Before the FEDERAL COMMUNICATIONS COMMISSION FCC 94-286 Washington, D.C. 20554 In the Matter of ) ) Implementation of Sections of ) the Cable Television Consumer ) Protection and Competition ) MM Docket No. 92-266 Act of 1992: Rate Regulation ) Implementation of Sections of ) the Cable Television Consumer ) Protection and Competition ) MM Docket No. 93-215 Act of 1992: Rate Regulation ) SIXTH ORDER ON RECONSIDERATION, FIFTH REPORT AND ORDER, AND SEVENTH NOTICE OF PROPOSED RULEMAKING Adopted: November 10, 1994 ; Released: November 18, 1994 By the Commission: Commissioner Quello issuing a statement; Commissioner Barrett dissenting and issuing a statement; Commissioner Ness issuing a statement; Commissioner Chong dissenting in part and issuing a statement. Comment Date: January 13, 1995 Reply Comment Date: February 13, 1995 Table of Contents Paragraphs: I. Introduction 1 II. Executive Summary 2 III. New Product Tiers 16 IV. A La Carte Package Offerings 38 V. Adjustments to Capped Rates for Addition, Deletion, and Substitution of Channels on Cable Programming Services Tiers 54 1. Going Forward Price Cap Structure 66 2. Per Channel Adjustment Factor 72 3. Operator's Cap 76 4. License Fee Reserve 80 5. Programming Cost Increase Mark-Up 83 6. Deletion And Substitution of Channels 84 7. Headend Upgrades for Small Systems 87 8. Systems with More than 100 Channels 95 9. Term of the Revised Channel Addition Rules 98 VI. Negative Option Billing 99 VII. Affiliate Transactions 120 VIII. Seventh Notice of Proposed Rulemaking 132 IX. Regulatory Flexibility Act Analysis 135 X. Paperwork Reduction Act 147 XI. Procedural Provisions 148 XII. Ordering Clauses 150 Appendices I. Introduction 1. In 1992, Congress passed the Cable Television Consumer Protection and Competition Act ("1992 Cable Act") in large part to ensure that where competition for cable services is absent, cable rates will be regulated to protect the interests of consumers. Since the passage of the 1992 Cable Act, the Commission has adopted and implemented comprehensive rules governing cable rates. In February 1994, we adopted a further notice of proposed rulemaking to determine whether we should amend our rules to provide additional incentives for adding new programming services. In this Report and Order we modify our rules in order to provide cable operators with additional incentives to expand their facilities and services in a way that both ensures that cable rates are reasonable and expands the opportunities for cable programmers to reach viewers. These incentives will: (1) allow cable operators to offer new product tiers ("NPTs") to be priced as operators elect, provided certain limited conditions are met; (2) permit cable operators to add new channels at reasonable prices to existing cable programming services tiers ("CPSTs"); and (3) create an additional option pursuant to which small cable operators may add channels to CPSTs. In addition, we determine that a la carte packages are CPSTs and therefore subject to rate regulation. We also confirm that cable operators do not have to obtain the affirmative consent of subscribers before making rate adjustments so long as the changes are permitted under our rules and the fundamental nature of the affected tier is unaltered. Finally, we decide not to adopt our proposal modifying restrictions on transactions between cable operators and their affiliates; instead, we retain our existing cable affiliate transaction rule. II. Executive Summary 2. The 1992 Cable Act seeks to address problems that arise from the market power cable operators have over the distribution of video programming in virtually all geographic markets. That market power may allow the operator to limit access for programmers and to pay less than competitive prices for programming. The cable operator's market power also may allow the operator to restrict the supply of programming to consumers and to charge higher than competitive prices for programming. Thus, the Commission is concerned with the possible exercise of market power by operators in two markets: (1) the purchase of programming from programmers and (2) the sale of services to subscribers. 3. Under the 1992 Cable Act, we must reconcile and accomplish the goals of ensuring that cable rates are reasonable, while expanding opportunities for cable programmers to reach viewers. These goals must be pursued with regard to current unused channel capacity and with regard to capacity that may be added by operators in the future. We are convinced that our current rules, which permit operators to increase rates to reflect costs associated with adding channels and to obtain a 7.5% mark-up on new programming costs, by themselves do not create a sufficient incentive for most operators to provide subscribers with additional channels from either unused or new capacity. The Commission recognizes that under current industry practices, new programming typically must be offered in packages or bundles if it is to obtain sufficiently high subscription rates to be commercially successful. Therefore, this new programming must be added to a cable operator's basic service tier ("BST"), to a CPST or offered in a new package. However, in developing additional incentives for adding channels to a cable operator's offerings, we are mindful that consumers are entitled to reasonable prices for basic and cable programming services, set pursuant to the 1992 Cable Act. 4. New Product Tiers. To accommodate the introduction of new packages of channels, we will permit cable operators to offer a new type of CPST called an NPT. Operators are permitted to price these NPTs as they elect. The Commission has determined that NPTs and current CPSTs will compete with each other, ensuring that the price for NPTs will not be unreasonable. As explained more fully in this Report and Order, the conditions for offering NPTs are: (1) cable operators must continue to offer their current BSTs and CPSTs at prices set by regulations we established previously; (2) cable operators may not weaken the status of current tiers as reasonably priced competitive alternatives to NPTs by removing channels from existing tiers and offering them on NPTs; (3) cable operators must continue to offer BSTs and current CPSTs in such a manner that subscribers should reasonably be aware that they may choose whether or not to subscribe to the NPT; and (4) a subscriber may not be charged for an NPT unless the cable operator has obtained the subscriber's affirmative consent. In addition, operators generally may not require consumers to subscribe to a CPST as a condition for subscribing to an NPT. Further, operators may not require subscription to an NPT as a condition for subscribing to a CPST. 5. Under these rules, operators may offer the same channel simultaneously on both a CPST and an NPT. This option gives the operator greater flexibility to market NPTs so that they are more attractive to subscribers. Furthermore, operators may place new programming services on existing CPSTs and, at any time, move them to an NPT. In addition, operators may add a channel to an NPT that was previously on a BST or CPST, if the channel was dropped from the BST or CPST before September 30, 1994. For channels that were offered on a BST or CPST on September 30, 1994, operators may not drop any of those channels and move them to an NPT unless they wait a minimum of two years from the time the channel was dropped. 6. In short, our rules governing NPTs ensure that subscribers may choose to obtain additional programming at reasonable rates. In addition, our rules are clear and simple. Cable operators are not required to complete any forms or obtain any regulatory approval to offer NPTs, and they may set the price for the tier at the level they elect. 7. A La Carte Package Offerings. Under the 1992 Cable Act, video programming offered on a per channel or per program (a la carte) basis is not subject to rate regulation. The Commission has determined that some cable operators have evaded rate regulation by purporting to offer channels a la carte, when in fact the individual offerings were not a realistic service offering. This determination has lead the Commission to conclude, contrary to prior decisions, that a la carte packages are CPSTs within the meaning of Section 3(l)(2) of the 1992 Cable Act. As such, the packages are subject to rate regulations. Operators are free, however, to create packages of a la carte channels under our new rules governing NPTs. A la carte packages available on April 1, 1993 remain grandfathered. 8. Rate Adjustments for Channels Added to BSTs and CPSTs. The Commission's existing rate regulation rules permit operators to increase rates by a per channel amount when channels are added to BSTs and CPSTs, with the per channel amount decreasing as the number of channels on a system increases. These rules also permit operators to pass through to subscribers the costs of obtaining programming plus a 7.5% mark-up on new programming costs. The comments we have received in response to the Fifth Notice provide evidence that these existing rules may not provide sufficient incentives for systems with more than 12 current channels to add new channels (especially new channels with low license fees) to CPSTs. Because appropriate incentives for adding new channels serves the statutory goal of "promot[ing] the availability to the public of a diversity of views and information," we conclude that the rate regulations ought to be supplemented to incorporate a flat fee mark-up for adding new channels to a CPST. The revised regulations may be used to adjust rates after December 31, 1994, for channel additions occurring after May 14, 1994. 9. Operators electing to use the new rules will be allowed to take a per channel mark-up of up to 20 cents for each channel added to CPSTs. This 20 cents per channel adjustment represents the Commission's best estimate of the average amount by which operators in a competitive environment would adjust rates for the addition of a new channel, exclusive of programming costs. Operators may make rate adjustments under this rule at any time during the three-year period beginning on January 1, 1995. They may not make per channel adjustments to monthly rates totalling more than $1.20 per subscriber over the first two years of the three-year period for new channels added on CPSTs or by more than $1.40 over the full three-year period (the "Operator's Cap"). Operators may make the 20 cents per channel adjustment in the third year only for channels added in that year. Operators electing to use the per channel adjustment in the new rules may not take the 7.5% mark-up on programming cost increases for channels added after May 14, 1994. 10. The Operator's Cap is based on our observations of cable industry behavior prior to the 1992 Cable Act, adjusted for the lack of effective competition prevalent in the industry, so as to replicate a competitive market. The Commission believes the Operator's Cap will provide an adequate incentive to operators to add new services to CPSTs, while protecting subscriber interests by keeping overall regulated rates reasonable. 11. Operators may use any portion of the Operator's Cap to recover license fees associated with adding new channels to CPSTs. In addition, operators may recover an additional amount of not more than 30 cents per subscriber per month for license fees associated with adding new channels (the "License Fee Reserve") during the first and second years the Operator's Cap is in effect. The License Fee Reserve is necessary because, without one, operators might have incentives to add no-cost or low-cost channels to CPSTs. We believe our rate regulations should not distort market incentives for cable operators to add channels that subscribers are most likely to desire, whether high-cost or low-cost, and the License Fee Reserve seeks to accomplish this goal. In the third year, license fees will not be subject to special rules, but will be subject to our general rate rules. 12. Small System Relief. Our revised rules allow independent small systems and small systems owned by small multiple system operators to pass through to subscribers the costs of new headend equipment for adding not more than seven new channels to CPSTs over the next three years. The amount the qualifying small system may recover is limited to the actual cost of the headend equipment necessary to add a channel, not to exceed $5,000 per channel, plus the channel's licensing fee, if any. The cost of headend equipment must be amortized over the useful life of the equipment and operators will be allowed an 11.25% return on the undepreciated investment. Alternatively, small systems may use the current or revised channel addition rules that are available to all operators. 13. Negative Option Billing. We affirm that an operator's decision to add, delete or replace channels on any tier is outside the negative option billing prohibition of the 1992 Cable Act -- so that the cable operator does not have to obtain each subscriber's affirmative consent before making a change -- if the channel changes do not alter the fundamental nature of the tier. Specifically, we determine that the affirmative consent requirements of the 1992 Cable Act do not apply: (1) when a cable operator raises its rates as a result of passing through external costs or inflation adjustments under the Commission's rules or (2) when a cable operator changes its rates as a result of the addition, deletion or substitution of channels pursuant to the Commission's "going forward" regulations, unless there has been a change in the fundamental nature of a tier. We determine that the addition of a relatively few channels to a tier as is permitted by our revised channel addition rules will not, except in the case of an unusually small tier, change the fundamental nature of a tier, and accordingly does not require affirmative consent. We also determine that state or local consumer protection laws that conflict with or undermine the rate regulation rules established pursuant to Section 3 of the 1992 Cable Act may not be enforced. 14. Affiliate Transactions. We decline to adopt a proposal to limit the application of a prevailing company price as a measure of a reasonable price for an affiliate transaction. The proposal would have allowed the use of prevailing company prices only for affiliate transactions in which the affiliate sells at least 75% of its output to nonaffiliates. The record demonstrates that many programming services that have achieved widespread distribution among cable operators would be unable to establish a prevailing company price under the proposed rule because of their affiliations with multiple system operators. We believe it would not be in the public interest to bar such programmers from using their prevailing price because there is no basis in this record to conclude that cable operators are paying excessive amounts for assets or services from those unregulated affiliates. We will, therefore, retain our existing rule, which provides that an operator may value an asset or service at the prevailing company price if the affiliated provider has provided the same kind of asset or service to a substantial number of third parties. 15. 7.5% Markup on Increases in License Fees. We have decided not to allow operators using the per channel adjustment of up to 20 cents under our new rules to take the 7.5% mark-up on programming costs or cost increases for such channels. We also solicit comment on (1) whether operators electing to use the per channel adjustment under our new rules should be allowed to take the 7.5% mark-up on programming cost increases for channels added before May 15, 1994, and (2) whether operators electing to use the current going forward rules should be permitted to pass-through the 7.5% mark-up on new programming cost increases after the initial mark-up of programming costs of new channels. III. New Product Tiers A. Background 16. In developing our cable rate regulations, we are guided by the policy goals set forth by Congress in enacting the 1992 Cable Act. These goals are: (1) promote the availability to the public of a diversity of views and information through cable television and other video distribution media; (2) rely on the marketplace, to the maximum extent feasible, to achieve that availability; (3) ensure that cable operators, where economically justified, continue to expand their capacity and the programs offered over their systems; (4) where cable television systems are not subject to effective competition, ensure that consumer interests are protected in the receipt of cable service; and (5) ensure that cable television operators do not have undue market power vis-a-vis video programmers and consumers. 17. The 1992 Cable Act requires us to ensure that CPST rates are not unreasonable upon the receipt of a specific complaint. The Act requires the Commission to establish criteria for determining whether a rate is unreasonable after considering a number of factors, such as the rates of similar systems, the rates charged by cable operators that face competition, and the operator's costs and revenues. The 1992 Cable Act also permits the Commission to consider other relevant factors for determining what constitutes unreasonable rates for CPSTs. 