are not irrational. If they felt that cable, at the price it was offered, did not provide a service that they believed was worth the cost, they would not pay for it. They would migrate to other sources of video programming -- including, most obviously, free over-the-air broadcast programming. But cable subscribership grew by almost 2 million since the end of 1996. See id. at para. 17; App. B, Table B-1. This evidence casts substantial doubt upon the notion that cable is somehow "overpriced," given the presence of choices for other video programming services. Either the consumers who subscribed to cable last year did not know of the availability of these services at lower prices in 1996, or the value they placed on the increased quality in cable service outweighed the intervening price increases. I find the latter more plausible. DBS is making dramatic gains, presenting mounting competition to cable. The Report blinks reality in suggesting that DBS is not having a real competitive effect in the multichannel video programming market. DBS subscribership has jumped by 2.2 million since June of 1997, an increase of 43%. See id. at para. 62. According to Paul Kagan Associates, "DBS is on course to capture nearly two-thirds of all new multichannel subscriptions sold in the U.S. Of the 3.6 mil. projected new broadband subs in 1998, some 2.2 mil. will be sold by the three main DBS providers." Marketing New Media, Oct. 19, 1998. For these reasons, market analysts have called DBS "'the fastest-growing consumer electronics product in history.'" Antennae Attract Viewers to Satellite TV, Wall Street Journal at B-1, Dec. 1, 1998 (quoting Jimmy Schaeffler, chairman, Carmel Group). While the Report stresses that DBS and cable are not perfectly substitutable, that is not the point; what matters is whether they are sufficiently similar such that DBS they can have a disciplining effect on each other, as explained above. I submit that the evidence in this report shows that DBS does just that. The Report itself states that "to meet competition and customer demands for more video channels and advanced services, MSOs must continue to improve their systems through increased channel capacity," supra at para. 38, and documents large infrastructure investments, id. at paras. 37-41 (noting, among other things, that the largest MSOs have "spent as much as half a billion dollars each on capital expenditures"). These facts are reflective of a market in which, increasingly, cable will play catch-up with DBS. See, e.g, Satellite TV rivals to merge services, Washington Times at B-7, Dec. 15, 1998 (noting that Hughes Electronics' purchase of USSB would "expand DirecTV's 185-channel programming lineup to more than 210 channels" and that Echostar Communication's purchase of News Corp. satellites "will mean more channels and services for Echostar subscribers, including 500 channels, Internet access and other date services"). Sounding not at all like monopolists, cable companies are now asserting, in response to actions taken by DBS, that they can still compete in the MVPD market. Antennae Attract Viewers to Satellite TV, Wall Street Journal at B-1 ("'Any cable system with an upgraded technical platform can be fully competitive with any DBS company'") (quoting Julian A. Brodsky, vice chairman of Comcast Corp.). Moreover, DBS has recently made serious inroads on the "competitive disadvantages" of its service. To deal with the issue of local broadcast signals, DBS companies are now "simply adding a separate advanced antenna to their satellite package" to "give customers the local channels they want." Id. These "powerful new antennae [are] capable of tapping local to channels with the mere zap of a remote control." Id. Prices on equipment are still falling, from about $150 to as low as zero in some circumstances. As the Report explains, some DBS companies are providing customers with free dishes. See supra at para. 73; see also Dish Network Advertisement, Philadelphia Inquirer at A-33, Dec. 6, 1998 (offering free digital satellite tv system, after rebate, with guarantee of no rate increases until 2000 with one-year subscription). Also, consumers can decide to pay for professional installation at relatively low prices, or they can choose free do-it-yourself packages. See id. (offering $49 installation or free self-installation kit) Almost two years ago, based in part on research conducted by economists Leland Johnson and Deborah Castleman, I concluded that "[o]nce the cost of receivers, including installation, falls to about $500, DBS should render traditional cable service contestable, assuming that it and cable deliver a similar array of services with equivalent reception quality." Crandall & Furchtgott-Roth at 92. Today, the cost of receivers and installation is well below $500; cable and DBS provide similar programming (even without local broadcast, which they now, in any event, facilitate with antennae sales, as described above); and DBS is considered by many to have not just similar but superior reception, as well as sound, quality. In my view, the day has already come when DBS creates a market disciplining and thus pro-competitive effect. New entrants are on the scene. The Report chronicles well but, unfortunately, then downplays the many innovative providers now on, or waiting in the wings of, the video scene. For example, electric and gas utilities, either on their own or in partnership with others, are providing facilities-based video, telephony, and internet. See supra at paras. 120-121. So are local exchange carriers, who are doing overbuilds in many areas. See id. at paras. 112-117. New, aggressive SMATV operators are making their presence felt too, sometimes in combination with DBS providers, see id. at paras. 90-93, and new technologies are expected to further boost SMATV systems, see id. at para. 92. Internet video, while admittedly not currently comparable to broadcast programming, is around the corner. With digital television, broadcasters, already providing an alternative to cable for the delivery of video programming, will become stronger competitors. Wireless has had its difficulties, but the Commission recently loosened regulatory restrictions on two-way transmissions, see supra at para. 85, which the wireless industry now plans to put to use in the market. The wireless industry also plans to take advantage of digital technology. See id. at para. 84. These are just a few of the new kinds of companies that have entered the video programming delivery market. Others are described in the factual sections of the Report. Suffice it to say that many new and improved services are now here and more are coming into being. * * * Perhaps it is a question of seeing the glass as half empty or half full, but I believe that we have a significant amount of competition in video programming delivery and that, moreover, the imminent future holds a great deal of promise for even more video competition.