Report No. 2568 EXECUTIVE SUMMARY February 22, 1994 IMPLEMENTATION OF SECTIONS OF THE CABLE TELEVISION CONSUMER PROTECTION AND COMPETITION ACT OF 1992; REPORT AND ORDER AND FURTHER NOTICE OF PROPOSED RULEMAKING (MM DOCKET NO. 92-266) The Commission today adopted a Second Order on Reconsideration, Fourth Report and Order, and Fifth Notice of Proposed Rulemaking in MM Docket 92-266, Implementation of the Rate Regulation Provisions of the Cable Act of 1992. The Second Order on Reconsideration modifies, among other things, the Commission's previous benchmark approach for determining initial rates of regulated cable systems. The Commission's revised rules will better ensure that consumers are offered regulated services at reasonable rates, and will provide incentives for cable operators to launch new program services and invest in advanced technology. The modified rate regulations will apply to regulated rates in effect on and after the effective date of the new rules; regulated rates in effect before that date will continue to be governed by the old benchmark system. The Revised Competitive Differential The Commission's revised competitive differential is based on a strengthening of its statistical and economic model for estimating the difference between rates charged by noncompetitive systems and systems subject to "effective competition," as that term is defined in the 1992 Cable Act. The Commission's model is based on a survey of industry rates conducted by Commission staff in the winter of 1992. The competitive differential represents the Commission's best determination of the average amount by which the rates charged by a cable operator not subject to effective competition exceed "reasonable" rates. In response to comments made by petitioners on reconsideration, and upon further analysis by the staff, the Commission significantly improved its statistical analysis of the 1992 survey results. This effort has resulted in a revised benchmark formula that is both more accurate and more sophisticated. The revised benchmark formula will be used to help estimate the competitive differential and to determine which noncompetitive systems are covered by the phased implementation program described above. (over) - 2 - In addition, the Commission revised its economic analysis to better evaluate the record evidence concerning the rates charged by the three types of systems Congress deemed subject to effective competition (i.e., systems with penetration rates of less than 30 percent, systems that face actual competition, and systems operated by municipalities). In the Rate Order adopted in this docket last April, the Commission computed the competitive differential by simply averaging the data for all of the systems that meet this statutory definition. On reconsideration, the Commission determined that the 1992 Cable Act required it to "take into account" the rates charged by the three different types of effectively competitive systems in determining reasonable rates, but did not require it to use the methodology adopted last spring. In addition, the Commission determined that its previous methodology understated the competitive diferential by weighing systems on the basis of the number of systems, rather than by evaluating which type of system best illustrates a competitive price. Under the revised approach for determining the competitive differential, the Commission computed, and considered, the competitive differential for each of the three types of systems deemed subject to effective competition. After analyzing the various characteristics of the three types of effectively competitive systems, and exercising its expertise and discretion, the Commission determined that the best estimate of the average competitive differential is 17 percent. The Commission will issue forms upon release of the Order for use in applying the revised competitive differential to rates of regulated cable systems. It also will help operators apply the revised benchmark formula by making Cable Service Bureau staff available to answer questions and by distribution of a computerized spread sheet. Further Competitive Rate Rollbacks Under the Commission's revised benchmark regulations, noncompetitive cable systems that have become subject to regulation will be required to set their rates at a level equal to their September 30, 1992 rates minus a revised competitive differential of 17 percent. Cable operators who seek to charge rates higher than those produced by applying the competitive differential may elect to invoke cost of service procedures the Commission also adopts today in a separate action. - 3 - Although all noncompetitive systems will potentially be subject to the new competitive differential, the Commission has adopted a phased implementation program which will give it more time to evaluate whether certain noncompetitive systems have lower than average competitive differentials. These systems include noncompetitive systems with relatively low prices (defined as systems whose rates would be below the benchmark after subtracting the 17 percent competitive differential from their September 30, 1992 rates or reducing their rates to the new benchmark level). The phased implementation program will also apply to systems owned by small operators (defined for this purpose as operators serving a total subscriber base of 15,000 or fewer subscribers and that are not owned or controlled by larger companies). While the Commission collects additional cost and price data about the low priced and small operator systems, such systems will not be required to reduce their regulated rates immediately by the full competitive differential. Rather, implementation of the full differential will be stayed pending completion of the Commission's cost inquiry. At the same time, to protect consumers while the cost studies are being conducted, a system subject to phased implementation will be required to calculate the extent to which its rate reduction falls short of 17 percent. This reduction "deficit" will then be offset against any inflation adjustment pending completion of the cost studies. The Price Cap Governing Cable Service Rates Calculation of External Costs. In addition to revising the benchmark formula and the competitive differential used in setting initial regulated cable rates, the Commission adopted rules to simplify the calculations used to adjust those rates for inflation and external costs in the future. Under current rules, operators may adjust their regulated rates annually by inflation and up to quarterly by the net change in external costs. Any change in external costs must also be measured against inflation and adjusted for the corrected inflation rate. To simplify these rate adjustments, the Commission has separated the inflation adjustment from the external cost adjustment. This refinement will reduce the administrative burden associated with seeking a rate increase. A form to be released with the Order will set forth the specific steps for making these calculations. Copyright and Pole Attachment Fees. The Commission also determined to treat increases in compulsory copyright fees incurred by carrying distant broadcast signals as external costs in a fashion parallel to increases in the contractual costs for nonbroadcast programming. The