18. In the Report and Order and Further Notice of Proposed Rulemaking in MM Docket No. 92-266 ("Rate Order"), we determined that, to comply with the statute, our standards for identifying unreasonable CPST rates must reflect a reasonable balancing of the statutory factors. In considering the factors, we decided to give primary weight to the rates of systems subject to effective competition. Accordingly, the benchmark formula we developed for the purpose of establishing initial rates for regulated cable services was based on a comparison of rates for cable systems in competitive markets with a random sample of systems that did not face effective competition. Using econometric techniques, we established a "competitive differential" by estimating the difference between competitive and noncompetitive rates. We also designed the benchmark formula to comply with the other statutory factors for determining whether CPST rates are unreasonable. In addition, the statutory factors were given consideration in the cost-of-service approach which we established as an alternative to the benchmark approach. 19. We also decided that a "tier neutral" approach was preferable to establishing different rate regulation schemes for BSTs and CPSTs. We adopted the same benchmark approach for purposes of resolving complaints regarding CPST rates as for determining whether basic rates are reasonable, and we applied the benchmark in the same manner to determine the initial permitted per channel rate for a CPST. For the purpose of adjudicating an initial complaint, we determined that a per channel rate for a CPST at or below the benchmark at the time the complaint is filed is reasonable and will be a permitted rate. For a system with rates at the time of regulation that are above the benchmark, the permitted rate level for the system is the system's September 30, 1992 per channel rate, reduced by a competitive differential of 17%, mitigated by annual inflation increases. Under our transition rules, the requirement that rates be set in accordance with this general rule does not apply immediately to (1) small operators, (2) systems whose March 31, 1994 rates are below the benchmark, or (3) systems whose March 31, 1994 rates are above the benchmark but whose permitted rates are at or below the benchmark. 20. We have also sought to adopt rules that promote "a diversity of views and information" and ensure that "cable operators continue to expand . . . programs offered over their systems." Under these rules, cable operators may increase rates for BSTs and CPSTs to reflect inflation, increases in external costs, and the addition of new channels. The current formula for channel additions permits operators to collect a sliding per channel adjustment for adding new programming channels to CPSTs and to recover all programming expenses associated with adding channels, plus a 7.5% mark-up on new programming expenses. B. Comments 21. A number of programmers have expressed the view that the cable industry's ability to create new programming networks that can benefit consumers depends on operators' being able to offer these new services in packages of programming. They assert that if new services must be offered on a stand-alone basis, the costs of marketing will increase the retail costs to consumers. These programmers urge the Commission to provide increased incentives to cable operators to offer such packages of new programming services. Other commenters suggested that a marketplace system is preferable to regulation in certain programming and tiering decisions. In addition, as reflected in the record, many ex parte comments supported the adoption of rules allowing operators to establish tiers of new services priced at market rates. C. Discussion 22. We are concerned, based on the comments filed by operators and programmers, that our current rules may not provide sufficient incentives for operators to expand capacity and provide new services to consumers. Accordingly, we are establishing a new category of CPSTs -- an NPT -- that will provide additional incentives for operators to provide new services to consumers because operators will be permitted to price these tiers as they choose. Our new rules also will help programmers by encouraging operators to add new attractive programming to NPTs in order to induce customers to subscribe to the NPTs. 23. Competition for NPTs. NPTs are, by definition, "cable programming services" under the 1992 Cable Act, because NPTs are composed of video programming provided over cable systems that are not carried on the BST and are offered in a package rather than exclusively on a per channel or per program basis. We therefore have a duty under the 1992 Cable Act to ensure that NPTs are not unreasonably priced. 24. We find that, so long as the conditions set forth below are met, the rates for NPTs will not be unreasonable. The conditions set forth below will ensure that subscribers may choose to subscribe to BSTs, NPTs, or CPSTs or combinations of those tiers and, that as a result, NPTs will face competition from BSTs and CPSTs. We believe this for four reasons. First, all cable subscribers will continue to be able to purchase services on BSTs and CPSTs at reasonable rates set at either the benchmark or cost-of-service levels, with future rate increases limited by our rules. Second, the services provided on BSTs and CPSTs will be comparable to the services provided on NPTs, in that both types of tiers will provide programming packages that contain multiple channels of video programming services. Third, as explained below, operators offering NPTs will be required to preserve the fundamental nature of their BSTs and CPSTs as of September 30, 1994, so that cable operators that charge unreasonable rates for NPTs should attract few subscribers for their new offering. Fourth, because NPTs are likely to be composed primarily of channels not offered by the operator on September 30, 1994, operators will not have an established audience for NPTs when they are first introduced. Thus, market forces will ensure that operators will charge rates for NPTs that are low enough to attract new viewers. 25. Conditions for Offering NPTs. The principal reason for our belief that the rates charged for NPTs will not be unreasonable is that consumers retain the option to subscribe to BSTs and/or CPSTs regulated under the benchmark formula or pursuant to cost- of-service standards and therefore will not choose an NPT if the price is unreasonable. To ensure that BSTs and CPSTs continue to provide subscribers with a meaningful choice, our new rules establish the following conditions for operators offering NPTs. 26. First, operators offering NPTs are prohibited from making fundamental changes to what they offer on their BSTs and CPSTs on September 30, 1994. This requirement is necessary to ensure that cable subscribers continue to receive basically the same cable service they now receive at prices we have set pursuant to our rate regulations. This requirement, however, is not intended to freeze BSTs and CPSTs. Operators remain free to move channels from the existing tier to a single channel offering or drop channels entirely, so long as the aggregation of such changes does not constitute a fundamental change of their BSTs or CPSTs. 27. Second, operators may not drop channels from BSTs and CPSTs and move them to NPTs (including time-shifted, slightly altered or renamed versions of channels offered on other tiers), if the channels were offered on their BSTs or CPSTs on September 30, 1994. This will protect consumers by ensuring that operators electing to provide NPTs do not dilute the BSTs and CPSTs that are currently available to consumers. This will also help ensure that BSTs and CPSTs provide a competitive option to NPTs. 28. Third, BSTs and CPSTs must continue to be cognizable services. That is, the operator must continue to market its BSTs and CPSTs so that customers are reasonably aware of: (1) the availability of those tiers to the public; (2) the names of the channels available on those tiers; and (3) the price of the tiers. Within 30 days of the offering of an NPT, operators shall file with the Commission a copy of the new rate card that contains the following information on their BSTs, CPSTs, and NPTs: (1) the names of the programming services contained on each tier, and (2) the price of each tier. Operators also must file with the Commission copies of notifications that were sent to subscribers regarding the initial offering of NPTs. After this initial filing, cable operators must file updated rate cards and copies of customer notifications with the Commission within 30 days of rate or service changes affecting the NPT. This information will help the Commission ensure that operators are complying with our conditions for NPTs. No prior regulatory approval, however, is required to offer an NPT. 29. Furthermore, in accordance with the 1992 Cable Act's prohibition on negative option billing, an operator may not charge any subscriber for an NPT unless the subscriber has requested the NPT by name. Thus, a decision to subscribe to an NPT will be the product of affirmative consumer choice and reflect a decision to subscribe to the NPT in addition to, or in place of, other services. Moreover, fundamental changes to an NPT must be approved by subscribers in accordance with the negative option billing rules. 30. Operators may not require the subscription to any tier, other than a BST, as a condition for subscribing to an NPT. Further, operators may not require subscription to an NPT as a condition to subscribing to a CPST. We believe that restricting the ability of operators to link the purchase of NPTs and other CPSTs will maximize subscriber choice and foster competition between NPTs and CPSTs. 31. Apart from the foregoing limited, specific requirements, operators will have complete flexibility to offer programming services on an NPT. Thus, our NPT rules provide that operators may offer the same programming services on NPTs as are on one or more BSTs and CPSTs. This will permit operators to place high value channels on NPTs without constraining subscriber choice. 32. Operators may add any channel to an NPT that was previously on a BST or CPST if the channel was dropped from the BST or CPST before September 30, 1994. If a channel was offered on a system on a BST or CPST on September 30, 1994, however, the channel may not be moved to an NPT unless the operator waits at least two years from the date the channel is dropped from the BST or CPST. However, operators may offer new channels (i.e., channels first offered on a system after September 30, 1994) on CPSTs before moving them to NPTs, subject to the conditions outlined in this Report and Order. The flexibility to move new channels to NPTs will keep the prices for CPSTs from becoming unreasonable and will create additional capacity for new services on CPSTs. This capacity should help create opportunities for programmers to establish an audience for their new channels. 33. These rules will be easy to apply. In order to offer an NPT, a cable operator is not required to complete any forms or obtain the approval of any agency. Furthermore, operators will be permitted to price NPTs as they choose and should encounter no regulatory problems unless they attempt to weaken their existing tiers of service so that BSTs and CPSTs do not compete effectively with NPTs. Although these rules will be clear and easy to apply, they also will ensure that subscribers will not be charged unreasonable rates. In short, our rules governing NPTs promote the goals of ensuring that the rates are reasonable and expanding opportunities for cable programmers to reach viewers. 34. Statutory Authority. The 1992 Cable Act directed the Commission to establish "criteria ... for identifying, in individual cases, rates for cable programming services that are unreasonable." In addition, Congress instructed us, "[i]n establishing the criteria for determining in individual cases whether rates for cable programming services are unreasonable," to "consider" six factors. Those six factors include: (1) the rates of similar cable systems; (2) the rates of systems that face effective competition; (3) the history of rates for a system; (4) the system's rates for the BST and equipment; (5) the system's capital and operating costs; and (6) the system's advertising revenues. We were not, however, instructed to consider each factor in the course of evaluating a particular system's rates, but instead were instructed to consider the factors in the course of establishing criteria by which to determine whether rates for CPSTs are unreasonable. 35. We considered the six statutory factors in the course of establishing our rate regulations, and our rate rules accordingly incorporate our analysis of those factors. In brief, the benchmark approach by which most cable operators set their rates is based directly on the first two factors -- the rates of similar systems and the rates of systems that face effective competition. The cost-of-service alternative is based directly on the last three factors -- the rates, costs, and revenues of a system. In addition, both approaches indirectly reflect our consideration of each factor, because the various factors are interrelated. 36. Our conclusion that the rates at which cable operators choose to offer NPTs will not be unreasonable reflects our consideration of the statutory factors that the Commission must consider in establishing criteria for determining whether a rate for a CPST is unreasonable. As explained above, we believe that the rates charged for NPTs will be constrained by the rates charged for BSTs and CPSTs. Our rate standards for BSTs and CPSTs were set directly by our analysis of the factors the 1992 Cable Act instructs us to consider. We believe that the rates charged for NPTs must be competitive with the rates charged for CPSTs or consumers will decline to subscribe to NPTs. Therefore, the rates charged for NPTs will reflect our analysis of the statutory factors because cable operators will have to offer NPTs at prices that are attractive in comparison to services subject to our benchmark or cost-of-service regulations. 37. Our NPT rules depart to a degree from the "tier neutral" approach we have applied previously. Our benchmark and cost-of-service approaches to setting rates have required cable operators to set rates for BSTs and CPSTs under the same standard -- and thus are tier neutral -- while our approach to NPTs treats those tiers differently from other CPSTs. We find that this approach is consistent with our interpretation of the statute. We do not construe the statute to require tier neutrality, but to permit a tier neutral approach. For the reasons we have explained above -- primarily the desirability of providing incentives to cable operators to provide new outlets for programming -- we believe that a departure from tier neutrality is warranted for NPTs. Allowing cable operators to set the rates for NPTs, rather than requiring NPT rates to be set under the rules set forth in 47 C.F.R.  76.922, is consistent with our statutory duties because NPTs will compete with tiers offered at rates regulated pursuant to our benchmark or cost of service rules. Accordingly, our treatment of NPTs will both promote the availability of additional channels to subscribers and ensure reasonable rates. IV. A La Carte Package Offerings A. Background 38. Under the 1992 Cable Act, video programming offered on a per channel or per program (a la carte) basis is not subject to rate regulation. In the April 1993 Rate Order, we held that we would not regulate packages of otherwise exempt per channel or per program services so long as: (1) the price for the combined package does not exceed the sum of the individual charges for each component of service, and (2) the cable operator continues to provide the component parts of the package to subscribers separately. We stated that the second condition would be met only when the per channel offering provides subscribers with a realistic service choice. We also stated that we would retain jurisdiction to review packages of a la carte channels to determine whether the attempted offering constituted an evasion of rate regulation. 39. Given the limited type of packages of per channel services that were available at the time we adopted the Rate Order, we believed that market forces would likely ensure that the rates for these offerings would be reasonable. However, following the adoption of the Rate Order, a number of operators restructured service offerings so that channels that would have been subject to regulation were removed from a regulated tier and offered on both an a la carte basis as well as on a package basis. In our Second Recon. Order, we expressed concern that the restructuring in some instances (1) may not be consistent with the purposes of the 1992 Cable Act, (2) may not comply with our requirement that subscribers must have a realistic option to purchase channels on an a la carte basis and (3) may constitute prohibited evasions of rate regulation. 