Market Dynamics and Public Policy Issues in the Video Programming Industry

Order Code RL32026

CRS Report for Congress

Received through the CRS Web

Market Dynamics and

Public Policy Issues in the

Video Programming Industry

July 28, 2003

Charles B. Goldfarb

Specialist in Industrial Organization and Telecommunications

Resources, Science, and Industry Division

Congressional Research Service ˜ The Library of Congress

Market Dynamics and Public Policy Issues in the Video

Programming Industry

Summary

In the past 15 years, the successful introduction of new technologies, coupled

with changes in government rules, has created strong market forces for fundamental

structural change in the video programming industry. About 80 percent of U.S.

households subscribe to cable or satellite systems offering multiple channels of

programming. These alternatives to broadcast television now attract more than half

the total viewing audience, although broadcast television still attracts a majority of

viewers during prime-time when popular broadcast network fare is aired. Similarly,

movie producers today receive more than twice as much revenue from the rental and

sale of video cassettes and DVDs as they do from movie theaters.

At the same time, there has been widespread vertical and horizontal integration

in the video programming industry. The industry is increasingly dominated by a

small number of firms that finance the development of new programming through a

wide variety of arrangements with content providers (including joint ventures and

direct ownership), own extensive libraries of existing programming, own a variety

of distribution channels for bringing content to the public, and also own retail

pipelines such as local broadcast stations and video store chains (and, currently

proposed, a direct broadcast satellite system).

These fundamental changes in the market structure affect the public policy

issues that Congress faces. Today, there are more pipelines into the home and more

distribution networks than ever before, but a limited number of big media players

control a large portion of both programming and distribution. This has engendered

debate on how well the existing FCC ownership rules address the impact of

consolidated ownership of programming and distribution on the public interest goals

of diversity, competition, and localism, and whether new rules that re-regulate the

industry could or should be formulated that would better serve those goals.

The purposes of this report are:

!

to explain how and why underlying market forces have created

strong pressure for vertical integration across segments and

horizontal mergers within segments;

!

to explain how that market consolidation could be used to benefit or

to harm consumers; and

!

to identify public policy issues that may arise as a result of the

vertical and horizontal consolidation.

See CRS Report RL32027 for background and detail on the structure of the

video programming industry.

This report will be updated as events warrant.

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Market Dynamics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Viewers Tend to Value New Viewing Options . . . . . . . . . . . . . . . . . . . . . . . 1

New Viewing Options Fragment Viewing Audiences . . . . . . . . . . . . . . . . . . 4

Costs Continue to Rise for Popular Programming . . . . . . . . . . . . . . . . . . . . . 6

Rising Costs and Fragmented Audiences May Increase Risk

That Could Be Mitigated by Consolidation . . . . . . . . . . . . . . . . . . . . . 9

Consolidation Also Could Be Used for Strategic Purposes

That Harm Consumers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Some Fundamental Questions Remain Unanswered . . . . . . . . . . . . . . . . . . 15

Public Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Station Ownership Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Programming Ownership Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Non-Discriminatory Access to Programming . . . . . . . . . . . . . . . . . . . . . . . 20

Retransmission Consent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

A La Carte . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Programming Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Fairness Doctrine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

List of Tables

Table 1. Television Viewing by Cable and Non-Cable Households,

1990-91 and 2000-01 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Table 2. End-User Expenditures on Various Video Media, 1990-2000 . . . . . . . . 5

Table 3. Estimated Share of U.S. TV Home Set Usage by Program Source . . . . 6

Market Dynamics and Public Policy Issues

in the Video Programming Industry

Introduction

Over the past 15 years, technology-driven market forces and changes in

government rules have led to widespread vertical and horizontal integration1 in the

video programming industry. Some of these integrated firms are very large, with

extensive holdings that cross both functional segments (i.e., content production,

distribution and packaging, and pipelines to end user customers) and technologies

(broadcast, cable, direct broadcast satellite (DBS), VCRs, and DVDs).2 This has

raised concerns in some quarters that these firms could use their market positions to

harm competition and that media concentration reduces the diversity of independent

voices and lessens sensitivity to local needs, interests, and standards. Other

policymakers have found benefit to consumers from efficiency gains made possible

by such consolidation, and have pointed to some empirical evidence that media

consolidation has increased the amount and quality of local news programming.

The purpose of this report is to describe the market dynamics driving vertical

and horizontal consolidation in the video programming industry, to show the

potential benefits and harm to consumers from such consolidation, and to identify

potential public policy issues that may be raised by the consolidation.

Market Dynamics

Viewers Tend to Value New Viewing Options

The emergence of new technologies for the provision of video programming to

end users -- cable television, direct broadcast satellite, and video cassette and DVD

rental and sales all represent relatively recent alternatives to traditional broadcast

television and movie theaters -- has increased the options available to viewers. In

2001 cable television service was available to 96.7 percent of U.S. households and

65.0 percent of households subscribed, while 17.7 percent of U.S. households

1

Horizontal integration occurs when firms that compete directly with one another combine.

Vertical integration occurs when firms that are in a supplier-customer relationship combine.

The supplying firm can be providing products (e.g., programming) or services (e.g.,

distribution services) that are inputs for the customer.

2

The structure of the video programming industry and the interrelationships among the

functional segments and technological alternatives are discussed in detail in CRS Report

RL32027.

CRS-2

subscribed to satellite service.3 The average cable system devotes 82.5 channels to

video delivery.4 In addition, in 2001, 85.2% of U.S. households had VCRs; 13.0%

had DVD players.5

Viewers clearly value these options. As shown in Table 1,6 Americans continue

to increase the amount of time they spend watching video programming, and

subscribers to multiple channel systems in particular have increased their viewing.

Table 1. Television Viewing by Cable and Non-Cable Households,

1990-91 and 2000-01

(hours per week)

1990-1991

BroadcastOnly

Households

1990-1991

Cable

Household

s

2000-2001

BroadcastOnly

Households

2000-2001

Cable

Households

Total Television Viewing

41.6

54.7

45.3

63.0

Total Broadcast Viewing

41.6

31.9

45.3

26.8

29.4

24.0

29.4

20.8

10.3

8.1

12.9

4.7

PBS

1.9

1.3

3.0

1.3

Total Cable Viewing

–

22.8

–

36.2

Advertiser-Supported

Cable

–

18.2

–

29.8

Premium Pay Channels

–

4.6

–

4.0

–

–

–

2.4

Network Affiliates

Independents

a

b

All Other Cable

c

Source: Cablevision Advertising Bureau, Cable TV Facts 1992 ed., p. 6 and 2002 ed., p. 41.

a. Network affiliates ABC/CBS/NBC in 1990-1991 and ABC/CBS/FOX/NBC in 2000-2001.

b. WB/UPN/PAX affiliates and independents.

c. This category was not listed separately in 1990-1991. It includes cable networks neither

advertising-supported nor premium pay, e.g., pay per view, home shopping.

3

Jonathan Levy, Marceline Ford-Livene, and Anne Levine, “Broadcast Television:

Survivor in a Sea of Competition,” OPP Working Paper 37, Federal Communications

Commission, September 2002, Table 1, p. 4.

4

Implementation of Section 3 of the Cable Network Consumer Protection and Competition

Act of 1992, Statistical Report on Average Prices for Basic Service, Cable Programming

Services, and Equipment, MM Docket No. 92-266, Report on Cable Industry Prices, 17 FCC

Rcd at 6313, Table 11 (2002).

5

Jonathan Levy, Marceline Ford-Livene, and Anne Levine, “Broadcast Television:

Survivor in a Sea of Competition,” OPP Working Paper 37, Federal Communications

Commission, September 2002, Table 1, p. 4.

6

Reproduced from Jonathan Levy, Marceline Ford-Livene, and Anne Levine, “Broadcast

Television: Survivor in a Sea of Competition, OPP Working Paper 37, Federal

Communications Commission, September 2002, Table 8, p.20.