Commission will not, however, accord external cost treatment to pole attachment fees. (over) - 4 - "A La Carte" Packages The Commission also revised its regulatory treatment of packages of "a la carte" channels. In its April 1993 Rate Order, the Commission exempted from rate regulation the price of packages of "a la carte" channels if certain conditions were met. On reconsideration, however, the Commission determined that its rules governing the provision of "a la carte" channels in a package should be refined to better ensure that the marketing of channels in this fashion is designed to enhance subscriber choice rather than evade rate regulation. When assessing the appropriate regulatory treatment of "a la carte" packages, the Commission will consider certain factors, among other considerations, that would suggest that packages should not qualify for non-regulated treatment, including : whether the introduction of the package avoids a rate reduction that otherwise would have been required under the Commission's rules; whether an entire regulated tier has been eliminated and turned into an "a la carte" package; whether a significant number or percentage of the "a la carte" channels were removed from a regulated service tier; whether the package price is deeply discounted when compared to the price of an individual channel; and whether the subscriber must pay significant equipment or other charges to purchase an individual channel in the package. In addition, the Commission will consider factors that will reflect in favor of non regulated treatment such as whether the channels in the package have traditionally been offered on an "a la carte" basis or whether the subscriber is able to select the channels that comprise the "a la carte" package. " A la carte" packages which are found to evade rate regulation rather than enhance subscriber choice will be treated as regulated tiers, and operators engaging in such practices may be subject to forfeitures or other sanctions. This process will be conducted on a case-by-case basis. Small Systems The Commission also lifted the stay of rate regulation for small cable systems, which were defined as all systems serving 1,000 or fewer subscribers. Thus, as of the effective date of the Commission's new rules, noncompetitive, small systems will be subject to rate regulation. (The Commission will entertain requests for extensions of time to comply if operators of small systems meet certain showings requirements). To reduce the regulatory burdens, particularly the equipment cost calculations, that rate regulation imposes on small systems, the Commission also adopts two types of administrative relief for small systems. - 5 - First, the Commission suspended, pending development of average equipment cost schedules, the requirement for unbundling equipment and installation charges, and permitted a simple across- the-board reduction in each individual regulated rate separately billed by the operator. This relief allows operators of such systems to reduce their overall rates and the rate for each regulated component (programming or service) by the revised competitive differential, without the need to complete a Form 393 or to prepare a cost-of-service showing. This administrative relief is available to independently owned small systems and small systems owned by small operators. The Commission defined a small operator for purposes of obtaining administrative relief as an operator that has 250,000 or fewer total subscribers, owns only systems with fewer than 10,000 subscribers each, and has an average system size of 1,000 or fewer subscribers. Second, the Commission decided to permit larger operators of small systems to use the average equipment costs of its small systems in setting rates in individual franchise areas. The Commission defined a larger operator of small systems as one that owns more than one cable system, one of which has 1,000 or fewer subscribers, and is not a small operator as defined above. The Commission also determined that it would later provide additional administrative relief for small systems by developing an average equipment cost schedule that can be used by all small systems to unbundle their equipment and installation revenues and rates. The cost schedule will be based on industry-wide figures derived from the Commission's cost survey (to be conducted over the next twelve to eighteen months.) Such a schedule will ultimately be made available for use by all operators as part of the Commission's efforts to simplify its procedures. Adjustments to Capped Rates for Addition and Deletion of Channels In the Fourth Report and Order, the Commission also adopted a methodology for determining rates when channels are added to or deleted from regulated tiers. This methodology is similar to the third alternative proposed in the Third Further NPRM. In order to determine rates following the addition or deletion of channels, each operator, after applying the revised competitive differential, will adjust its per channel rates to reflect the proportionate decrease in per channel rates captured by the Commission's rate survey, based on the total number of regulated channels. Under this approach, cable system operators must pass on to subscribers the efficiencies and economies of scale that arise as operators add channels to their systems. (over) - 6 - The Commission also will treat programming costs as external costs, to be calculated under the methodology described in the Rate Order as modified by our Reconsideration Orders. Thus, operators may recover the full amount of programming expenses associated with added channels. This will help promote the growth and diversity of cable programming to the benefit of subscribers, cable operators, and programmers. Operators may also recover a mark-up on their programming expenses. The Commission stated that its methodology will provide a ready way for operators to determine rates when new programming services are added to regulated offerings and will not be unduly burdensome for subscribers, operators, and regulators. It is also fully consistent with the revised approach to setting initial regulated rates, can be used for deletions of channels and moving channels among regulated tiers as well as for channel additions, and protects subscribers on one tier from having their rates raised by changes on other tiers. Cable operators will use an FCC Form, to be released with the text of the Commission decision, to adjust capped rates when channels are added to or deleted from regulated tiers, and to make external cost and inflation adjustments. Adjusting Capped Rates for Cable Systems Carrying More Than 100 Channels Finally, in the Fifth Notice of Proposed Rulemaking, the Commission seeks comment on whether it should establish a benchmark methodology for adjusting capped rates when a cable system carries more than 100 regulated channels, and if so, what that methodology should be. Action by the Commission February 22, 1994, by Report and Order and Further Notice of Proposed Rulemaking (FCC 94-38). Chairman Hundt, Commissioners Quello and Barrett, with Commissioner Barrett issuing a statement. - FCC - News Media contacts: Karen Watson and Susan Sallet at (202) 632-5050. Cable Services Bureau contact: Patrick Donovan at (202) 416- 0856.