40. In the Second Recon. Order, we concluded that the public interest will be served by generally permitting nonregulated treatment of collective offerings of a la carte channels, if the offering enhances consumer choice and does not constitute an evasion of rate regulation. We concluded that these objectives would be achieved if operators complied with the standards set forth in our initial rules. However, in order to address our concerns that some packages established by operators in response to rate regulation were not consistent with the 1992 Cable Act and our regulations, and the fact that other offerings raising similar concerns could be initiated in the future, the Second Recon. Order provided 15 interpretive guidelines for determining whether an operator's collective offering of a la carte channels should be accorded regulated or unregulated treatment. We stated that the guidelines would enable operators to better determine which packages of a la carte channels would be considered an evasion of rate regulation rather than a realistic service offering, and also would help local authorities and the Commission to assess expeditiously the appropriate regulatory status of specific packages of a la carte channels. We stated that in evaluating particular packages we would consider whether consumers were being offered a greater variety of programming options and whether the price for those choices was increasing or decreasing from previous levels. 41. We also determined that packages of a la carte channels offered prior to April 1, 1993 (the date we adopted the Rate Order) would be accorded unregulated treatment. This limited "grandfathering" of packages available on April 1, 1993 was intended to avoid elimination of discounts that were available to consumers and clearly were not offered to evade rate regulation. Finally, our Second Recon. Order stated that we would monitor our treatment of packages of a la carte channels and that, if it appeared that such offerings were not adequately fulfilling the purposes of the 1992 Cable Act, we would promptly revisit the issue. Previously, on November 17, 1993, the Mass Media Bureau issued 16 letters of inquiry to various cable operators, and on December 13, 1993, it issued another 35 letters of inquiry, most of which addressed the issue of removal and repackaging of channels. On February 22, 1994, the Cable Services Bureau issued 11 letters of inquiry to cable operators that, among other things, asked operators to justify a la carte offerings that may be inconsistent with the Commission's rate regulations. B. Comments 42. We have received numerous comments with respect to a la carte issues. Most of the commenters requested greater clarification of the Commission's a la carte rules and guidelines. These comments indicate that our a la carte rules are thought to be very unclear and that clarification is needed before most operators are willing to market new a la carte offerings. Cable programmers suggest that the existing uncertainty makes it difficult for new services to gain exposure to viewers either on regulated tiers or in a la carte packages. 43. One major area of concern of commenters is the ambiguity surrounding the number of channels that can be moved from regulated tiers to an a la carte tier under our 15- factor test. For example, NCTA requests guidelines on what would constitute "significant" versus "insignificant" migration of channels from a regulated tier to an a la carte package under the test set forth in the Second Recon. Order. Another issue that generated numerous comments involved clarification of the extent to which an a la carte package could be discounted as compared to the aggregate price of its components before we would conclude that the individual channels in an a la carte package were not "realistically" available to subscribers. 44. Commenters also made suggestions concerning the treatment of a la carte offerings that are found not to meet Commission guidelines. Viacom suggests that the Commission adopt guidelines under which operators who have initially launched a service on an a la carte basis may safely move the network back to a regulated tier, so called "reverse migration." Discovery Communications favors the adoption of guidelines that allow for the movement of a la carte channels back to regulated tiers without the requirement of affirmative consent under the negative option billing rule and without incurring liability of any kind. These comments are premised on the theory that cable operators should not be penalized for failing to satisfy our test for a la carte packages because it is unclear. C. Discussion 45. The evidence we obtained in response to the letters of inquiry issued to cable operators offering a la carte packages and the comments we have received from cable operators convince us that we should reconsider our approach. It seems clear that some cable operators have evaded rate regulation by purporting to offer channels a la carte, when in fact the individual offerings were not a realistic service alternative. On the other hand, we must acknowledge that there is merit to the industry's claim that neither our original two-part test nor our interpretative guidelines provides a clear answer with respect to the permissibility of some a la carte packages that have been offered. Indeed, it is perhaps inevitable that our test would not be capable of precise application in many instances because it is not clear how various factors should be weighed and applied. 46. Our analysis leads us to conclude, contrary to our prior decisions, that a la carte packages are CPSTs within the meaning of Section 3(l)(2) of the 1992 Cable Act. Justice Frankfurter said: "Wisdom too often never comes, and so one ought not to reject it because it comes late." In this case, we think that the conclusion that all packages are "cable programming services" is supported by the language of the statute, the legislative history, and practical considerations as well. 47. Section 3(l)(2) defines CPSTs as "any video programming provided over a cable system, regardless of service tier, including installation or rental of equipment used for the receipt of such video programming, other than (A) video programming carried on the basic service tier, and (B) video programming offered on a per channel or per program basis." A package of channels, whether or not the channels also are offered a la carte, plainly is "video programming provided over a cable system," and hence is a "cable programming service." The package is not "video programming offered on a per channel or per program basis;" the individual channels are. Accordingly, it is apparent from the statutory language that a la carte packages are cable programming services, and we therefore have a duty under Section 3(c)(1) to establish "criteria . . . for identifying, in individual cases, rates for cable programming services that are unreasonable." We acknowledged as much in our original decision authorizing a la carte packages when we said that, by authorizing a la carte packages, we were declining to "interpret[] the statute in . . . a literal fashion." 48. A conclusion that rate regulation does not apply at all to video programming packages if the channels are offered individually would fatally undermine the rate regulation rules Congress enacted. If a package of a la carte channels is not a CPST, any cable operator may avoid rate regulation simply by announcing the offering of channels on an a la carte basis even if very few subscribers would choose the a la carte offerings rather than the package. For example, Adelphia Cable in Dade County, Florida purported to remove its entire 32-channel cable programming services tier (which had been priced at $13.95) from rate regulation by offering the individual channels a la carte. However, in order to receive a single channel a la carte, Adelphia imposed a $6 equipment charge plus a per-channel charge. Only two-tenths of one per cent of Adelphia's customers subscribed to individual channels rather than the package. Congress could not have intended to allow cable operators to evade rate regulation through such an offering. That practical consideration confirms our conclusion that a package of channels is a "cable programming service" whether or not the channels are offered a la carte. 49. The conclusion that a package of a la carte channels is a CPST is further supported by the legislative history, which focused on the fact that bundled offerings of cable programming would be subject to rate regulation. The Senate Report stated that the definition of "cable programming service" and the provision requiring the Commission to regulate the rates for such service "demonstrate the Committee's belief that greater unbundling of offerings leads to more subscriber choice and greater competition among program services. Through unbundling, subscribers have greater assurance that they are choosing only those program services they wish to see and are not paying for programs they do not desire." While the Committee said it had "no desire to regulate programming," it nevertheless concluded that, when bundling was involved, rate regulation of programming was necessary: "[B]ecause cable operators bundle transmission, equipment and programming, it is impossible to contain a cable operator's market power without oversight of the bundled rate. The Committee has tried to make this oversight minimal by . . . not extending regulation to programs offered on a per channel or per program (unbundled) basis." 50. Similarly, the House Report indicated that "the only cable services potentially not subject to the Commission's regulatory authority would be services traditionally offered on a stand-alone, per-channel basis (premium channels like HBO or Showtime) or other programming that cable operators choose to offer on a per-programming service [sic], per- channel or pay-per-view basis." In light of that legislative history, we think it clear that Congress intended all collective offerings of channels to be subject to our regulatory authority, as the statutory language provides. 51. However, as we recognized in the Rate Order, there are sound policy reasons to treat as reasonable any price offered for a package of channels that traditionally have been offered on a per-channel basis. Indeed, we cannot envision circumstances in which any price of a collective offering such as the commonly offered "HBO/Showtime" package would be found to be unreasonable. For the future, our new rules authorizing "new product tiers" should provide cable operators with sufficient flexibility to offer such packages at whatever price they choose. Although cable operators may not remove channels from regulated tiers and offer them on NPTs, they are free to create packages of a la carte channels under our new rules governing NPTs. Moreover, as stated above, we previously "grandfathered" packages available on April 1, 1993. The difficult question concerns the treatment of a la carte packages created between April 1, 1993, and September 30, 1994. In some cases we think it is clear that the package at issue was not a permissible package under a fair reading of our test. In other cases, however, it is not clear how our test should be applied to the package at issue. In those cases, we think it is fair, in light of the uncertainty created by our test, to allow cable operators to treat existing packages as NPTs even though it would not qualify under the rules we establish today, provided that such packages involve only a small number of migrated channels. We see little reason to require an operator to "reverse migrate" a package that was not clearly ineligible for unregulated treatment under our a la carte policy. We intend to address whether specific operator packages should be treated as NPTs in ruling on individual cases in the near future. 52. In sum, our experience with a la carte packages leads us to conclude that we should not have departed from a plain reading of the statutory text in the first place. The Supreme Court's recent decision in MCI v. AT&T confirms our conclusion that we should adhere to statutory language. In that case the Court invalidated our "permissive detariffing" policy, pursuant to which we declined to require some telephone companies to file tariffs even though Section 203(a) of the Communications Act states that "[e]very common carrier ... shall designate, file with the Commission, and print and keep open for public inspection" tariffs showing its rates. Just as Congress directed us to require telephone companies to file tariffs, Congress has directed us to ensure that rates for packages of cable channels are not unreasonable. 53. Moreover, our experience with a la carte packages replicates the Supreme Court's experience in a different area. In O'Callahan v. Parker the Court departed from "the plain language of Clause 14" of Section 8 of Article I of the Constitution and held that a court-martial could try a defendant only if his offense was "service connected." In Relford v. Commandant, U.S. Disciplinary Barracks, the Court established a multi-factor test to determine whether an offense was "service connected." Sixteen years later, the Court concluded that the multi-factor test "has proved confusing and difficult for military courts to apply." The Court therefore overruled O'Callahan, abandoned the multi-factor test, and returned to a plain reading of Clause 14, explaining that "[w]hen considered together with the doubtful foundations of O'Callahan, the confusion wrought by the decision leads us to conclude that we should read Clause 14 in accord with the plain meaning of its language." Although we have had only a few months' experience with our multi-factor test -- rather than the 16 years -- we have taken a similar course with respect to a la carte packages. V. Adjustments to Capped Rates for Addition, Deletion and Substitution of Channels on CPSTs A. Background 54. Pursuant to Section 623 of Communications Act the Commission adopted a comprehensive framework governing the rates for BSTs and CPSTs. Under this framework, once initial rates are set pursuant either to the benchmark or cost-of-service approaches set forth in our earlier orders, rates are governed by a price cap designed to assure that rates for regulated cable services remain reasonable. Under the cap, operators may adjust rates annually for inflation as measured by the gross national product price index ("GNP-PI") and for certain categories of external costs. 55. Our price cap rules were amended in March, 1994 to specify a "going forward" mechanism under which capped rates are adjusted for changes in the number of channels offered on BSTs and CPSTs. Under these provisions, operators first remove all external costs from the tier charge and then adjust the residual component of the tier charge by a specified per channel adjustment amount when the total number of regulated channels changes. The methodology for adjusting capped rates when channels are added or deleted from a regulated tier is set forth in detail in section 76.922(e) of our rules and in FCC Form 1210. 56. In March, 1994, we also permitted operators to include a mark-up of 7.5% on new programming expense related to programming added on or after May 15, 1994. In setting the 7.5% mark-up, we noted that virtually no one had provided any material evidence on what, if anything, would be an appropriate mark-up on new programming costs. We chose 7.5% as a "cautious choice" for an initial permitted mark-up on new programming expense and stated that we would monitor the impact of this permitted mark-up to assure its fairness to cable operators and subscribers. We also issued a further notice of proposed rulemaking to determine if any changes in our going forward methodology were warranted to permit the continued growth of programming services. B. Comments 57. Parties filing petitions for reconsideration and many commenters filing in response to the Fifth Notice ask the Commission to revise the existing going forward rules substantially. Many criticize the existing per channel adjustment. Some argue that the current methodology for calculating per channel adjustments is flawed because it is based on the rates charged by systems of various sizes, rather than the costs or rate effects of adding a channel. Operators also argue that the existing mechanism fails to provide sufficient incentives to add channels. Others allege that the per channel adjustments are not sufficient to cover the costs of rebuilding systems. Some programmers and networks also contend that the declining per channel adjustment methodology is inadequate. USA Network proposes a per channel adjustment of no less than five cents per channel for each new channel added to a system, which, it says represents the cost to a 26-channel system of activating one channel. 58. The Consumer Federation of America ("CFA") argues that our existing going forward rules provide operators with sufficient incentives to add new channels. CFA states that cable operators threaten to close off new and existing outlets for programming under existing rules in an attempt to use programmers as a means of putting pressure on the Commission to increase the rates cable operators may charge for channel additions. 