CRS-3

The alternatives to broadcast television now attract more than half the viewing

audience, though broadcast television still attracts a majority of viewers during

prime-time when popular broadcast network fare is aired. According to the National

Cable & Telecommunications Association,7 basic cable networks and pay cable

services captured a 59 share of the viewing audience in 2002, while broadcast

stations captured only a 53 share.8 The FCC reports9 that the prime-time share of all

cable networks increased from 51.9 in July 2000 - July 2001 to 56.5 in July 2001 June 2002, while the prime-time share of all broadcast television networks fell from

63 to 59 during the same period.10 Similarly, the FCC reported that in 2000, of $29.9

billion in total U.S. end-user expenditures for filmed entertainment, $22.45 billion

came from home video and only $7.45 billion from box office receipts.11

Viewers also have demonstrated a willingness to pay for programming. Table

2 shows how end-user expenditures on various video media grew, in current dollars,

from 1990 to 2000. During that period, the consumer price index grew by 32.5%;13

consumer spending on each and every video medium grew at a faster pace, in most

cases at a substantially faster pace. As shown in Table 2, cable video subscription

revenues increased from $16.1 billion in 1990 to $31.9 billion in 2000, while direct

broadcast satellite subscription revenues increased from zero to $8.4 billion, and the

rental and sale of video cassettes and DVDs increased from $11.1 billion to $22.4

billion during the same period. Although the growth in demand for these new video

services siphoned off viewers of traditional video outlets, those outlets too continued

to enjoy revenue growth. As shown in Table 2, from 1990 to 2000, advertising

revenues for broadcast television and box office receipts from movie theaters

12

7

“Viewing Shares: Broadcast Years: 1991/92–2001/02,” Cable Developments 2003,

National Cable & Telecommunications Association, at p. 16, citing data from Nielsen Media

Research and Cable Status Report Data, published by the Cablevision Advertising Bureau

in Cable TV Facts, 1993 through 2003.

8

A program’s or network’s “share” is defined as the percentage of the television

households watching television at a given time that are tuned to that particular program or

network. The sum of all shares typically exceeds 100 because in some households there will

be multiple televisions being watched at the same time.

9

Annual Assessment of the Status of Competition in the Market for the Delivery of Video

Programming, Federal Communications Commission, MB Docket No. 02-145, Ninth

Annual Report, released December 31, 2002, at pp. 5 and 6.

10

For a more detailed discussion of broadcast and cable market shares, see CRS Report

RL32027.

11

Jonathan Levy, Marceline Ford-Livene, and Anne Levine, “Broadcast Television:

Survivor in a Sea of Competition,” OPP Working Paper 37, Federal Communications

Commission, September 2002, Table 2, p. 6, citing Veronis Suhler, “Communications

Industry Forecast,” July 2001.

12

Reproduced from Jonathan Levy, Marceline Ford-Livene, and Anne Levine, “Broadcast

Television: Survivor in a Sea of Competition, OPP Working Paper 37, Federal

Communications Commission, September 2002, Table 2, p.6.

13

U.S. Department of Labor, Bureau of Labor Statistics, Consumer Price Index, All Urban

Consumers, U.S. city average, All items, [ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt],

viewed 7/28/2003.

CRS-4

continued to rise. In all, end user and advertising expenditures on video

programming increased from $61 billion in 1990 to $128 billion in 2000.14

New Viewing Options Fragment Viewing Audiences

Despite the increase in the overall size of the market for video programming, the

availability of additional options has resulted in the fragmentation of viewing

audiences for individual channels. As shown in Table 3,15 the market share of

broadcast television continues to fall. The three major networks and their affiliates

captured 80 to 90 percent of the audience in the 1950s through 1970s. Today, there

are seven networks, but they and their affiliates have only a 39 percent market

share.16 As described by Kagan World Media,17

Thanks to a tremendous rise in competition from cable networks, a low rating on

broadcast TV 20 years ago would be a high rating today. The top 10 average of

12.7 in the 2001-2002 season was dangerously close to the bottom 10 average of

12.0 in 1980-1981.

Although cable networks in aggregate now command half the viewing audience, that

aggregate audience is shared by more than one hundred cable networks; no single

cable network commands as much as a two percent rating.18

14

Standard & Poor’s estimated that in 2002, U.S. consumers would spend $44 billion for

TV programming (delivered via basic cable, pay cable, and satellite programming), $9

billion for theatrical movies, and $22 billion for rental and purchase of prerecorded

videocassettes and DVDs, and that the television industry also would be supported by $61

billion in advertising expenditures, yielding total industry revenue of $136 billion. Tom

Graves, “Movies and Home Entertainment,” Standard & Poor’s Industry Surveys, November

14, 2002, at p. 7.

15

Reproduced from Jonathan Levy, Marceline Ford-Livene, and Anne Levine, “Broadcast

Television: Survivor in a Sea of Competition, OPP Working Paper 37, Federal

Communications Commission, September 2002, Table 25, p.62.

16

These market shares do not match up exactly with the share of television households data

presented on p. 3 above, in part because the “share” being measured is different, in part

because the time period covered is different. But all the data show the same pattern – the

broadcast television market share is falling, and no network or individual program attracts

audiences of the size or market share that existed before the successful entry of cable and

satellite systems.

17

Kagan World Media, The Economics of TV Programming & Syndication 2002, August

2002, at p. 6.

18

According to the Television Bureau of Advertising, for the 2002-2003 season, TNT, the

highest-rated advertiser-supported cable network, had a rating of only 1.56%. (A program’s

or network’s “rating” is the percentage of total television households (approximately 107

million) viewing that program or network. In April 2003, the highest ranked ad-supported

cable program came in at number 146 for the month, with a 3.2% household rating. See

“HH Ratings - Primetime Broadcast and Ad-Supported Cable Season-to-Date 2002-2003 v.

Season-to-Date 2001-2002,” “HH Ratings - Primetime Top Ranked Ad-Supported Cable

Networks Season-do-Date 2002-2003 v. Season-to-Date 2001-2002,” and “Top 100

Programs on Broadcast & Cable: Apr-2003,” Television Bureau of Advertising,

(continued...)

CRS-5

Table 2. End-User Expenditures on Various Video Media,

1990-2000

(millions of current dollars)

1990

1995

2000

Total Broadcast Television

$26,716

$32,720

$44,802

Network Advertising Revenues

$9,963

$11,600

$15,888

Syndication Advertising Revenues

$1,109

$2,016

$3,108

Stations’ Advertising Revenues (local + national

sport)

$15,644

$19,104

$25,806

Total Cable Video-Related Revenues

$18,401

$26,870

$44,808

Total Cable Television Operators’ Revenuesa

$16,604

$22,898

$3,435

Operators’ Video Subscriptionsb

$16,128

$21,823

$31,992

Operators’ Advertising Revenues

$476

$1,075

$2,430

$1,797

$3,972

$10,456

Total DBS Revenues

$0

$663

$8,467

DBS Video Subscriptions

$0

$63

$8,440

DBS Advertising Revenuesc

$0

$0

$27

Total Subscription Video-Related Revenues

$18,401

$27,533

$53,275

Filmed Entertainmentd

$16,129

$21,023

$29,906

Box Office

$5,022

$5,494

$7,453

Home Video

$11,107

$15,529

$22,453

Basic Cable Network Advertising Revenues

Sources: Broadcast Television Revenues: Television Bureau of Advertising, “Trends in

Advertising Volume,” [http://www.tvb.org/tvfaxts/trends], visited June 26, 2002; Cable

Operator Revenues: Kagan World Media, The Economics of Basic Cable Networks (date and

pages not provided); DBS Revenues: Kagan World Media, The State of DBS 2002, Dec.

2001, at p. 16; Filmed Entertainment Revenues: Veronis Suhler, “Communications Industry

Forecast,” July 2001, at p. 203.

a. Only video-related revenues are listed here. Revenues from installations, equipment, and

non-video services like high-speed Internet access services and telephony are not included.

b. Includes home shopping commissions.

18

(...continued)

[http://www.tvb.org/rcentral/viewertrack/monthly/top100-b-c/top100.asp?ms=Apr2003.html], viewed 6/20/03. Premium cable networks, such as HBO and Showtime, that

offer premium programming for monthly subscriber charges have attained ratings of 6.0 and

higher for several successful programs, such as The Sopranos and Sex and the City. See,

e.g., “Ratings: Weekly Pay Cable,” [http://www.allyourtv.com/ratingscablepay.html],

viewed 7/15/2003.

CRS-6

c. DBS advertising is the equivalent of cable’s “local avails,” though they are sold as

national time.

d. Filmed entertainment in this table includes movie theater box office and video stores.

The data source for filmed entertainment includes expenditures on television programming

as a third category. Because programming is an input into television, cable, and DBS

services, it is not listed separately under filmed entertainment.

Table 3. Estimated Share of U.S. TV Home Set Usage by

Program Source

(annual averages)

Early

1950s

Early

1960s

Early

1970s

Early

1980s

Early

1990s

Early

2000s

ABC/CBS/NBC

60%

58%

55%

54%

31%

21%

DuMont

4%

–

–

–

–

--

FOX/WB/UPN/PAX

--

--

--

--

2%

8%

Network Affiliatesa

30%

29%

25%

23%

18%

10%

Independent Stationsb

6%

11%

16%

20%

16%

11%

PBS Stations

–

2%

4%

3%

3%

3%

Pay Cable

–

–

–

4%

4%

6%

Basic Cablec

–

–

1%

3%

20%

35%

VCR Play

–

–

–

–

5%

5%

Video Games

–

–

–

1%

1%

1%

Pay Per View

–

–

–

–

–

Average Hours of Set

Usage (Weekly)e

35

39

46

51

54

d

62

Source: Media Dynamics, TV Dimensions 2001 Report (2001).

a. Includes syndicated shows.

b. Excludes WTBS and FOX or other on-air networks; includes syndicated shows.

c. Includes WTBS.

d. Less than 1 percent.

e. Counts multiple-set usage to different sources at the same time as separate exposures.

Costs Continue to Rise for Popular Programming

As entry has fragmented audiences, the costs of producing programming

continue to increase at least at the rate of inflation. Electronic Media19 estimates that

19

Michael Freeman, “TV’s new math: How the economic models for producing TV shows

have changed,” appendix to “Special Report: The New Economics of TV – Forging A

(continued...)

CRS-7

the cost of producing scripted television series for prime time has increased by about

30% since the early 1990s, and that the costs of production have increased from the

$1.1 - $1.4 million range to the $1.4 - $1.6 million range for a one hour drama and

from the $400,000 - $900,000 range to the $550,000 - $1.2 million range for a half

hour situation comedy.20

It is important to understand, however, that production costs vary from these

average levels in significant ways. On one hand, successful existing network

programs that have demonstrated the ability to generate larger audiences than the

average program – hit programs such as Friends or certain sports events – become

more expensive to produce precisely because they are successful. Costs increase as

the talent associated with those programs (athletes, actors, directors, producers) are

able to renegotiate contracts to command a larger portion of the revenues they

generate. Popular programming that attracts a large audience (or perhaps attracts a

somewhat smaller audience that has a high intensity of demand) typically generates

large revenues, either from advertisers or from direct subscriber charges. These

higher than average revenues are shared by the owners of the programming, in the

form of profits, and by the talent (actors, directors, athletes), in the form of high

renegotiated salaries that include what economists call “economic rents.” These

economic rents become part of the cost of the programming.

The costs associated with each episode of a successful network program at the

peak of that program’s popularity therefore could be many times the average costs

identified above. For example, the license fee per episode in the 2001-2002 season

was $8.2 million for ER, $5.6 million for Frasier, and $5.5 million for Friends, and

at least seven other programs has license fees per episode exceeding $2 million.21

These license fees often do not cover the full costs of production because the owners

of the programming can generate additional revenues from syndication of reruns and

from international markets. Sometimes such costs can be built into production before

a new (pilot) series has demonstrated audience appeal. Talent with a proven track

record sometimes can command high salaries in advance.

ESPN recently announced a rate increase of 20 percent, the fifth consecutive

year it has had an increase of that size.22 A portion of that increase goes to the sports

19

(...continued)

Model for Profitability,” Electronic Media, January 28, 2002.

20

Similarly, movie production costs continue to rise. Although it does not provide

quantitative data, Standard and Poor’s states that “expenses are going up due to more

frequent and spectacular special effects in action and science fiction films; projects that

must be shot on location as opposed to a controlled studio environment; and astronomical

star salaries.” Tom Graves, “Movies and Home Entertainment,” Standard & Poor’s Industry

Surveys, November 14, 2002, at p. 11.

21

Kagan World Media, The Economics of TV Programming & Syndication 2002, August

2002, at p. 16.

22

Apparently, a number of years ago many cable system operators contractually agreed to

a 20% annual escalator in ESPN license fees. This year, ESPN has offered an alternative

to the 20% escalator, offering to start dropping the rate of increase first to 16 percent

(continued...)

CRS-8

leagues and thus indirectly to the athletes. More generally, James M. Gleason,

chairman of the American Cable Association, an association of small cable operators,

claims that “programming costs for 14 top cable networks have risen 66.6% over the

past five years – an increase of more than 5 times the Consumer Price Index.”23

Presumably these networks have a substantial proportion of programming that have

successfully found audiences and these charges include the economic rents accruing

to the talent that produced the programming.

From the perspective of the viewing public, the extremely high economic rents

to talent that drive up these costs – which ultimately are passed on to consumers

through higher cable charges or higher advertising charges that raise the prices for

advertised goods and services – are beneficial if they generate additional

programming of the sort that the public prefers. If these “windfalls” are ploughed

back into the production of equally popular programming, or innovative

programming that might not otherwise be produced, the public benefits. But to the

extent most talent – athletes, writers, directors, producers, etc. – would continue to

perform at the same level even if they could not command such high prices for their

services, the public does not benefit from a system that fosters extremely high

economic rents.

At the same time, there is a lot of original programming being produced at much

lower cost directly for basic cable networks (such as Discovery and A&E) with much

smaller expected audiences and revenues.24 These independent producers are

providing hundreds of programs for dozens of series on budgets of less than

$100,000 per hour of programming.25

22

(...continued)

annually and eventually to 11 percent in exchange for wide distribution and relatively high

license fees for all its products, including ESPN Classic, start-up Spanish-language service

ESPN Deportes, and a new pay-per-view service. Further, ESPN wants long-term

commitments and pricing schedules for more-uncertain products, such as a high-definition

ESPN feed, a nascent interactive-TV product, video-on-demand packages, and a high-speed

Internet product. The 20% price increase will go into effect as of August 1, 2003, if

operators do not agree to the alternative arrangements. As of mid-July, no major multisystem operator had agreed to those arrangements. See John M. Higgins, “ESPN, MSOs

FACE OFF:Cable operators wary of network’s proposed alternative to annual 20% licensefee hike,” Broadcasting & Cable, April 28, 2003, at p. 1, and John M. Higgins, “Does ESPN

Have a Plan C?”, Broadcasting & Cable, July 14, 2003, at p. 10.

23

Written testimony of James M. Gleason before the Senate Committee on Commerce,

Science, and Transportation Hearing on Media Ownership, May 6, 2003

24

See, for example, John M. Higgins, “It’s Production On the Cheap,” Broadcasting &

Cable, 4.28.03, pp. 38-39.

25

The most successful of these series is “Trading Places,” a household make-over

program. It should be noted that once a production team has had a successful track

record, it may be able to demand a higher price for its services.

CRS-9

Rising Costs and Fragmented Audiences May Increase Risk

That Could Be Mitigated by Consolidation

Despite these cost differences, most program producers face a similar

underlying cost situation. They have substantial up-front production costs and they

do not have any prior guarantee that their programming will ever reach an audience,

no less capture such a large audience that they will be able to renegotiate a larger

portion of the revenues generated. As a result producers face very high up-front risk

and it is generally in their interest to attempt to reduce that risk. There are two

general ways to accomplish this: (1) to produce many different programs, so that the

fate of the company does not depend on the success of individual programming

projects, but rather on the overall success rate of the full portfolio of projects, and (2)

to negotiate a joint venture with a program distributor or retail provider of video

programs in which the latter makes an up-front investment in the production in return

for a share of the profits or a lower price for programming.