59. Most petitioners and commenters contend that the current 7.5% mark-up on new programming is an inadequate incentive for operators to add new programming services to regulated tiers. Cable operators, programmers, and networks state that the percentage- based approach to the programming mark-up results in disincentives for operators to add low- or no-cost services to BSTs and CPSTs (noting that 7.5% of zero is zero). The commenters state that the percentage-based approach is particularly problematic for new services because they generally are offered, at least initially, as low-cost or no-cost services. Similarly, long- term carriage of services having business plans that make them low- or no-cost is less attractive. Some suggest that the percentage mark-up approach gives operators an incentive to replace low cost services with higher cost services and, accordingly, also encourages programmers to raise their licensing fees. Public Interest Petitioners and others allege that because programming targeted to specific groups, such as minorities, is generally low- or no- cost programming, these groups are disproportionately harmed by the percentage mark-up methodology. Others more generally state that the 7.5% mark-up fails to provide sufficient incentives. They suggest that the 7.5% mark-up does not account for the costs of launching a new channel, including the foregone opportunity to devote the new channel to unregulated services. Some argue that the current mark-up deters investment and stifles innovation in the industry. Others suggest that the existing rules may cause operators to add no, or at most only a few new channels. Some programmers, however, favor retention of the 7.5% markup. 60. Most of the alternatives on going forward issues proposed by the industry involve a flat per channel charge. The National Cable Television Association ("NCTA") and Telecommunications, Inc. ("TCI") submitted economic studies to support a flat per channel adjustment of at least 25 to 30 cents. Others propose a flat fee for new services and a percentage mark-up on increased costs for existing services, or a flat fee adjusted for inflation. Continental Cablevision, Inc. ("Continental") proposed setting the mark-up on new channels at a rate equal to the average mark-up that an operator was allowed per channel on existing regulated services. 61. Some, including NCTA, propose a flat-fee mark-up subject to an annual cap. Cablevision Industries, Inc. ("CVI") supports a flat fee mark-up of 35 to 40 cents per channel, plus licensing fees with a $1.50 annual cap on the aggregate rate increases attributable to the per channel mark-up and license fees. CVI adds that the cable operator, rather than the programmer, should be allowed to retain the vast majority of the rate increase associated with the addition of a new channel. CVI argues that an annual cap encourages operators to choose new services wisely while minimizing the risk of adding services merely to justify higher rates. CVI also would allow operators to accrue such increases for two years to accommodate upgrades and rebuilds. The Cable Telecommunications Association ("CATA") agrees with the flat fee with an annual cap approach and suggests a mark-up of between 25 and 50 cents with a cap of an unspecified amount. Others propose an annual cap applicable only to the mark-up and not the underlying license fee. Others disagree with the adoption of an annual cap, arguing that an annual cap discriminates against high cost services and thus, at a minimum, a cap should not be applicable to services such as regional news and sports. The Commission also received comments suggesting that it should adopt separate going forward rules specifically applicable to small systems. 62. In addition to the comments in this proceeding, in response to, and during the period contemplated by, the Fifth Notice, the Commission has received a number of other informal comments from representatives of operators, programmers, local franchising authorities and public interest groups discussing proposed revisions to the going forward rules. NATOA also argued against permitting programming additions to BSTs on the ground that to do so would force BST-only subscribers -- "who include many low-income and elderly subscribers and captive subscribers who could not otherwise receive over-the-air broadcast stations" -- to pay for programming they did not want. NATOA urged the Commission to limit the ability of operators to take advantage of new permitted rate increases to add home- shopping revenues, advertising revenues and other compensation from certain programming services. NATOA also expressed concern over license fee increases in years subsequent to those covered by any license fee cap, suggesting either limiting license fee increases to inflationary adjustments, requiring that new services be moved to a new tier or offered only a la carte at the end of the capped period or eliminating the rate increase made on the channel's addition. Finally, NATOA urged the Commission not to permit channel additions to the BST so as to minimize the regulatory burden on local franchising authorities. 63. The City of St. Louis, Missouri, argues that revisions to the current going forward rules will cause rate shock to consumers. They questioned whether operators need additional incentives above benchmark rates to add new channels and expressed concern over a perceived lack of protection against more shopping and advertising channels and double- recoveries by operators through revenues from programmers. The Consumer Federation of America also expressed concern that a flat mark-up would encourage the addition of home shopping and low cost programming. The St. Louis letter supports NATOA's arguments against encouraging channel additions to BSTs. The letter urges the extension of price caps in respect of programming costs for as long as a channel is on a BST/CPST or, in the alternative, that the new rules require the channel's removal on termination of the price cap restraints. Finally, the St. Louis Letter states the Commission should seek to ensure that the financial gain from additional channels goes to programmers rather than operators. C. Discussion 64. As noted, the Commission previously adopted a mechanism by which cable operators may adjust rates when adding channels to BSTs and CPSTs. The Commission is supplementing its existing going forward rules by creating an alternative channel adjustment methodology. Cable operators adding channels to CPSTs under the new, supplemental rules may receive (1) a flat per channel mark-up, subject to a cap through December 31, 1997, and (2) recovery of programming costs, subject to a cap through December 31, 1996, and pursuant to our existing rules on permitted programming costs through December 31, 1997, modified to remove the 7.5% mark-up. In so doing, the Commission seeks to permit operators to provide new services on CPSTs, while assuring that rates for CPSTs are not unreasonable. Our new rules will benefit consumers by assuring that operators will have incentives to add new services, but without the unreasonable rate increases that some operators implemented prior to regulation. Our revised going forward rules will form an integral part of our comprehensive regulatory framework governing cable service rates. 65. Operators may adjust rates for CPSTs pursuant to our new going forward rules beginning January 1, 1995, the effective date of the new rules, for channel changes, if any, made to these tiers on or after May 15, 1994, the effective date of our existing going forward rules. Operators adding channels to CPSTs on and after May 15, 1994, may use either the new rules or the existing rules for adjusting rates. Thus, under the regulatory requirements we establish today, the permitted charge for a CPST will consist of two elements. The first element is the permitted rate for channels offered on CPSTs on May 14, 1994, determined under current rules. The second element is the permitted rates for channels added to, or dropped from, CPSTs on or after May 15, 1994, determined under our new rules, or, if the operator so elects with respect to channel additions, our current rules as modified to remove the 7.5% mark-up on increases in programming costs under certain circumstances described below. Operators must elect to apply either our new rules or our current rules the first time they adjust rates after December 31, 1994, to reflect a channel addition to a CPST that occurred on or after May 15, 1994, and must use the elected methodology for all rate adjustments through December 31, 1997. Rates for the BST will continue to be governed exclusively by our current rules, except that where a system offered only one tier on May 14, 1994, the cable operator will be allowed to use the revised rules for channel additions to the BST, as if the tier was a CPST. 1. "Going Forward" Price Cap Structure 66. Operators electing to use the new rules may adjust their rates between January 1, 1995 and December 31, 1997, by up to 20 cents, exclusive of license fees, for each new channel added to CPSTs on or after May 15, 1994, subject to the Operator's Cap and the reserve for license fees, described below. Operators are not required to raise rates, but rather are permitted to do so. Operators may add channels under the new rules at any time from May 15, 1994 to December 31, 1997. They may not, however, raise their prices as a result of channel additions by more than $1.20 per subscriber per month between January 1, 1995, and December 31, 1996, and by more than $1.40 between January 1, 1995, and December 31, 1997 ("Operator's Cap"). 67. Operators may use any portion of the Operator's Cap to pay for license fees between January 1, 1995 and December 31, 1996 for channels added between May 15, 1994 and December 31, 1996. Moreover, operators may recover an additional amount of not more than 30 cents per subscriber per month for license fees (the "License Fee Reserve") between January 1, 1995 and December 31, 1996 for channels added between May 15, 1994 and December 31, 1996. After December 31, 1996, license fees may be passed through to subscribers pursuant to our existing rules, except that, as described below, operators will not be allowed the current 7.5% mark-up on programming costs for channels added on or after May 15, 1994. 68. The new going-forward rules for channel additions should benefit consumers by increasing their viewing options on existing CPSTs, while avoiding unreasonable price increases for those tiers. Our revised rules are designed to continue to give "primary weight to the rates of systems subject to effective competition" in determining whether CPST rates are unreasonable. As we explain in the Technical Appendix (attached as Appendix C to this Report and Order) the particular channel adjustment factors that we incorporate into our rules are based on a comprehensive analysis of the changes in channel offerings and rates operators made during the years prior to regulation, adjusted to account for the lack of effective competition. Just as cable systems that are subject to effective competition continue to add channels to CPSTs, our new rule is designed to allow some additions to these tiers by systems subject to regulation. We will permit such channel additions to be reflected in reasonable price increases commensurate with the added value subscribers are receiving. 69. A Commission review of a sample of 500 systems reported in the Television and Cable Factbook indicates that, in the five years prior to the passage of the 1992 Cable Act, 18.2% to 31.5% of cable systems in any one year increased rates by more than $0.50 per channel added, 3.3% to 10.8% raised rates by $1.50 or more per channel added and some raised rates by as much as $8.00 per channel added. The average per channel price for channels currently offered on BSTs and CPSTs is 43 cents and for channels currently offered on CPSTs is 65 cents. The $1.50 cap on retail price (i.e., the $1.20 Operator's Cap over two years plus the 30 cent License Fee Reserve) increases resulting from channel additions to CPSTs will allow subscribers to CPSTs to receive as many as six additional channels at an average cost of 25 cents per channel, including license fees, during the first two years. Our observation that six channels could be added at 25 cents per channel is not intended to limit the number of channels an operator may add to its CPSTs under our revised rules during the first two years. All that our rules require is that rate increases be limited. An operator is free to add as many channels as it wishes so long as it limits its rate increases. 70. The Commission recognizes that allowing operators to use the new rules when they add channels to CPSTs, but not when they add channels to BSTs, may create greater incentives to add channels to CPSTs than to BSTs. We believe this departure from tier neutrality is justified for at least three reasons. First, we agree with NATOA that preserving rate stability on the BST, which carries broadcast signals and which every subscriber must purchase in order to receive other programming services, is sufficient reason to limit the applicability of the revised channel addition rules to CPSTs. Although at the time we adopted tier neutrality, we found that suppressing rates for the BST would give operators incentives to move services off the BST and add to regulatory complexity, we believe these factors have less weight where channel additions are at issue. Second, we believe that providing enhanced incentives to add channels to CPSTs will maximize choice for subscribers, because subscribers are not required to purchase CPSTs to obtain NPTs and will, therefore, be able to determine whether the CPSTs, any NPTs or both offer the best value. Third, we agree with NATOA that applying the revised rules to the BST would increase the complexity of the regulatory task faced by local regulatory authorities. Accordingly, we limit application of the new rules to CPSTs, provided that an operator offers at least one CPST to subscribers. If an operator only offers a BST, the operator may use the new rules to make rate adjustments for adding channels to the BST. 71. In the succeeding paragraphs, we explain and justify each of the elements of this going forward price cap structure. In the Technical Appendix we justify and explain the particular values we have incorporated into this price cap structure. The Technical Appendix also details why we rejected various commenters proposals with respect to the going forward price cap structure. Our rules describe the application of these requirements in detail. The Commission will release a revised version of Form 1210 subsequent to this Report and Order. 2. Per Channel Adjustment Factor 72. As indicated, we establish a "per channel adjustment factor" of up to 20 cents per channel for channels added to CPSTs. Operators may increase rates by up to 20 cents, exclusive of programming costs, for each channel added to a CPST on and after May 15, 1994, subject to the Operator's Cap of $1.20 on rate increases attributable to channel additions through December 31, 1996, and $1.40 through December 31, 1997. An operator may choose a lower per channel adjustment, if that would further its business plan by, for example, allowing it to devote a portion of the Operator's Cap to license fees. 73. The per channel adjustment factor will compensate the operator for its costs of adding the channel plus a reasonable profit. Twenty cents falls within the historical range of 15-22 cents by which operators in a competitive environment would adjust rates for the addition of a new programming channel, exclusive of programming costs. We determined the 15-22 cent range by analyzing rate increases associated with growth in the number of channels offered in the five years prior to the 1992 Cable Act. The methodology we used in deriving the 15-22 cent range is set forth in the Technical Appendix. 74. In the Rate Order, we provided that any revenues received from a programmer, or shared by a programmer and an operator, must be netted against costs for purposes of calculating whether there has been an increase or decrease in external costs. We extend this requirement for offsetting revenues against costs to the per channel adjustment factor for channels added to CPSTs pursuant to our revised channel adjustment rules. The revenues must be deducted from programming costs and then, to the extent revenues are remaining, from the per channel adjustment. Offsetting will apply on a channel-by-channel basis. We believe that this best balances the interest of the cable operator in being compensated for adding new programming and the interest of subscribers in receiving reasonable rates. 