As a result of audience fragmentation and generally increasing programming

costs, in most situations no single retail channel (e.g., broadcast television or movie

box office) reaches enough viewers to allow the producer to fully recoup the costs of

producing the programming solely through that channel. At the same time,

advertisers seeking to reach a wide audience no longer can reach their full target

audience through advertiser-supported programming on a single channel. Thus, the

old system of producing programming primarily for one retail channel is in most

situations no longer financially viable.

These market forces are affecting market behavior and structure in several ways.

First, the pressure on program producers to expand and diversify their programming

or to enter into joint ventures with distributors or retailers has encouraged both

horizontal mergers among producers and vertical mergers with distributors and

retailers. To the extent reducing overall risk fosters the production of more programs

or the undertaking of higher-risk projects, such consolidation will benefit consumers.

Second, audience fragmentation is forcing producers to market their products

through multiple retail channels. This is known as “windowing”26 when it involves

motion picture programming and “repurposing”27 when it involves television

programming. For example, a producer may schedule a new product to first be

released through first run movie theaters, then after some delay to be released on payper-view cable or video channels, then after additional delay to be made available for

rental or sale at video stores, finally after yet additional delay to be shown on non-pay

cable, DBS, or broadcast television channels.28

26

For an excellent discussion of the economic forces underlying windowing, see Bruce M.

Owen and Steven S. Wildman, Video Economics, Harvard University Press, Cambridge,

Massachusetts, 1992.

27

For a detailed discussion of repurposing, see, e.g.,Michael Freeman, “Forging a Model

for Profitability,” Electronic Media, Vol. 21, Issue 4, 1/28/2002.

28

In the case of repurposing, the delays between pipelines may be quite short. In several

(continued...)

CRS-10

The reason for doing this is to take advantage of the fact that different customers

have different intensities of demand for video programming. Those with the highest

intensity pay the most to see the video in movie format at a first run theater as soon

as it is released. Those with somewhat lower intensity accept a delay and pay

somewhat less to watch the video as a movie on pay-per-view. Those willing to wait

longer and pay still less, wait until the video is available for rent or purchase at a

video store. Finally, those with the lowest intensity wait to view the programming

when it is on non-pay cable, satellite, or broadcast channels. These options allow the

viewing public to select their preferred mode of obtaining video programming, based

on their sensitivity to price and to time delay. In turn, by not having a single price

for video programming that would be lower than some viewers would be willing to

pay and higher than others would be willing to pay, this viewer selection allows

producers to maximize the revenues generated by their programs.29 Windowing

allows more programming to be profitable than would otherwise be the case and

therefore more programming is produced for viewers.

However, it is not easy to negotiate the many pricing and timing variables across

the production, distribution, and retail segments of the industry, as well as across

multiple retail channels, especially when those channels compete with one another

for audiences and, in some cases, for advertisers. One way to simplify this process

and perform windowing efficiently is to vertically integrate across the production,

distribution, and retail segments, and to consolidate across channels within a

segment.

Third, in their efforts to gain viewers among the fragmented audience, program

distributors and retailers have the incentive to take fullest possible advantage of

whatever successes they have with their existing programs. One way to do that is to

create brand identity for a network and extend that identity to affiliated networks.

For example, the Discovery Channel, once successful, spawned a number of affiliated

programming networks – Discovery Civilization, Discovery En Español, Discovery

Health, Discovery Home & Leisure, Discovery Kids, etc. These, in turn, provide the

opportunity for cross-marketing of programs among the co-branded networks. This

28

(...continued)

recent repurposing deals between broadcast networks and cable networks, the programs have

been rerun on the cable network within about a week of its initial broadcast. Apparently this

has not hurt ratings for the programs, though there is some concern that such initial

saturation will lower the value of the programming for later syndication. See, e.g., Michael

Freeman, “Special Report: The New Economics of TV – Forging A Model for Profitability,”

Electronic Media, January 28, 2002.

29

It is interesting to note that a major strategy that the networks have used to contain

programming costs – the creation of “reality television” programming – does not lend itself

to windowing since the programs lose their appeal once viewers know who won the

competition. Thus, although these programs reduce up-front production costs, they lack a

“back-end” revenue stream. Similarly, most sports programs do not lend themselves to

windowing and where they are expensive to produce this typically results in very high

charges to the retail channels that carry the sports programming, since there will be little or

no back-end revenue stream. Recent price increases in sports programming have been a

source of controversy, particularly where producers and distributors have not allowed cable

systems to place those sports programs on premium channels.

CRS-11

same formula has been followed by many programming networks, including FOX,

HBO, BET, ESPN, and MTV.30 Independent networks cannot perform such crossmarketing as effectively. These branding and cross-marketing activities need not be

limited to a single industry segment and, in fact, can be facilitated by vertical

integration. Many of the most successful examples involve branding and crossmarketing that goes beyond the video industry, into books, magazines, comic books,

newspapers, musical recordings, and amusement parks that all build off a single

recognizable character or concept. Branding and cross-marketing frequently can be

most efficiently and effectively accomplished within a single corporate family.

Fourth, given the consolidation that has occurred in cable system ownership,31

with just a handful of multi-system operators (MSOs) controlling access to the

majority of cable viewers, individual content providers need to take whatever steps

are necessary to create leverage in their dealings with MSOs, and an obvious choice

is to join forces with programming conglomerates or with the large MSOs,

themselves. Although most local cable (and satellite) systems now have capacity to

carry 80 or more networks, with more than 300 existing cable networks it is

becoming increasingly difficult for new networks to get onto systems. As start-ups

in a business with high up-front production costs, they face even more directly than

existing networks the need to get onto as many local cable systems as possible, as

quickly as possible. One strategy that new networks have used is to offer their

programming to MSOs and local cable systems without charging any per subscriber

license fee – or even paying the cable systems to carry their programming. This

limits the cable networks’ revenues to advertising revenues, and unless they are

carried by many local systems they cannot command very much in terms of

advertising rates. As a result, start-up networks have increasingly been forced to

follow one of two strategies. Some new cable networks have agreed to give the

major MSOs – especially Comcast and AOL Time Warner – substantial equity

interests in their networks in exchange for being carried on their systems.32

Alternatively, some new cable networks have agreed to give “mega-programmers”

such as Viacom, Discovery Networks, or Disney, substantial equity interests in their

networks in exchange for becoming part of those companies’ line of cable channels,

30

The efficiency advantages from combining into networks or in other ways is not

new. Broadcast networks for many decades have put together weekly program

schedules that are intended to maximize viewership by carefully analyzing the

optimal order in which programs are presented in order to hold onto audiences once

they have tuned into a particular network to watch a particular program. It would be

much more difficult for individual stations to perform the market research needed to

optimize program schedules.

31

The ten largest multi-system operators serve almost 60 million of the approximately 72

million households receiving basic cable service (83.3%); the five largest serve 71.2%, and

the two largest serve 45.2%. (National Cable & Telecommunications website,

[http://www.ncta.com/industry], citing data from A.C. Nielsen Media Research and Kagan

World Media, Cable TV Investor.)

32

See, e.g.,R. Thomas Umstead, “Indie Nets Face Barren Landscape: New Programming

Ventures Find It’s Hard to Stake a Digital Claim Without Corporate Ties,” Multichannel

News, 6/9/2003. “Operators are seeking steep ownership stakes in new programming

services in return for carriage.”

CRS-12

taking advantage of those larger entities’ ability to negotiate carriage with the MSOs.

Data on cable network television household penetration from 1994 through 200133

show that the only new networks able to gain rapid and high levels of household

penetration during that period were owned in whole or in part by one of the major

program distributors or MSOs.