75. The per channel adjustment factor permitted by this Report and Order will apply only to net increases in channels from the highest number of channels offered on all CPSTs (excluding NPTs) on May 15, 1994 or any date thereafter. If an operator substitutes a new channel for an existing channel, no per channel adjustment may be made under the revised channel adjustment rules. Rather, the operator should continue to charge the residual associated with the channel that was dropped. To permit an operator to receive a per channel adjustment in these situations would encourage operators to evade the purpose of the revised going forward incentives by substituting new for existing channels simply to get an additional per channel adjustment. 3. Operator's Cap 76. For the addition of new channels to CPSTs on or after May 15, 1994, we establish a per subscriber cap on the amount by which monthly cable rates may increase between January 1, 1995, and December 31, 1997. Operators may not make rate adjustments to monthly rates totalling more than $1.20 per subscriber over the first two years of the three- year period or more than $1.40 over the full three-year period. Rate changes prior to January 1, 1997 resulting from programming costs of new channels must fall within the Operator's Cap unless they are covered by the License Fee Reserve. Price increases will be counted against the Operator's Cap when rates are increased as a result of channel additions, not when the addition occurs. Any rate increases pursuant to the revised rules shall be subject to the notice and prior approval requirements of our regulations. In addition, operators will be required to send the Commission copies of the notices sent to subscribers. 77. The Operator's Cap on the rate increase attributable to the addition of new channels to CPSTs is necessary because without such a cap, the per channel mark-up could create an incentive for operators to add large numbers of channels to CPSTs so as to increase the aggregate mark-up received. In the absence of rate regulation, cable operators with market power may be motivated to raise rates unreasonably. Because the rates of cable operators not subject to effective competition are lowered by regulation, these operators might use their market power to increase the number of channels on their CPSTs so as to regain the monopoly profits not available as a result of regulation. This result would undermine the 17% competitive rate reduction previously ordered by the Commission and could raise overall rates toward monopoly levels that would have occurred in the absence of the 1992 Cable Act. The result would be unreasonable CPST prices, contrary to the statutory requirements of the 1992 Cable Act. An unreasonable CPST rate also would cause the CPST to be an unattractive choice for subscribers, thereby removing it as a viable competitor to an NPT. The absence of a viable competitor would result in the lack of market constraints on NPT pricing. The result could be unreasonable NPT rates, in addition to unreasonable CPST rates. Thus, the Operator's Cap will help assure that both CPST and NPT rates remain reasonable. 78. In addition, we adopt the Operator's Cap because there is no evidence that consumers want to pay for an unlimited number of channels in CPSTs. The cap will also provide operators with incentives to choose which new services offered on CPSTs would be most valued by subscribers. Finally, because the per channel adjustment of up to 20 cents reflects an average based on historical data, adjusted for the lack of effective competition, it may provide some operators with a greater incentive to add channels than would exist in a competitive market. The Operator's Cap prevents operators from adding unlimited numbers of channels in these circumstances. The Operator's Cap will thus keep overall regulated rates reasonable and will provide an incentive to operators to add channels to CPSTs that subscribers will demand most. 79. As we explain in the Technical Appendix, before setting the Operator's Cap, we conducted an extensive analysis of rate changes instituted by cable operators prior to regulation and adjusted for the lack of effective competition faced by most systems at that time. In that analysis we observed that, in the five years prior to regulation, operators generally added on average 2.4 new channels per year to their basic and upper tiers. Our Operator's Cap would permit six channels to be added to CPSTs through December 31, 1996, assuming operators seek the full 20 cents mark-up per channel. In addition, a seventh channel may be added between January 1, 1997 and December 31, 1997 for an additional 20 cents. To ensure that rate increases associated with channel additions do not constitute an abuse of an operator's continuing market power and to ensure that rates remain reasonable, as explained below, the per channel adjustment is imposed to approximate rate adjustments an operator facing effective competition would receive for adding a channel. 4. License Fee Reserve 80. We also establish a License Fee Reserve of 30 cents which operators may use, between January 1, 1995 and December 31, 1996, to recover programming costs for new channels. The License Fee Reserve may be applied against the initial license fee or any increase in the license fee for channels added during the first two years that the Operator's Cap is in effect. During this period, operators also may use all or any portion of the amount permitted as a per channel adjustment under the Operator's Cap to pay for license fees in excess of the License Fee Reserve. License fees incurred in the third year the Operator's Cap is in effect may be passed through to subscribers as external costs without counting against either the License Fee Reserve or the Operator's Cap. 81. The 30 cents License Fee Reserve would allow 6 channels to be added at an average license fee of 5 cents per channel. The 5-cents average, per channel license fee falls within the historical range of 4-12 cents which we observed. Within that range, we determined that a choice toward the lower end of the range was appropriate because the 12 cent upper figure included price increases for programming already on operators' systems as well as for new programming. The methodology we used in deriving the License Fee Reserve is explained in the Technical Appendix. 82. We have adopted a License Fee Reserve in response to programmers' concerns that a cap on total rate increases attributable to new channels, without a reserve for license fees, might give rate-regulated cable operators incentives to increase profits by adding only no cost or low cost channels. That is, if we adopted only the $1.20 cap for the first two years of the Operator's Cap, which includes the 20 cent per channel adjustment, operators might add six channels over the first two years with no license fees so as to maximize their share of the rate increase. The License Fee Reserve makes no judgment about the relative value to subscribers of high or low cost channels, but seeks to replicate the incentives operators would have to add channels in a competitive market, which accommodates both low and high cost services. 5. Programming Cost Increase Mark-Up 83. We have decided not to allow operators using the per channel adjustment under our new rules to take the 7.5% mark-up on programming cost increases, including retransmission consent fees and copyright fees incurred for coverage of broadcast signals, for channels for which the per channel mark-up of up to 20 cents was taken. Our analysis indicates that the per channel adjustment of up to 20 cents for additional channels, in addition to the License Fee Reserve, will provide full and fair compensation to operators adding channels to CPSTs. Operators who have added channels prior to the effective date of the new rules will not be harmed by this change since the operators may elect to add channels to CPSTs under the old or the new rules. 6. Deletion And Substitution of Channels 84. The attached regulations also specify how operators shall adjust rates for BSTs and CPSTs when channels are dropped from, or moved between, BSTs and CPSTs. In general, when dropping a channel from a BST or CPST, operators will be required to make their rates reflect the net reduction in external costs as is required under our existing rules. Operators also will be required to reduce the price of that tier by the "residual" associated with that channel. For channels that were on a BST or CPST on or before May 14, 1994 or channels added after that date pursuant to the current rules, the per channel residual is the charge for the tier, minus the external costs for the tier, and any per channel adjustments made after that date, divided by the number of channels on the tier. For channels added to a CPST on or after May 15, 1994 pursuant to our new channel addition rules, the residuals shall be the actual per channel adjustment taken for that channel when it was added to the tier plus any inflation adjustment since that time. The residual and programming cost shall be calculated as of the date the channel is dropped. 85. As noted above, when an operator substitutes a new channel for an existing channel on a CPST, no per channel adjustment may be taken. The residual for the new channel is that of the channel it replaced. Operators substituting channels will be required to adjust their rates for changes in license fees as provided by our current rules. To preserve the overall effectiveness of the Operator's Cap and the License Fee Reserve, if the license fee for the new service is greater than the license fee for the replaced service, and the operator chooses to pass that increase through to subscribers, the excess shall count against the aggregate of the Operator's Cap and the License Fee Reserve. If the license fee for the new channel is less than the license fee for the replaced channel, no credit shall be given against the cap or the reserve, so as not to create an artificial incentive to replace higher license fee channels with lower license fee channels. With respect to channels to which the 7.5% mark- up on new programming costs applies, the operator shall treat the mark-up as part of its programming costs and subtract the mark-up from its external costs when a channel is dropped. When such a channel is substituted, the operator may retain in its rates the 7.5% mark-up on the license fee of the dropped channel, so long as that amount is not more than 7.5% of the license fee of the new channel. 86. When a channel is shifted between a BST and a CPST or between CPSTs, it shall be treated as if it was dropped from one tier and the residual and programming cost associated with the shifted channel shall be shifted to the other tier. The residuals associated with the shifted channel shall be adjusted by reference to the number of subscribers on each tier to ensure aggregate revenues remain the same. Revenue neutrality protects consumers by ensuring that our requirements do not create incentives for operators to move channels to tiers with more subscribers solely to increase revenues. And because the per channel adjustment of up to 20 cents applies only to the CPSTs, an operator may not move a channel for which it received a per channel adjustment under the new rules from a CPST to the BST. Our revised rules describe in detail the application of these requirements. 7. Headend Upgrades for Small Systems A. Background 87. The Commission recognizes that regulatory and administrative burdens placed on small systems and small multiple system operators ("MSOs") by our regulations may be greater than the burdens faced by other operators. The Commission has adopted various transition and administrative procedures in order to alleviate regulatory burdens experienced by small systems and small MSOs. B. Comments 88. In order to give small systems incentives to add channels, CATA suggests that the Commission adopt a sliding scale that would permit higher rates to be charged for new channels as the subscriber base decreases from 1,000 to 100. CATA's comments indicate that the capital used to purchase cable equipment must come from additional fees charged subscribers before reasonable profits can be made. Since equipment costs are fixed, the smaller the system, the longer it will take to recover equipment costs and the less incentive there is to add channels. 89. According to CATA, typical per channel equipment costs associated with the addition of satellite-delivered channels are $500 to $1,000 for a receiver to convert from satellite frequencies to video baseband, $800 for a descrambler, and $1,250 for a signal processor. CATA states that labor costs are dependent on various factors, including whether additional satellite dishes are needed. In addition, CATA comments that an additional satellite dish costs approximately $2,500. 90. Summit also submitted comments focusing on the ability of small cable systems to recover equipment costs associated with the addition of new channels. Summit states that even the combination of a pass-through of programming cost plus a mark-up does not cover the costs of headend equipment required to add a channel to a small cable system and, therefore, these costs should be accorded external cost treatment. C. Discussion 91. We have decided to adopt a special streamlined cost-of-service procedure for independent small systems and small systems owned by small MSOs that upgrade their headend equipment to add new channels to CPSTs. This procedure addresses CATA's concern that small systems may find it difficult to recover the fixed costs of the headend equipment required for adding channels, since the cost must be recovered over a small subscriber base. We limit this relief to independent small systems and small systems owned by small MSOs because (1) systems with more than 1,000 subscribers can spread the fixed costs of headend equipment over a larger customer base and (2) small systems owned by larger operators should have adequate financial resources to add channels under our generally applicable rules. Qualified small systems that add channels to their CPSTs, therefore, have the option of either using this special procedure or using the existing or revised going forward rules applicable to all operators. 92. Under this streamlined cost-of-service procedure for upgrading headend equipment, independent small systems and small systems owned by small MSOs may increase rates to recover the costs associated with new headend equipment that is used to add channels to CPSTs. In order to recover costs for headend equipment, qualified small systems will be required to certify to the Commission the level of costs they have actually incurred for adding headend equipment. 93. Notwithstanding these concerns, we do not want to burden subscribers of small systems with paying high rate increases. Therefore, as we have done with our new per channel adjustment formula, we have decided to limit the amount small systems may recover under this special allowance to prevent unreasonably sharp rate increases to small system subscribers. The amount a small system may recover for each channel added shall be limited to programming costs incurred plus the lesser of the actual cost of the headend equipment or $5,000. Headend costs that are to be recovered through increased rates must be depreciated over the useful life of the equipment. In addition, we find that the rate of return the small system may earn on this investment may not exceed 11.25%. 94. Small systems may apply this streamlined cost-of-service procedure for channels added after May 14, 1994, but may not use this methodology to increase rates to reflect channel additions until January 1, 1995. Moreover, small systems that increase rates as a result of any channel additions pursuant to either this methodology may add a maximum of seven channels to CPSTs over the next three years. This is equal to the number of channels that a system taking the maximum 20 cent per channel adjustment may add under the Operator's Cap. 8. Systems with More than 100 Channels 95. In our Fifth Notice, we noted that the Fourth Report and Order (Fourth Report) in MM Docket No. 92-266 established per channel adjustments for systems with total channels on regulated tiers of 100 channels or fewer. It did not establish per channel rates for systems that provide more than 100 channels. We solicited comment on whether we should establish a method for adjusting capped rates in situations where there are more than 100 regulated channels and, if so, what that method should be. We also sought comment on whether we could use mathematical formulations derived from existing data or tables. We asked whether instead of adopting a method for setting rates for offerings of more than 100 channels, we should cap rates at the 100 channel level unless the operator could justify a higher rate based on a cost-of-service showing. We solicited comments on how any of these proposals would affect incentives for operators to provide additional channels on an a la carte basis. We additionally asked whether our going forward methodology should be modified to provide greater or lesser compensation to operators for adjustments to capped rates when channels are added or deleted from BSTs and CPSTs, and whether this would better meet our goals of encouraging infrastructure development and growth of programming. We stated that operators should provide a complete factual justification for any claims that the current methodology is inadequate. 96. With respect to the Commission's request for comments on how to deal with systems with 100-plus channels, CATA states that if the Commission would increase the per channel adjustment to 25 to 50 cents, there would be no need for a special mechanism for systems with over 100 channels. Time Warner, Inc. ("Time Warner") argues that the Commission cannot derive a formula for 100-plus channel systems from the existing data tables because those tables are based upon data for systems with fewer than 100 channels and include systems that did not implement any upgrade. Providence Journal asks the Commission to deregulate rates for channels in excess of 100. TCI proposes that the Commission set a demarcation point at 75 regulated channels, allow cable operators to choose which 75 channels are regulated, and deregulate all additional channels. GTE Service Corporation, a telephone company, favors establishing rates for 100-plus channel systems in accordance with price cap principles, rather than requiring a cost-of-service showing. 97. Our existing going forward regulations use a declining per channel adjustment as the number of channels on a system increase. In contrast, in this Report and Order we have decided to allow (1) a flat per channel adjustment for the addition of new channels to CPSTs, subject to an Operator's Cap, and the License Fee Reserve, and (2) NPTs for which cable operators set the price. Because our revised regulations allow operators to set the price for an unlimited number of channels on NPTs, we do not believe it is necessary to adopt any other rules that are based on a specific number of channels. 9. Term of the Revised Channel Addition Rules 98. The new rule for adjusting rates when channels are added, deleted or substituted on CPSTs will be in place through December 31, 1997, and will be reviewed prior to the end of that period to determine if there is any reason to continue to provide incentives to increase the number of channels on any CPST. The new rule will expire on that date and will be replaced by our existing rule unless it is reinstated by the Commission. The special streamlined cost-of-service procedure for headend equipment costs for small systems also will expire on December 31, 1997 unless it is reinstated by the Commission. VI. Negative Option Billing A. Background 99. Section 3(f) of the 1992 Cable Act prohibits negative option billing, which occurs when a cable operator charges a subscriber for any service or equipment that the subscriber has not affirmatively requested by name. A subscriber's failure to refuse a cable operator's proposal to provide such service or equipment may not be deemed to be an affirmative request for such service or equipment. The Rate Order provided that changes in the mix of programming in a tier, including additions or deletions of channels, will not be subject to the negative option billing provision unless they change the fundamental nature of the tier. We believe that, on balance, the benefits to subscribers from giving operators the ability to diversify, improve or otherwise modify their offerings in a tier outweigh the slight reduction in subscriber choice that results from exempting such changes from the negative option billing prohibition. 100. In the Rate Order, we held that it is not necessary to subject any service changes accompanied by a price increase to the negative option billing prohibition, provided that these changes do not change the fundamental nature of the tier, because subscribers will receive 30 days' advance notice of any rate, programming or channel changes, and any actual or implicit rate changes will be subject to our rate regulations. We also stated that restructuring tiers and equipment, including restructuring necessary to comply with the 1992 Cable Act, will not violate the ban on negative option billing, unless the restructuring constitutes a change in the fundamental nature of the tier. Finally, we stated that the negative option billing prohibition does not apply to system-wide equipment improvements accompanied by rate increases. 101. The Rate Order provided that operators could pass increases in external costs and inflation adjustments through to subscribers. We did not address whether passing these costs through constitutes negative option billing. 102. In the Third Reconsideration Order, we concluded that the Commission and state and local governments have concurrent jurisdiction to regulate negative option billing. The rationale for this conclusion was that regulation of negative option billing, while discussed in the section of the 1992 Cable Act governing rate regulation, is more in the nature of a consumer protection measure than rate regulation per se. Section(8)(c)(1) of the 1992 Cable Act, codified in Section 632(c)(1) of the Communications Act, provides that nothing in the "Consumer Protection Laws" title of the Communications Act may "be construed to prohibit any State or any franchise authority from enacting or enforcing any consumer protection law, to the extent not specifically preempted by this title." Given our conclusion that Section 3(f) of 1992 Cable Act is a consumer protection measure, we stated that Section 632(c)(1) of the Communications Act preserves the ability of a state or local government to regulate negative option billing except to the extent such regulation is "specifically preempted." 103. We found in the Third Reconsideration Order that there is nothing in the language of Section 3(f) of the 1992 Cable Act or its legislative history to suggest that state and local authorities are specifically preempted from regulating negative option billing. In fact, the legislative history refers to the efforts of state attorneys general in this area, which further supported our conclusion that there is no specific preemption. However, we also stated that if we became aware of a particular state or local regulation of negative option billing that went beyond consumer protection and instead approached actual regulation of "rates for the provision of cable service" we would consider the question of federal preemption in that specific factual context. B. Comments 104. On reconsideration, Time Warner and NCTA request that we clarify what channel additions to a tier will not require affirmative marketing under Section 3 (f) of the 1992 Cable Act. They also asked us to declare that local authorities may not require affirmative marketing for channel additions under state or local laws. More specifically, NCTA asks us to clarify that three specific "scenarios" do not trigger the federal negative option billing rule and that state or local authorities are preempted from enacting or enforcing their own negative option billing laws. The three scenarios are: (1) a cable operator raises its rates (with no change in service or equipment offerings) as a result of passing through external costs or inflation adjustments, as provided by the Commission's rules; (2) an operator changes its rates as a result of the addition or deletion of channels to its regulated tiers pursuant to the Commission's "going forward" regulations; and (3) an operator replaces an existing channel of service on a regulated tier with a different channel of service, with or without a change in the rates. 105. In support of its position, NCTA points to the Rate Order, where we stated that the negative option billing prohibition is not violated by: (1) changes in the mix of programming on a tier, including additions or deletions of channels; (2) rate changes accompanying changes in regulated programming unless there is a fundamental change in service; or (3) restructuring of tiers and equipment if subscribers will continue to receive the same number of channels and the same equipment unless there is a fundamental change in service. NCTA claims that these provisions make clear that, as a matter of federal law, neither rate increases resulting from Commission approved pass-throughs of external costs or inflation adjustments nor channel changes resulting from the addition or deletion of programming to a regulated tier would violate the negative option billing rule. Moreover, NCTA argues that because the three situations in its letter "plainly implicate rate regulation," rather than the marketing or billing of those services, and "clearly are not violative of federal negative option billing requirements, state and local authorities are preempted from enforcing their laws in a manner inconsistent with the federal determinations." 106. NCTA states that the practical consequences of permitting state and local authorities to require that cable operators obtain subscribers' affirmative consent before implementing federally permitted rate increases or channel changes would be far reaching. According to NCTA, without federal preemption, a cable operator could be effectively precluded from achieving the return permitted under the Commission's price cap and going forward rules NCTA also states that if any of these minor changes were considered to be subject to the negative option billing prohibition, subscribers who do not affirmatively "request" the "service" would have their service discontinued, and most subscribers would not even realize why their service had been cut off. C. Discussion 1. Application of the Negative Option Billing Rules to the Three Scenarios 107. In determining whether any of the scenarios involve negative option billing, we are guided by the language of the negative option billing provision, its legislative history, and our prior interpretations. Section 3(f) states that "[a] cable operator shall not charge a subscriber for any service or equipment that the subscriber has not affirmatively requested by name." "Service" may be read very broadly. But if "service" were read in that manner, the negative option billing provision would require a cable operator to obtain subscribers' affirmative consent before making any change in offerings, including even relatively minor changes such as the addition of one channel to a large tier, and the legislative history makes clear that such an interpretation is not appropriate. With regard to the negative option billing provision, the Conference Committee explained: The language adopted by the conferees ensures that cable operators will not be able to charge customers for tiers or packages of programming services or equipment that they do not affirmatively request as well as individually-priced programs or channels. This provision is not intended to apply to changes in the mix of programming services that are included in various tiers of cable service. In light of that guidance, we have concluded that "a change in the mix of channels in a tier, including additions or deletions of channels, will not be subject to the negative option billing provision, unless they change the fundamental nature of the tier." We adhere to that construction of the negative option billing provision. 108. With respect to NCTA's first scenario, which involved passing through external costs or inflation adjustments, we hold that these types of rate changes do not in and of themselves invoke the federal negative option billing rule. As an initial matter, they do not constitute "service or equipment" within the meaning of Section 3(f). Moreover, under our rate regulations, operators are specifically permitted to pass through to subscribers increases in external costs and inflation adjustments. These types of rate changes do not constitute a change in the fundamental nature of a tier, and, therefore, do not implicate the federal negative option billing prohibition for that reason as well. 109. With regard to the second and third scenarios identified in NCTA's letter, we specifically addressed how we would treat channel changes with respect to negative option billing in the Rate Order. We stated that "a change in the mix of channels in a tier, including additions or deletions of channels, will not be subject to the negative option billing provision, unless they change the fundamental nature of the tier." We believe that, on balance, consumers benefit from giving operators the ability to diversify, improve or otherwise modify their offerings without obtaining every subscribers' affirmative consent. 110. Determinations as to what constitutes a change in the fundamental nature of a tier will generally depend on the individual circumstances of each case. However, as we indicated in the Rate Order, if an operator deleted all existing channels from a particular tier and added a completely new set of channels, this would change the fundamental nature of the tier, thus requiring subscribers' prior affirmative assent. Accordingly, channel changes involving relatively few channels generally will not change the fundamental nature of that tier, and thus will not implicate the federal negative option billing rule. Consistent with this approach, additions of channels and rate adjustments within the Operator's Cap and License Fee Reserve of our revised going forward rules generally will not change the fundamental nature of a tier. As we indicated in the Rate Order, because our rules require operators to give subscribers 30-days' advance notice of any changes in rates, programming or channel positions, we do not believe subscribers need the additional protection of the negative option billing provision for relatively modest changes. 2. State Authority 111. Section 632(c)(1) of the Communications Act provides that "[n]othing in this title shall be construed to prohibit any State or any franchising authority from enacting or enforcing any consumer protection law, to the extent not specifically preempted by this title." This provision makes clear that state and local authorities generally may apply statutes proscribing fraud or misleading advertising practices to cable operators. We have recognized that negative option billing practices are also usually "in the nature of a consumer protection measure rather than a rate regulation provision per se." Hence, state and local consumer protection laws apply to negative option billing practices. For example, if a cable operator engaged in a practice that violated the terms of the negative option billing provision added by the 1992 Cable Act and the terms of a state or local negative option billing rule, enforcement could proceed under state and local law as well as under federal law. 112. However, Section 3(a)(1) of the 1992 Cable Act makes clear that regulation of "the rates for the provision of cable service" is governed exclusively by the federal statute and Commission regulations. It therefore "specifically preempts" state and local regulation that is inconsistent with the federal rules. We have recognized that there may be cases where "state or local regulation of negative option billing goes beyond consumer protection and instead approaches actual regulation of `rates for the provision of cable service.'" In such a case, state or local regulation would be prohibited by the 1992 Cable Act. The scenarios NCTA presents require us to consider again the relationship between Section 632(c)(1) of the Communications Act and Section 3(a)(1) of the 1992 Cable Act. 113. We conclude that a two-step approach is warranted. First, is the state or local negative option rule consistent with the federal rule? If it is, then the state or local rule may be enforced. If the state or local rule is inconsistent with the federal rule, then it is necessary to consider whether its enforcement "approaches, actual regulation of `rates for the provision of cable service.'" In elaborating on that inquiry, we now conclude that state or local consumer protection laws may not be enforced in a manner that conflicts with or undermines our rate regulation rules established pursuant to Section 3 of the 1992 Cable Act. If there is an actual conflict between federal and state law or where state law stands as an obstacle to the accomplishment and execution of the full objectives of Congress, the state law is preempted. 