All four of these factors are at play currently in the market for cable

programming. Kagan World Media, which follows the cable industry very closely

and publishes a number of annual cable reference books, has described this situation

in several recent publications:

The environment for launching a cable network has changed dramatically over

the last decade: With cash-for-carriage fees and periods with no license fee now

common, a daunting economic equation has developed for cable network startups. That’s why the majority of new networks launched have been owned by

major media companies and even well-heeled international players like the BBC

and National Geographic have chosen joint ventures rather than go it alone. It’s

simply too expensive and risky for many companies to join the long list of nets

seeking carriage, and the odds for success get better if a partner with leverage

can team up with a powerful backer such as Discovery.34

For independents, there are a number of challenges. First, they don’t have the

built-in-ad-sales and affiliate-relations infrastructure giants like Discovery

Networks and MTV Networks that enable them to launch new channels at low

cost. The media giants are also at an advantage in the programming-cost

department – they use “recycled” programming already aired on their core

networks, which results in low incremental costs. That’s why a number of the

networks listed among upcoming/pending/past launches have fallen by the

wayside. They just haven’t been able to raise the capital to make it through the

long haul.35

A network launching from scratch, without a big infrastructure in place for

administration and sales, could easily burn through more than $100 mil. to get

to breakeven, versus less than $25 mil. for a Discovery spinoff. Additionally, an

independently owned network would have a hard time getting the attention of

cable and satellite operators, as it wouldn’t have the brand-name panache of a

Discovery or MTV Networks...[T]he economics [is] so different between analog

and digital networks and between independent networks and those owned by

media conglomerates....36

It is noteworthy that this consolidation results in economies of scale and scope that

lower costs, which benefit consumers to the extent those reductions are passed

33

“Cable Network TV Household Penetration,” Kagan World Media, Economics of Basic

Cable Networks 2003, September 2002, at pp. 36-37.

34

Kagan World Media, Economics of Basic Cable Networks 2003, September 2002, at p.

9.

35

36

Id., at pp. 12-13.

Kagan Media World, Benchmarking Cable Network Financial Statistics 2002, July 2002,

at p. 5.

CRS-13

through as lower consumer rates, but at least partially at the expense of program

diversity, as a major source of costs savings for Discovery and its counterparts is to

recycle old programming on their new cable channels.

One observer has raised another market-driven dynamic – to bypass existing

bottlenecks to technological advancement – that may at least be motivating the

proposed News Corp.-DirecTV merger. In his testimony at the June 18, 2003 Senate

Judiciary Committee hearing, Scott Cleland, CEO of Precursor Group, stated that the

combination of News Corp.’s content with DirecTV’s DBS distribution platform

would allow News Corp. to become “a fully digital distributor, legally bypassing the

snail-pace, snake-bit, all-cost-little-gain, migration of over-the-air broadcast analog

businesses to HDTV.” He also stated the merger would allow “more of Fox’s

programming to be transmitted over the more secure and controlled DBS distribution

platform and less over the over-the-air broadcast platform, which is increasingly

vulnerable to piracy from Napster-like file-sharing and to pricing pressure from adzapping via TIVO-like technology.”

Consolidation Also Could Be Used for Strategic Purposes

That Harm Consumers

In addition to these incentives to consolidate to exploit production and

marketing economies and efficiencies that may benefit consumers, individual

companies may have incentives to expand vertically or horizontally to extend market

power in a fashion that does not benefit, and indeed may harm, consumers. These

opportunities typically arise when a company has some market power that conveys

to it the ability to dictate the terms, conditions, and/or rates at which it either buys or

sells (or refuses to buy or sell) its services or products because it enjoys a superior

market position.37 One potential source of market power is control over highly

sought after programming. Another potential source of market power is control over

scarce spectrum, such as broadcast spectrum.

When a company possesses market power that yields a superior negotiating

position, that does not, by itself, mean that consumers will be harmed. For example,

a company with popular programming might elect to follow a strategy of making its

programming available at a low price in order to garner as wide an audience as

possible and using the strength from its programming to enforce low retail rates. One

might imagine, for example, the producer of children’s movies setting and enforcing

such low rates for video cassettes.

There are situations, however, where a company has both the incentive and the

ability to use its market power in a monopolistic fashion that harms consumers. For

example, if a company has the ability to increase short term or long term profits by

tying the sales of its highly-demanded programming to purchases of its lightly-

37

For example, in his testimony before the Senate Judiciary Committee Antitrust

Subcommittee, Scott Cleland, CEO of the Precursor Group, identified one motivation for

News Corp.’s proposed merger with DirecTV to be “Un-leveraged to Leveraged

Distribution: NewsCorp understands that negotiating leverage increases dramatically with

other programmers, if you are also a major distributor.”

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demanded programming, and in so doing consumers do not get their preferred

programming or are forced to pay excessively for programming, then there will be

consumer harm. There have been a number of allegations that some of the large

integrated media companies are doing this. For example, in his testimony at the May

6, 2003 Senate Commerce Committee hearing, James M. Gleason, chairman of the

American Cable Association, stated:

Obviously, some of our customers want ESPN or Fox Sports. But ABC-Disney

and Fox/News Corp. will not let us buy ESPN or Fox Sports. Oftentimes, in

order to get the local ABC or Fox affiliate, Disney and Fox will force us through

retransmission consent to take and pay for other channels we know our

customers don’t want. This abuse of retransmission consent goes further – in

order to get consent to carry a local broadcast station in one market, our members

are forced to carry Disney or Fox’s satellite programming in other markets,

where Disney or Fox do not even own the broadcast station. For example, is it

really in the public interest for all of my customers to pay for recycled soap

operas, a programming for which most of them have absolutely no interest, just

so some of my customers can be permitted to watch the ABC affiliate? Adding

to the absurdity of the situation, these conditions for carriage often outlive the

terms of the retransmission consent period for the local broadcast station by

many years. As a result, these mandated conditions clog a cable system’s

channel capacity ... while denying that capacity to independent ... programmers.

The end result is ... increased[d] costs and decrease[d] choice for consumers. It

gets worse. One solution might be to offer the expensive services in tiers or a la

carte. This would allow consumers to choose whether or not they wish to pay for

the expensive services. But all of the [integrated] programming companies force

their programming onto the lowest, basic levels of service, making our

companies and customers pay for all of their programming whether they want it

or not.

This reference to the retransmission consent requirements provides an example

of how consolidation can affect the impact of existing rules on firms’ negotiating

positions and acquisition decisions. In the early 1990s, in response to the general

concerns of all local broadcast stations that they should be able to control how their

programming is used by other parties, and to the specific concerns of the smaller

broadcast stations that they would be placed at a competitive disadvantage if the local

cable monopoly did not carry their signals, Congress enacted copyright and cable

statutes allowing each broadcast station to choose between allowing local cable

systems within its service area to carry its signal, with no compensation, under a

“must carry” obligation, and negotiating with the local cable systems compensation

for carrying its signal, under a “retransmission consent” agreement.38 If no agreement

is reached, the cable system is not allowed to carry the broadcaster’s signal.

The retransmission consent requirement subsequently was extended to direct

broadcast satellite companies. The law denies the FCC the ability to regulate the

terms, conditions, and agreements of those retransmission consent agreements,

beyond a good faith negotiations standard and a prohibition on providing any pipeline

exclusive retransmission consent. Thus, there are no restrictions against a vertically

38

The Cable Television Consumer Protection and Competition Act of 1992, Pub. L. No.

102-385, 106 Stat. 1460, codified at 47 U.S.C. § 521 et seq.

CRS-15

integrated company with broadcast stations and cable networks requiring local cable

companies that seek to retransmit the company’s local broadcast signals also to carry

the company’s cable networks. Subsequent vertical integration has rewarded local

broadcast station owners with the ability to tie retransmission consent to carriage of

multiple cable channels owned by their parent company, a result that probably had

not been contemplated when the rules were established.

There is another powerful market dynamic driving consolidation. Mergers often

upset existing equilibrium among market participants and therefore foster additional

mergers. Thus, for example, in his testimony at the June 18, 2003 Senate Judiciary

Committee hearing, Robert Miron, chairman and CEO of Advance/Newhouse

Communications, stated that the relative equilibrium between the large programming

conglomerates and the large MSOs would be broken if News Corp. were to acquire

DirecTV, since it would give News Corp. unique access to a multi-channel pipeline

to end users that it could use as leverage when negotiating with MSOs. That is, it

could take a very tough stance when negotiating the terms, conditions, and rates at

which it would make its popular cable or broadcast network programming available

to MSOs, knowing that it could always provide the programming to end users over

its satellite system. According to Mr. Miron, this market advantage likely would

trigger an attempt by another large programming conglomerate to purchase the only

other DBS system, EchoStar, in order to obtain the same market leverage. More

generically, mergers create the need for other companies to respond in kind in order

to protect their negotiating leverage. It is therefore possible that the effect of an

individual merger on consumers, in isolation, may be positive or neutral, but that

merger could start a chain reaction of mergers that would, in aggregate, harm

consumers. No firm wants to be party to the merger that breaks the camel’s back and

elicits government rejection, however, and therefore each firm will have the incentive

to respond quickly to other mergers.