114. Underlying our approach is our construction of Section 632(c)(1) of the Communications Act. That provision makes clear, in our view, that Congress has not so comprehensively occupied the cable field that there is no room for the enforcement of state consumer protection laws. In the absence of Section 632(c)(1) of the Communications Act, a powerful argument could be made to the contrary, because the 1992 Cable Act is comprehensive legislation that relates to nearly all aspects of cable television. Moreover, Section 632(c)(1) of the Communications Act makes clear that there is room for enforcement of state and local consumer protection laws, along with federal enforcement, wherever state or local law does not conflict with federal law. But where there is conflict that would undermine our enforcement of the rate rules Congress ordered us to implement, state and local law must give way. 115. The scenarios NCTA presents involve situations where enforcement of state and local negative option billing rules would be inconsistent with the federal rule and enforcement might undermine implementation of the cable rate rules we have promulgated pursuant to Congress's instruction. With respect to the first scenario, the federal negative option billing rule plainly would not require cable operators to obtain affirmative consent from subscribers before passing through external costs and inflation adjustments as permitted by our rules, as explained above. In addition, enforcement of a state or local negative option billing rule requiring affirmative consent prior to the pass-through of external costs and cost- of-service increases, as permitted by our rate rules, would undermine the federal regime governing cable rates. We have issued detailed rate rules implementing Section 3 of the 1992 Cable Act. Under our rules, most cable operators must reduce their rates from pre-1992 levels, many by as much as 17%, to ensure that cable rates are reasonable. However, as the first scenario presented by NCTA recognizes, our rules also allow cable operators to increase their rates to reflect increases in the cost-of-living or other external costs, most of which are beyond cable operators' control. The 17% rate reduction and the rules authorizing the pass- through of external costs and inflation adjustments are of a piece; the rate cut would not be fair to cable operators if they were prohibited from raising rates to reflect increased costs that are beyond their control. The result would be unreasonably low rates, contrary to Congress's command that we must ensure that cable operators that do not face effective competition charge "reasonable" rates. 116. If state or local officials were able to enforce negative option billing rules that, contrary to the federal negative option billing rule, require cable operators to obtain affirmative consent before increasing rates to reflect increases in inflation or other external costs, our cable rate rules would be fatally undermined. As NCTA states, cable operators would not be permitted to increase rates until a subscriber completed a form authorizing the rate increase, even though the increase was fully justified under our rate rules. As a practical matter, chaos would ensue every time a cable operator tried to increase rates as permitted under our rate rules, and our rules authorize cable operators to pass through external costs quarterly. Rate increases would not be permitted until each subscriber gave affirmative consent, and subscribers would have no reason to consent unless cable operators threatened to cut off service and followed through on that threat with respect to subscribers who failed to complete and mail the form authorizing the rate increase. Moreover, since many subscribers undoubtedly fail to read carefully every mailing from their cable operator, many subscribers would have their service cut off, to their surprise and dismay, each time a cable operator passed through external costs. That would impose significant transaction costs on cable operators and subscribers for no good reason. Accordingly, we conclude that state and local authorities may not enforce negative option billing rules that preclude cable operators from passing through cost-of-living increases and other external costs that are permitted to be passed through under our rate rules. 117. The other two scenarios presented by NCTA involve the addition, deletion and replacement of channels. Our negative option billing regulation makes clear that the requirement that cable operators obtain affirmative consent before charging for a new service "shall not preclude the addition or deletion of a specific program from a service offering, the addition or deletion of specific channels from an existing tier of service, or the restructuring or division of existing tiers of service that do not result in a fundamental change in the nature of an existing service, or tier of service." Accordingly, the replacement of a single channel, NCTA's third scenario, would not be prohibited by the federal negative option billing provision, because that would not result in a "fundamental change" unless the tier was very small. With respect to NCTA's second scenario, involving the addition or deletion of channels, the answer would depend on how many channels were added or deleted and other factors relevant to determining whether a "fundamental change" had occurred. As stated above, however, changes that are permitted under our "Operator's Cap" generally would not constitute "fundamental changes." 118. If the addition, deletion, or replacement of channels did not constitute a fundamental change in a tier, so that the federal negative option billing rule was not triggered, preemption of enforcement of a stricter state or local negative option billing rule would depend on whether enforcement would conflict with or undermine our rate regulation rules established pursuant to Section 3 of the 1992 Cable Act. It is not possible to provide a blanket response to NCTA's second and third scenarios in the absence of a specific set of facts to evaluate. However, it bears emphasis that our rate rules governing the addition, deletion, and replacement of channels are designed to ensure reasonable rates without impeding the provision of new services. Indeed, our rate rules are designed to encourage the provision of new services that subscribers desire at the reasonable rates mandated by Congress. Therefore, an interpretation of state or local law that required a cable operator to obtain the affirmative consent of every subscriber before making a change that did not fundamentally alter the affected tier would, in most cases, interfere with the accomplishment of Congress's objectives. The transaction costs imposed by a negative option billing requirement would create a major incentive for cable operators to freeze their service offerings. Thus, the goals of the rate regulation regime we have designed pursuant to Congress's direction would be frustrated and undermined if state and local governments enforced negative option billing rules that thwarted the accomplishment of the goals of our rate regulations. Indeed, state and local officials in effect would set cable rates by discouraging the addition, deletion, or replacement of channels even where the change did not fundamentally alter the nature of a tier. 119. We recognize that we stated in the Third Reconsideration Order that "[S]ection 3(a) of the 1992 Cable Act generally does not `specifically preempt' state and local governments from enacting and enforcing state or local consumer protection laws that may address negative option billing practices of cable operators." We believe that statement remains correct following our further consideration of when enforcement of state or local negative option billing rules would "approach actual regulation of `rates for the provision of cable service.'" In most cases, we think state and local officials would enforce negative option billing rules that are consistent with the federal rules. In relatively few cases, in our view, would state or local officials be likely to seek to enforce negative option billing rules that conflict with or undermine federal rate regulation provisions. But in any event, on further consideration we are convinced that, however numerous such cases are likely to be, state and local officials may not enforce negative option billing rules that obstruct the accomplishment of the objectives of Congress's cable rate provisions. VII. Affiliate Transactions A. Background 120. In the Cost Order in MM Docket No. 93-215, the Commission promulgated a rule for valuing transactions between cable operators and affiliated companies. The Commission found that it would be inconsistent with Congressional intent to allow rates for regulated cable service to reflect the prices affiliates charge each other for transactions that occur at other than an arm's length. The Commission found that allowing cable companies to pass increases in their costs through to rate payers could motivate those companies to pay excessive amounts for assets and services obtained from unregulated affiliates. The Commission also found that allowing service pass-throughs could induce cable companies to undercharge unregulated affiliates since the undercharges could be offset by increased charges to subscribers. 121. We therefore adopted a rule for affiliate transactions that applies to cable operators who elect cost-of-service regulation or seek to adjust benchmark/price cap rates for affiliated programming costs. This rule applies valuation methods that are similar to those telephone companies are now required to apply. The rules distinguish between asset transfers and the provision of services. Under the rule, charges for assets purchased by a cable operator from an affiliate, or sold by a cable operator to an affiliate is valued at the asset provider's prevailing company price, if the provider has sold the same kind of asset to a substantial number of third parties at a generally available price. Absent a prevailing company price, the cable company is required to value the asset at the higher of net book cost and estimated fair market value when the regulated cable system is the seller, and at the lower of net book cost and estimated fair market value when the regulated cable system is the buyer. 122. Charges for services purchased by a cable operator from an affiliate or sold by a cable operator to an affiliate are valued at the provider's prevailing company price, if the provider has sold the same kind of service to a substantial number of third parties at a generally available price. When the provider has established no prevailing company price, the cable operator is required to value the service at the service provider's cost. 123. In the Cost Further Notice, we tentatively concluded that the general changes we proposed for affiliate transactions involving telephone companies should be applied to cable operators. Accordingly, the Commission proposed a further limitation on the application of the prevailing company price as a measure of a reasonable price for an affiliate transaction. We tentatively concluded that the use of prevailing company pricing as a valuation method for transactions between cable operators and their affiliates should only be permitted where the predominant purpose of the transaction is to serve nonaffiliates. To that end, we proposed that any affiliate that sells less than 75 percent of its output to non-affiliates has too large a volume of affiliate transactions to be deemed to have a predominant purpose of serving non-affiliates. We therefore proposed to continue to allow prevailing company pricing as a valuation method for affiliate transactions only where at least 75 percent of the cable operators output is sold to non-affiliates. B. Comments 124. The cable industry generally opposes the proposed rule arguing that the proposal would require operators and programmers to adopt costly, inefficient and unnecessary methodologies to document the estimated fair market value of the assets or services exchanged. Time Warner and TCI argue that the 75% bright-line test would impose administrative burdens that would be excessive and outweigh the speculative benefits that might result. 125. BellSouth endorses the existing rule and opposes the proposed rule as unduly burdensome. 126. Several other parties oppose the proposed rules on the grounds that these requirements would discourage vertical integration and would result in decreased investment in quality cable programming. Several programmers also argue that the current rules permit vertical integration and thus encourage investment in programming while the proposed rules would penalize cable operators for carriage of programs produced by affiliated programmers and effectively discourage vertical integration. Other parties, observing that rules similar to the proposed rules for cable are being considered for local exchange carriers, argue that regulatory parity warrants the application of such rules to cable companies. Bell Atlantic states that while the proposed rules may be too restrictive, the Commission should adopt uniform rules for cable and telephone companies. 127. USTA opposes the proposed cable rules, however, arguing that the proposal is inappropriate for both cable operators and telephone companies. NCTA also opposes the proposal and states that the only rationale for the rules comes from an incorrect premise that the application of such rules in the telephone context necessitates similar rules in the cable industry. C. Discussion 128. We decline to adopt the proposal to prevent cable operators from valuing assets or services at the operators' prevailing company prices unless the providing affiliates sell more than 75% of their output to nonaffiliates. We find that this proposal would prevent, in many cases, cable operators from establishing a prevailing company price for programming services that have achieved wide distribution among cable operators. The record demonstrates, for example, that under the proposed rule, cable operators would be unable to value at a prevailing company price such ubiquitous services as the Cable News Network, TNT, WTBS, ESPN, MTV, and USA due to these programmer's affiliations with major MSOs. We will, therefore, not adopt the proposed rule because there is no evidence in the record to suggest that a cable operator would have an incentive to pay excessive amounts for assets or services obtained from affiliates where an asset or service is widely distributed among cable operators. 129. In addition, we are concerned that by preventing cable operators from valuing programming at the prevailing company price, we may discourage major MSOs with substantial resources from investing in cable programming and related services that could benefit subscribers. Thus, the proposed rule may discourage efficiencies in the distribution, marketing and purchase of programming which may, in turn, reduce subscriber fees and cable rates. Programmers may also lose access to cable industry financing for innovative, creative video programming. 130. We will, therefore, retain the existing cable affiliate transaction rule which provides that a cable operator may value an asset or service at the prevailing company price if the provider has sold the same kind of service or asset to a substantial number of third parties at a generally available price. We find that for cable affiliate transactions, the sale of an asset to a substantial number of third parties will ensure that cable operators will not have an incentive to pay excessive prices when they obtain services and assets from affiliates because in such cases the primary purpose of the transaction would not be to provide services and assets to the affiliated programmer. However, we will continue to examine our test for the establishment of a prevailing company price in MM Docket No. 93-215 and as we gain experience with our current cable affiliate transaction rule, we may seek further comment in order to refine the rule. 131. Finally, the Cost Further Notice sought comment on (1) the proposal to require cable operators that do not meet the prevailing company price test to value services at the higher of cost and fair market value when the cable operator is the seller and the lower of cost and fair market value when the cable operator is the buyer; (2) whether the current definition of an affiliate should be retained; (3) whether the interim cable affiliate transaction rules should be adopted as our final rules; and (4) whether our final cable affiliate transaction rule should be included in the uniform system of accounts that we adopted for cable operators. We will address these issues in conjunction with our general consideration of final cost rules in MM Docket No. 93-215 at a later time. VIII. Seventh Notice of Proposed Rulemaking 132. As discussed above, we have determined that operators electing to use the 20 cent per channel adjustment may not take the 7.5% mark-up on programming cost increases, including retransmission consent fees and copyright fees incurred for carriage of broadcast signals, for channels added on or after May 15, 1994. We made this determination because our analysis indicates that the 20 cent per channel adjustment will provide full and fair compensation to operators adding new channels to CPSTs. 133. We also believe that for operators using the per channel adjustment of up to 20 cents, maintaining the 7.5% mark-up on programming cost increases for channels offered before May 15, 1994 may no longer be necessary given the total incentive structure provided in our revised going forward rules. In addition, the 7.5% mark-up on such channels may create an artificial incentive for the operator to continue to offer programming that the operator would not otherwise continue to offer. For these reasons, we tentatively conclude that the 7.5% mark-up is unnecessary for such operators with respect to increases in programming costs for channels offered before May 15, 1994. We solicit comment on whether operators electing to use the per channel adjustment of up to 20 cents under the new rules should be allowed to take the 7.5% mark-up on increases in programming costs, including retransmission consent fees and copyright fees incurred for carriage of broadcast signals, for channels added before May 15, 1994. If we decide that such operators may not take a 7.5% mark-up on increases in programming costs, we will not consider requiring cable operators to prospectively remove from rates any 7.5% mark-up added prior to the effective date of a final rule on this issue. 