Some Fundamental Questions Remain Unanswered

Although there has been a lot of heated debate over the impact of media

consolidation, many fundamental factual and analytical questions about the dynamics

in the video programming industry remain unanswered.

!

Most observers acknowledge that the high profits from successful

programs are needed to fund other programs, since much

programming does not generate enough revenues to cover all costs.

No systematic analysis has been performed, however, to determine

whether a consolidated market structure is required to generate the

cash flow needed to produce additional popular and innovative

programming. Similarly, no systematic analysis has been performed

to determine the extent that the extremely high economic rents that

currently accrue to key talent behind popular programming fosters

the production of additional popular and innovative programming –

or whether a consolidated market structure fosters those high

economic rents.

CRS-16

!

Prices for basic cable service continue to increase at a significantly

faster rate than inflation,39 but to date no systematic analysis has

been conducted to determine the extent to which those price

increases are attributable to heavy infrastructure investment and real

increases in programming costs that have been attenuated by

efficiencies gained from consolidation vs. the extent they are

attributable to vertically integrated cable networks with successful

programming and large multi-system operators of local cable system

monopolies using their market power to maintain above-cost rates.

!

In the debate about whether to allow broadcast networks to own and

operate local television stations whose signals reach more than 35

percent of total U.S. television households, one still unanswered

underlying economic question of interest to policy makers is why

ownership of these additional local stations would be more valuable

to the acquiring broadcast network than they are to the current

owner. (If they weren’t more valuable to the network, no sale would

take place.) One possibility is that the network would be able to

exploit scale or scope economies that would not be available to the

current owner and these economies would be passed through to end

users, perhaps by providing additional cash for the network to use to

bid successfully on sports programming highly valued by viewers.

Another possibility is that, unlike the current owner, the broadcast

network also own cable networks, and when negotiating a

retransmission consent agreement with a local cable system it could

not only demand a certain price for retransmission of its local

broadcast signal but also could insist that the local cable system

carry all of its cable networks and that the parent MSO carry all of

its cable networks in markets where it did not have a local broadcast

station. If the programming on these tied cable networks are less

highly demanded by the MSO’s subscribers than the programming

that would otherwise be carried, the broadcaster’s acquisition of the

independent broadcast station would harm consumers.

!

Both the broadcast networks that sought to increase the 35 percent

cap and the local television stations owners who opposed lifting the

cap agreed that local television stations are highly profitable.40

Viacom President Mel Karmazin argued that broadcast networks are

not as profitable as stations and, as a result, the networks need to

39

According to the FCC’s Report on Cable Industry Prices released July 8, 2003, the

average monthly rate for cable service increased by 8.2% over the 12-month period ending

July 1, 2002. During that same period, the consumer price index increased just 1.5%.

40

For example, at the May 13, 2003 Senate Commerce Committee Hearing on Media

Ownership, Mel Karmazin, president and chief operating officer of Viacom Inc., and Jim

Goodmon, president and chief executive officer of Capitol Broadcasting Company, agreed

that local television stations are highly profitable, with profits in the range of 30 to 50

percent. They did not specify, however, whether local television stations in small markets

are profitable.

CRS-17

own additional local stations that generate profits in order to be able

to bid successfully against cable networks for sports events.

Without the additional funding from profitable owned and operated

stations, he claimed that sports events would end up going by default

to cable networks and thus not be available to households that

cannot afford to pay for their television programming. The local

affiliates and their broadcast networks share the need for good

network programming and the desire for the network to be able to

bid successfully. Yet the affiliates oppose allowing the network to

acquire additional local stations that might help the broadcast

networks accomplish this. An alternate way for the broadcast

networks to obtain the funds needed to compete for sports

programming is to reduce the compensation they currently pay to

their affiliates (or, in the extreme, to require the affiliates to pay

compensation to them). Affiliates oppose this as well. Given that

affiliates do have options available to them, albeit distasteful ones,

some observers have questions whether there is a public interest

reason – prospects of greater diversity, more local programming, or

lower rates for consumers – for government intervention into the

network-affiliate relationship.

Public Policy Issues

The various rules in place today were adopted to foster diversity of voices,

localism, and competition in an environment of technology-constrained availability

of broadcast spectrum. Primarily, they impose horizontal ownership limits on

entities. The one set of federal rules that explicitly addressed vertical integration –

the financial interest and syndication rules – was repealed in the early 1990s.41

The continued high profitability of local broadcast stations42 and the prices local

broadcast stations fetch in the marketplace,43 indicate that broadcast television

spectrum remains scarce, and that those entities that control it (especially in large

markets) enjoy market power, even as technological alternatives now exist that

provide consumers with many new options. At the same time, there are strong

market dynamics pushing toward consolidation – both vertical and horizontal

integration. Some of those forces involve drives toward efficiency that should

41

Evaluation of the Syndication and Financial Interest Rules, 8 FCC Rcd 3282 (1993) and

Review of the Syndication and Financial Interest Rules, 10 FCC Rcd 12165 ¶ 21 (1995).

42

Data from the National Association of Broadcasters, Television Financial Report, 2001

edition, at pp. 2-3, show the profits and cash flow of commercial television stations were

positive for every market size in 2000, and were especially robust for stations in large

markets. This is consistent with the testimony of Mel Karmazin, president and CEO of

Viacom, Inc., and Jim Goodmon, president and CEO of Capital Broadcasting Company,

Inc., at the May 13, 2003 Senate Commerce Committee hearing, that local stations in

medium and large markets enjoy profits in the range of 20 to 50 percent.

43

See, for example, John M. Higgins, “Big Four Look Small in the Margin Column,”

Broadcasting & Cable, June 20, 2003, at pp. 1, 3.

CRS-18

benefit consumers, some involve drives toward maximum exploitation of pockets of

market power that would harm consumers.

Given these market forces and the relative absence of vertical ownership

restrictions or ownership restrictions across the old (broadcast) and new (cable and

satellite) technologies, a few big media players have come to control a significant

percentage of both programming and distribution. A question now facing policy

makers is: Could or should new rules be formulated that would better safeguard the

goals of diversity of voices, localism, and competition?

Consolidation in the video programming industry unquestionably has generated

one type of diversity – in the scope of proposals for government action (or inaction)

in the video programming market. The debate focused initially on structural rules

because those dominate under the current regulatory scheme and have been the focus

of scrutiny in the FCC’s biennial review. But a number of parties have proposed the

imposition of conduct rules. And some parties propose leaving things entirely to the

market.

Station Ownership Rules

Ownership rules can cover a range of parameters depending on the policy goal

they are intended to foster. If the focus is on diversity of voices, ownership rules are

most likely to focus on maintaining the number of independent stations or voices.

If the focus is on competition, ownership rules are most likely to focus on some

measure of the market share or market power of entities. If the focus is on localism,

ownership rules are most likely to focus on some measure of ownership ties to the

local community. Of course, the number of stations owned by an entity also will

affect competition, and an entity that captures the largest share of the market will in

effect have the loudest voice in the market. The existing FCC rules sometimes

incorporate two or more parameters in a single rule. For example, the local television

multiple ownership rules restrict the total number of television stations an entity can

own in a market and allows only one of the stations to be among the top four in

ratings at time of purchase.

The existing local television ownership, local radio ownership, and cross

ownership rules address horizontal markets.44 Because they involve a mechanical

counting of television stations, radio stations, or newspapers (except for the “only

one in the top four” requirement in the television ownership rule), they do not give

weight to the size of the firm under scrutiny or to any market power it may have in

that market or in upstream or downstream markets.

During the most recent FCC biennial review process, Chairman Michael Powell

stated that he wanted to develop a “diversity index,” in some way analogous to the

Herfindahl-Hirschmann Index employed at the Department of Justice and Federal

Trade Commission to make preliminary judgments about whether proposed mergers

44

The national television ownership rule has a vertical element to it, in that its intent is to

limit entities’ ownership of local broadcast stations in order to limit the leverage of

broadcast television network when negotiating with non-owned affiliate stations.

CRS-19

required additional antitrust scrutiny, that could be applied to individual media

mergers.45 Although there was no public articulation of the diversity index, it was

suggested that the diversity index would take into account, for example, whether the

acquiring entity were an independent company or a vertically integrated media giant

with cable network and other programming interests. Critics of such an approach

claimed that any measure of diversity was inherently subjective and application of

a diversity index analysis to proposed mergers would increase uncertainty and

discourage mergers that might be beneficial. Ultimately, the FCC chose only to use

a diversity index for setting the restrictions in the rules, and explicitly refused to

apply its diversity index to individual mergers. Moreover, its diversity index did not

take into account the market share or market power of individual media outlets, but

rather gave the same weight to each television station, the same weight to each

newspaper, etc.

The only FCC rule designed, at least in part, to address the issue of concentrated

ownership of both video programming and distribution is the National Television

Ownership Rule, but that rule only addresses broadcast television, not cable or

satellite television.

Programming Ownership Rules

Although there are more pipelines into the home and more distribution networks

today than in the past, a few big media players control a large portion of both

programming and distribution. This has raised concerns in some quarters that such

vertical consolidation could threaten the diversity of voices, localism, or competition.

The Coalition for Program Diversity, an umbrella organization that includes Wolf

Films, Sony, Carsey-Werner-Mandalbach, the Directors Guild of America, the Screen

Actors Guild, and AFTRA, has proposed that the FCC adopt a rule that would require

the four major broadcast television networks to purchase 25 percent of their primetime programming from independent producers, which would include any studio or

production company not affiliated with a major network. The intent of the proposed

rule, which is derivative of the FCC’s old financial interest rule, is to increase

program diversity.

The Coalition members, representing writers, producers, and other creative

talent, claim that – with consolidation – decisions about airing programs are made by

a single organization or person, and once a decision is made not to include a show

in the network schedule there is a significantly lessened ability to shop the show

around to other networks or pipelines. They allege that this has reduced the amount

of innovative programming aired and fostered copy-cat programming.

Programming ownership rules do not directly address the three U.S.

telecommunications policy goals of diversity of voices, localism, and competition.

Diversity of voices has traditionally referred to news and informational voices, rather

than entertainment voices. Television broadcasters – networks and stations alike –

have always produced their own news programming. For the most part, that function

45

See Bill McConnell, “The Cap as Hot Potato,” Broadcasting & Cable, March 10, 2003,

at p. 1.

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has not been left to independent producers. The networks do not produce local news

or entertainment programs and thus network vs. independent ownership of

production studios does not affect localism. Although repeal of the fin-syn rules

opened up the gates for significant vertical integration and the loss of many

independent program producers, to the extent consolidation was driven by market

forces to reduce risk and gain marketing efficiencies consumers have arguably

benefitted. The majority of complaints about abuse of market power – as opposed

to complaints about relative negotiating power – involve tie-ins made possible by

consolidation that crosses technologies, from broadcast to cable or satellite, or vice

versa. By contrast, the programming ownership rules proposed to date all are limited

to broadcast programming.

From a public policy perspective, an examination of programming ownership

rules might hinge on whether it can be demonstrated that vertical integration

somehow gives the consolidated entity the ability to command higher profits from

its successful programming but does not foster the production of more, or more

innovative (and, hence, risky) programming for consumers – and whether it also can

be demonstrated that such additional programming would be forthcoming with

programming ownership restrictions. Neither the FCC nor any other party has

performed such analysis. Nor has anybody performed analysis to determine how

consolidation across the broadcast, cable, and satellite technologies will effect the

relationship between high profits (and economic rents) for successful programming

and the supply and diversity of programming.

Non-Discriminatory Access to Programming

Most of the programming provided by the large vertically integrated cable

networks is distributed to cable systems via satellite. This programming is known

as “satellite cable programming” or (if the original programming is from a distant

broadcast station, such as the Turner “Superstation”) “satellite broadcast

programming.” The FCC has adopted program access rules designed to increase

access to video programming for all providers of multichannel video programming

by prohibiting unfair or discriminatory practices in the sale of satellite cable

programming and satellite broadcast programming distributed by a cable network

programmer (a cable network) that is vertically integrated with a cable system. The

rules prohibit unfair and discriminatory practices in the sale of satellite cable and

satellite broadcast programming and prohibit or limit the types of exclusive

programming contracts that may be entered into between cable operators and

vertically-integrated programming vendors.

The FCC program access rules do not cover all situations. For example, they

do not cover cable or broadcast programming that is distributed over terrestrial

wireline (landline) facilities rather than satellite. Also, they do not apply to cable

networks that are vertically integrated but where that integration is with a satellite

system serving end users rather than a cable system serving end users.46 Nor do they

46

In its application for approval to merge with DirecTV, News Corp., which is a

large programmer with many cable networks, agreed to abide by these rules, even

(continued...)

CRS-21

apply to local broadcast signals, which are subject to the retransmission consent

rules.

Where program access rules are in effect, they eliminate one potential harmful

impact of vertical integration – a vertically integrated company with “must have”

programming refusing to make that programming available to companies that

compete with its multi-channel program distribution (cable or satellite) unit, or

making that programming available in a discriminatory fashion at inferior terms,

conditions, or rates.

But program access rules do not protect against the vertically integrated

company making its “must have” programming available at very high rates that raise

the costs to both its own satellite or cable system and also to all other satellite and

cable systems. These high rates are a “wash” to the vertically integrated company –

the higher costs to its satellite or cable system are matched dollar for dollar by the

higher revenues for its cable network. But the higher rates represent real costs for the

competitive satellite or cable system. This can raise rivals’ costs in an

anticompetitive fashion.47

Equally important for consumer welfare, program access requirements do not

restrict vertically integrated cable networks with market power from raising rates to

all cable and satellite systems, thereby forcing them to raise rates to consumers. To

the extent consolidation strengthens firms’ market power and ability to raise prices,

program access rules do not protect against those higher rates. But any harm to

consumers will be ameliorated to the extent these higher rates generate revenues that

are used by the integrated entities to produce more, and more innovative,

programming.

Retransmission Consent

The bulk of the complaints raised by small competitors against large vertically

integrated video companies have been about the ability of the latter to tie the

purchase of “must have” programming to the purchase of less desirable

programming. As discussed above, one frequently cited mode for accomplishing this

has been the practice of integrated companies with local broadcast stations and cable

networks tying retransmission consent for the broadcast signal to carriage of an entire

suite of cable networks. It has been alleged that these tie-ins sometimes extend

beyond carriage on the local cable system to requiring multi-system operators to carry

the suite of cable networks on all their cable systems and/or for time periods that

extend far beyond the period covered by the retransmission consent. Such tie ins can

46

(...continued)

though they formally apply only to cable networks affiliated with cable systems, not

those affiliated with satellite systems.

47

See, e.g., William P. Rogerson, “An Economic Analysis of the Competitive Effects of

the Takeover of DirecTV by News Corp.,” filed in FCC Docket MB Docket No. 03-124, “In

the Matter of: General Motors Corporation, Hughes Electronics Corporation, and the News

Corporation Limited Application to Transfer Control of FCC Authorizations and Licenses

Held by Hughes Electronic Corporation to the News Corporation Ltd.”

CRS-22

result in cable system operators providing programming their customers do not prefer

or passing through high programming charges to customers.

The current law does not authorize the FCC to regulate the terms, conditions,

and agreements of those retransmission consent agreements, beyond imposing a good

faith negotiations standard and a prohibition on providing any pipeline exclusive

retransmission consent. If Congress chooses to restrict the ability of vertically

integrated local broadcast television licensees from tying retransmission consent to

carriage of non-broadcast programming, it would have to change current law.

A La Carte

Most cable television networks, especially those supported in part by advertising

revenues, are available to subscribers only as part of large packages of networks.

Proposals have been put forward to require local cable systems to make cable

networks available to subscribers on an a la carte basis that allows customers to

choose, and pay for, individual cable networks. These proposals have been

controversial. As discussed below, there could be both benefits and harms to

consumers if an a la carte option were mandatory.

When large media companies with multiple cable networks require local cable

system operators to purchase packages of their cable networks and/or local cable

system operators require subscribers to purchase packages of cable networks, without

an option for the purchase of individual cable networks, some purchasers will be

forced to buy more programming than they want, and perhaps at an outlay that is

greater than they would make if allowed to purchase individual networks.48 Thus,

some purchasers are worse off when forced to purchase packages than they would be

if they could purchase individual channels.

At both the Senate Commerce Committee hearing on June 4, 2003, and the

Senate Judiciary Committee hearing on June 18, 2003, Senators asked panelists their

opinions about a rule that would require large media companies that own multiple

cable networks to make their networks available to local cable systems and satellite

systems on an a la carte basis and that would require the local cable systems and

satellite systems to make those cable networks available to consumers on an a la carte

basis. The large media companies and local cable system operators could continue

to offer packages of cable networks, but would have to make the a la carte option

available. The purpose of such a rule would be twofold: to allow cable and satellite

systems to carry the programming that they think their customers prefer, without

being forced to carry less preferred programming, and to allow end user customers

to choose the programming that they prefer and not have to pay for other

programming.

Proponents of such a rule have expressed concern that absent such a rule the

large media companies could use their market power from control over “must have”

48

For most consumers, the local cable system is owned by one of the large multi-system

operators (MSOs) and the packaging decision is made at the MSO level, not at the local

level.

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programming to force cable and satellite systems to carry less popular affiliated

programming at the expense of both consumer preferences and independent

programmers. They also have expressed concern that absent such a rule consumers,

especially low income consumers, are forced to pay much higher prices for basic

cable service because the basic service package includes high-cost sports

programming that they do not care to receive. An a la carte requirement could

restrict large media companies from imposing tie-in arrangements on cable and

satellite systems (by not allowing the media companies to condition access to one

cable network on the carriage of other cable networks) and also might allow end

users to select only the programming they prefer.49

An a la carte rule also might constrain the rents that athletes, performers, and

producers earn – and that raise the costs (and prices) of such programming – if

substantial numbers of subscribers with low intensities of demand for the sports or

entertainment programming choose a la carte options that do not include the highcost programming. As described earlier, sports programming is highly valued by a

small portion of cable subscribers, but currently such programming often is funded

by imposing higher rates on all subscribers to enhanced basic service. If that

programming had to be supported only by subscribers with high intensity of demand,

either those subscribers would have to pay more, or the talent producing that

programming would have to accept lower rents.

But an a la carte requirement also could have some effects that would harm

consumers. Packaged service offerings make it less risky for a cable or satellite

system to introduce a new cable network. With a package, the new cable network

does not sink or swim based on its immediate audience reception. Rather, the system

owner can allow the new cable network to acquire an audience by having viewers

accidentally tune in to the network. By contrast, under a la carte, viewers must make

the up-front decision to pay for a new cable network, perhaps without having had the

opportunity to see any of its programming in advance.

Similarly, with a packaged offering, the local cable system operator can

efficiently market new networks by advertising the new networks on their existing

networks. This marketing strategy is less efficient if, as in an a la carte environment,

many of the viewers receiving the marketing messages on the existing networks are

not subscribed to the new network and therefore cannot easily check out that network

in response to the marketing message.

Also, the availability of a large package of networks will increase overall

audience size because at any particular time viewers who pay a la carte may not have

any programming they choose to view on the channels they have paid for and

therefore might turn off the television altogether, but if they had access to the basic

49

Of course, local cable system operators would select an a la carte option from the large

media companies, and subscribers would select an a la carte option from their local cable

system operators, only if the price of the a la carte option relative to the price of the

enhanced basic service package option was favorable. For example, if the per network a la

carte price were $10.00 per month and the price for an 80-channel enhanced basic service

package were $35.00, then only those customers with very narrow video tastes that are

satisfied by three networks would select the a la carte option.

CRS-24

enhanced service package they might find programming they enjoy when surfing all

the channels offered in the package.

As a result of these lost efficiencies, it is possible that the sum of the individual

prices for each network that a typical household subscribes to in an a la carte

environment could be higher than the single price for a basic package. At the same

time, the choices available to consumers could be reduced both because they would

only have available to them the networks they paid for and because there are likely

to be fewer new networks because of the higher risk associated with an network

launch when many subscribers make a la carte network purchases.

The extent to which these potentially harmful effects of an a la carte requirement

will actually occur will depend on the proportion of subscribers that choose the a la

carte option vs. the enhanced basic service package. If the a la carte option is chosen

only by a very small portion of subscribers with narrow video tastes that can be met

by a limited number of networks, it may only create a very weak disincentive for new

network launches. But if the a la carte option is widely selected, the disincentive

could be substantial.

Some Nielsen Media Research data presented by the Television Bureau of

Advertising50 indirectly shed light on this. Nielsen asked the question, “As the

number of channels available to a TV household increases, as it has in recent years,

what is the effect on the number of channels actually viewed?” It found that “... after

reaching the 50-channel level, additional channels produce no significant increase in

the number of viewed channels. The viewing remains in the 15- to 19-channel range.

Even the 121+ channel group averages only 17.9 viewed channels out of an average

of 195 available channels.” These data are only for a single week of viewing. It is

possible that over a longer period of time subscribers view far more channels. But

the data suggest that many subscribers do not seek the great diversity of networks

provided by enhanced basic service offerings and, if a la carte pricing were not set

in a way that made the package preferable even when subscribers only sought a

handful of networks, there could be substantial migration to a la carte purchasing,

which could discourage new network launches.

Programming Requirements

At the June 4, 2003 Senate Commerce Committee hearing, in a free-wheeling

discussion of how to ensure localism and diversity of voices, one approach

mentioned in passing was to return to the old requirement, dating from the 1970s, for

each station to provide some minimum amount of local programming (perhaps more

narrowly couched as local news and informational programming). This approach has

the advantage of ensuring a certain level and diversity of such programming. It

addresses concerns about the many broadcast television stations that are no longer

50

“TV Basics: Channels – Received vs. Viewed,” Television Bureau of Advertising,

[http://www.tvb.org/rcentral/mediatrendstrack/tvbasics/10_Channels-RecVsViewed.asp],

citing Nielsen Media Research, National People Meter Sample, Aug. 20-26, 2001, viewed

on July 15, 2003.

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locally owned and operated, and about stations getting feeds from distant locations

that purport to be local but are not.51

It is not clear what the impact of such a rule would have in the marketplace. On

one hand, in large and middle-sized markets, local broadcast television news

programming tends to be very profitable and will be offered with or without the rule.

On the other hand, in small markets, where local stations may not have the financial

wherewithal to produce local news programming, such a requirement could drive

stations out of business or could foster further consolidation with a newspaper or

with a larger television group, which could have the consequence of lessening the

diversity of voices.

Fairness Doctrine

Some observers also have suggested that the Fairness Doctrine be re-imposed.

That requirement, which was repealed in the mid-1980s,52 required broadcasters to

cover issues of public importance and also to provide “balanced” coverage of such

issues. The Commission repealed it because it tended to have an unintended effect.

In order to avoid the costs and bad publicity associated with a Fairness Doctrine

complaint, broadcasters simply shied away from controversial topics when covering

issues of public importance. Thus, rather than fostering public debate, the rule

tended to impede it.

The dynamic forces at play today in the video programming industry as a result

of technological change will continue to play out and foster further market

consolidation. That consolidation may or may not prove to be consistent with the

U.S. telecommunications policy goals of competition, diversity, and localism. As a

result, Congress is likely to continue to face important policy issues relating to the

video programming industry.

51

This concern was raised during the Senate Commerce Committee markup of S. 1264, the

FCC Reauthorization Act of 2003, on June 26, 2003.

52

Syracuse Peace Council,2 FCC Rcd 5043. This decision was based in large part on a

Commission study, known as the “1985 Fairness Report, of the impact of the fairness

doctrine on broadcast practices. See 102 FCC 2d 145 (1985).