134. We believe that the 7.5% mark-up on new programming costs when channels are initially added to a system ought be preserved for systems that continue to use the existing going forward rules because the 7.5% mark-up is an important part of the total package of incentives to add new programming under the existing rules. Our rules permitting operators to pass through external costs are generally intended to compensate for added costs outside the operators' control and not to provide an additional mark-up without a clear policy purpose. In contrast to the situation where the goal of providing incentives to add new programming services justifies a mark-up, there appears to be no strong reason to allow a mark-up on programming cost increases for a service already being offered. We therefore solicit comment on whether operators electing to use the current going forward rules should be permitted to pass-through the 7.5% mark-up on programming cost increases after the initial mark-up on the programming cost of new channels. We will not, however, consider prospectively removing from rates any 7.5% mark-up that was reflected in rates prior to our reaching a decision on this issue. IX. Regulatory Flexibility Act Analysis A. Final Analysis for the Fifth Report and Order and Sixth Order on Reconsideration. 134. Pursuant to the Regulatory Flexibility Act of 1980, 5 U.S.C.  601-612, the Commission's final analysis with respect to the Sixth Order on Reconsideration and Fifth Report and Order is as follows: 135. Need and purpose of this action. The Commission, in compliance with  3 of the Cable Television Consumer Protection and Competition Act of 1992, 47 U.S.C.  543 (1992), pertaining to rate regulation, adopts revised rules and procedures intended to ensure that cable services are offered at reasonable rates with minimum regulatory and administrative burdens on cable entities. 136. Summary of issues raised by the public in response to the Initial Regulatory Flexibility Analysis. There were no comments submitted in response to the Initial Regulatory Flexibility Analysis. The Chief Counsel for Advocacy of the United States Small Business Administration (SBA) filed comments in the original rulemaking order. The Commission addressed the concerns raised by the Office of Advocacy in the Rate Order. The SBA also filed reply comments in response to the Fifth Notice. 137. Significant alternatives considered and rejected. Petitioners representing cable interests and franchising authorities submitted several alternatives aimed at minimizing administrative burdens. In the course of this proceeding, the Commission has attempted to accommodate the concerns expressed by these parties. For example, the revised going forward mechanisms are designed to enhance incentives to add new channels to regulated tiers without creating new regulatory burdens and to provide additional options tailored to the concerns of small systems. In addition, the New Products Tier is designed to ensure that regulated cable service rates are reasonable while reducing administrative burdens. B. Initial Regulatory Flexibility Analysis for the Seventh Notice of Proposed Rulemaking. 138. Pursuant to Section 603 of the Regulatory Flexibility Act, the Commission has prepared the following initial regulatory flexibility analysis (IRFA) of the expected impact of these proposed policies and rules on small entities. Written public comments are requested on the IRFA. These comments must be filed in accordance with the same filing deadlines as comments on the rest of the Notice, but they must have a separate and distinct heading designating them as responses to the regulatory flexibility analysis. The Secretary shall cause a copy of the Notice, including the initial regulatory flexibility analysis, to be sent to the Chief Counsel for Advocacy of the Small Business Administration in accordance with Section 603(a) of the Regulatory Flexibility Act, Pub. L. No. 96-354, 94 Stat. 1164, 5 U.S.C. Section 601 et seq. (1981). 139. Reason for action. The Cable Television Consumer Protection and Competition Act of 1992 requires the Commission to prescribe rules and regulations for determining reasonable rates for basic tier cable service and to establish criteria for identifying unreasonable rates for cable programming services. The Commission has adopted rate regulations for cable systems not subject to effective competition. This Notice proposes to revise regulations governing new programming costs for channels on a system before May 15, 1994. 140. Objectives. To propose rules to implement Section 3 of the Cable Television Consumer Protection and Competition Act of 1992. We also desire to adopt rules that will be easily interpreted and readily applicable and, whenever possible, minimize the regulatory burden on affected parties. 141. Legal Basis. Action as proposed for this rulemaking is contained in Sections 4(i), 4(j), 303(r) and 623 of the Communications Act of 1934, as amended. 142. Description, potential impact and number of small entities affected. We anticipate a possible impact on small entities because the Notice addresses the rates charged by cable operators that are not subject to effective competition, including small systems. 143. Reporting, record keeping and other compliance requirements. None. 144. Federal rules which overlap, duplicate or conflict with this rule. None. 145. Any significant alternatives minimizing impact on small entities and consistent with stated objectives. None. X. Paperwork Reduction Act 146. The requirements adopted herein have been analyzed with respect to the Paperwork Reduction Act of 1980 and found to impose a new or modified information collection requirement on the public. Implementation of any new or modified requirement will be subject to approval by the Office of Management and Budget as prescribed by the Act. XI. Procedural Provisions 147. Ex parte Rules - Non-Restricted Proceeding. This is a non-restricted notice and comment rulemaking proceeding. Ex parte presentations are permitted, except during the Sunshine Agenda period, provided that they are disclosed as provided in Commission rules. See generally 47 C.F.R. Sections 1.1202, 1.1203, and 1.1206(a). 148. Pursuant to applicable procedures set forth in Sections 1.415 and 1.419 of the Commission's Rules, 47 C.F.R. Sections 1.415 and 1.419, interested parties may file comments on or before January 13, 1995 and reply comments on or before February 13, 1995. To file formally in this proceeding, you must file an original plus four copies of all comments, reply comments, and supporting comments. If you want each Commissioner to receive a personal copy of your comments and reply comments, you must file an original plus nine copies. You should send comments and reply comments to Office of the Secretary, Federal Communications Commission, 1919 M Street, N.W. Washington, D.C. 20554. Comments and reply comments will be available for public inspection during regular business hours in the FCC Reference Center, Room 239, Federal Communications Commission, 1919 M Street N.W., Washington D.C. 20554. XII. Ordering Clauses 149. Accordingly, IT IS ORDERED that, pursuant to Sections 4(i), 4(j), 303 (r), 612, 622(c) and 623 of the Communications Act of 1934, as amended, 47 U.S.C.  154(i), 154(j), 303(r), 532, 542(c) and 543, the rules, requirements and policies discussed in this Sixth Order on Reconsideration and Fifth Report and Order, ARE ADOPTED and Part 76 of the Commission's rules, 47 C.F.R. Part 76, IS AMENDED as set forth in Appendix C. 150. IT IS FURTHER ORDERED that, pursuant to Sections 4(i), 4(j), 303(r), 612(c), 622(c) and 623 of the Communications Act of 1934, 47 U.S.C.  154 (i), 154 (j), 303(r), 532 (c), 542(c), and 543, NOTICE IS HEREBY GIVEN of proposed amendments to Part 76, in accordance with the proposals, discussions, and statement of issues in this Seventh Notice of Proposed Rulemaking, and that COMMENT IS SOUGHT regarding such proposals, discussion, and statement of issues. 151. IT IS FURTHER ORDERED that the Secretary shall send a copy of this Report and Order, including the Initial Regulatory Flexibility Analysis, to the Chief Counsel for Advocacy of the Small Business Administration in accordance with paragraph 603(a) of the Regulatory Flexibility Act. Pub. L. No. 96-354, 94 Stat. 1164, 5 U.S.C.  601 et seq. (1981). 152. IT IS FURTHER ORDERED that the requirements and regulations established in this decision shall become effective January 1, 1995, with the exception of new reporting requirements which will become effective on that date or as soon thereafter as they may be approved by the Office of Management and Budget. FEDERAL COMMUNICATIONS COMMISSION William F. Caton Acting Secretary ENDNOTES APPENDIX B Title 47, Part 76 of the Code of Federal Regulations is amended as follows: PART 76 -- CABLE TELEVISION SERVICE 1. The authority citation for Part 76 continues to read as follows: Authority: Secs. 2, 3, 4, 301, 303, 307, 308, 309, 48 Stat. as amended, 1064, 1065, 1066, 1081, 1082, 1083, 1084, 1085, 1101; 47 U.S.C. Secs. 152, 153, 154, 301, 303, 307, 308, 309, 532, 535, 542, 543, 552 as amended, 106 Stat. 1460. 2. Section 76.901 is amended to add paragraphs (d) and to read as follows: Section 76.901 Definitions * * * * * (d) New Product Tier. A new product tier ("NPT") is a cable programming service tier meeting the conditions set forth in Section 76.987 of this Subpart. 3. Section 76.922 is amended to revise paragraphs (d)(3)(x), (d)(3)(xi) and (e) to read as follows: Section 76.922 Rates for the basic service tier and cable programming service tiers. * * * * * (d)(3)(x) Adjustments to permitted charges on account of increases in costs of programming shall be further adjusted to reflect any revenues received by the operator from the programmer. Such adjustments shall apply on a channel-by-channel basis. (d)(3)(xi) In calculating programming expense, operators may add a mark-up of 7.5% for increases in programming costs occurring after March 31, 1994, except that operators may not file for or take the 7.5% mark-up on programming costs for new channels added on or after May 15, 1994 for which the operator has used the methodology set forth in paragraph (e)(3) for adjusting rates for channels added to cable programming service tiers. Operators shall reduce rates by decreases in programming expense plus an additional 7.5% for decreases occurring after May 15, 1994 except with respect to programming cost decreases on channels added after May 15, 1994 for which the rate adjustment methodology in paragraph (e)(3) was used. (e) Changes in the number of channels on regulated tiers. (1) Generally. A system may adjust the residual component of its permitted rate for a tier to reflect changes in the number of channels offered on the tier on a quarterly basis. Cable systems shall use FCC Form 1210 (or FCC Form 1211, where applicable) to justify rate changes made on account on changes in the number of channels on a basic service tier ("BST") or a cable programming service tier ("CPST"). Such rate adjustments shall be based on any changes in the number of regulated channels that occurred from the end of the last quarter for which an adjustment was previously made through the end of the quarter that has most recently closed preceding the filing of the FCC Form 1210 (or FCC Form 1211, where applicable). However, when a system deletes channels in a calendar quarter, the system must adjust the residual component of the tier charge in the next calendar quarter to reflect that deletion. Operators must elect between the channel addition rules in paragraphs (2) and (3) the first time they adjust rates after December 31, 1994, to reflect a channel addition to a CPST that occurred on or after May 15, 1994, and must use the elected methodology for all rate adjustments through December 31, 1997. A system that adjusted rates after May 15, 1994, but before January 1, 1995 on account of a change in the number of channels on a CPST that occurred after May 15, 1994, may elect to revise its rates to charge the rates permitted by paragraph (3) on or after January 1, 1995, but is not required to do so as a condition for using the methodology in paragraph (e)(3) for rate adjustments after January 1, 1995. Rates for the BST will be governed exclusively by paragraph (2), except that where a system offered only one tier on May 14, 1994, the cable operator will be allowed to elect between paragraphs (2) and (3) as if the tier was a CPST. (2) Adjusting Rates for increases in the number of channels offered between May 15, 1994, and December 31, 1997, on a basic service tier and at the election of the operator on a cable programming service tier. The following table shall be used to adjust permitted rates for increases in the number of channels offered between May 15, 1994, and December 31, 1997, on a basic service tier and subject to the conditions in paragraph (1) at the election of the operator on a CPST. The entries in the table provide the cents per channel per subscriber per month by which cable operators will adjust the residual component using FCC Form 1210 (or FCC Form 1211, where applicable). Average Number of Regulated Channels Per-Channel Adjustment Factor Average Number of Regulated Channels Per-Channel Adjustment Factor 7 $0.52 14 0.14 7.5 0.45 14.5 0.13 8 0.40 15-15.5 0.12 8.5 0.36 16 0.11 9 0.33 16.5-17 0.10 9.5 0.29 17.5-18 0.09 10 0.27 18.5-19 0.08 10.5 0.24 19.5-21.5 0.07 11 0.22 22-23.5 0.06 11.5 0.20 24-26 0.05 12 0.19 26.5-29.5 0.04 12.5 0.17 30-35.5 0.03 13 0.16 36-46 0.02 13.5 0.15 46.5 -99.5 0.01 In order to adjust the residual component of the tier charge when there is an increase in the number of channels on a tier, the operator shall perform the following calculations: (1) take the sum of the old total number of channels on tiers subject to regulation (i.e., tiers that are, or could be, regulated but excluding New Product Tiers) and the new total number of channels and divide the resulting number by two; (2) consult the above table to find the applicable per channel adjustment factor for the number of channels produced by the calculations in step (1). For each tier for which there has been an increase in the number of channels, multiply the per-channel adjustment factor times the change in the number of channels on that tier. The result is the total adjustment for that tier. (3) Alternative methodology for adjusting rates for changes in the number of channels offered on a cable programming service tier or a single tier system between May 15, 1994, and December 31, 1997. This paragraph at the Operator's discretion as set forth in paragraph (1) shall be used to adjust permitted rates for a CPST after December 31, 1994, for changes in the number of channels offered on a CPST between May 15, 1994, and December 31, 1997. For purposes of this paragraph (3), a single tier system may be treated as if it were a CPST. (i) Operators Cap Attributable to New Channels on All CPSTs Through December 31, 1997. Operators electing to use the methodology set forth in this paragraph may increase their rates between January 1, 1995, and December 31, 1997, by up to 20 cents per channel, exclusive of programming costs, for new channels added to CPSTs on or after May 15, 1994, except that they may not make rate adjustments totalling more than $1.20 per month, per subscriber through December 31, 1996, and by more than $1.40 per month, per subscriber through December 31, 1997 (the "Operator's Cap"). Except to the extent that the programming costs of such channels are covered by the License Fee Reserve provided for in subsection (iii) of this paragraph (3), programming costs associated with channels for which a rate adjustment is made pursuant to this paragraph (3) must fall within the Operator's Cap if the programming costs (including any increases therein) are reflected in rates before January 1, 1997. Inflation adjustments pursuant to Section 76.922(d)(2) of this Subpart are not counted against the Operator's Cap. (ii) Per Channel Adjustment. Operators may increase rates by a per channel adjustment of up to 20 cents per subscriber per month, exclusive of programming costs, for each channel added to a CPST between May 15, 1994, and December 31, 1997, except that an operator may take the per channel adjustment only for channel additions that result in an increase in the highest number of channels offered on all CPSTs as compared to May 14, 1994, and each date thereafter. Any revenues received from a programmer, or shared by a programmer and an operator in connection with the addition of a channel to a CPST shall first be deducted from programming costs for that channel pursuant to paragraph (d)(3)(x) of this Section and then, to the extent revenues received from the programmer are greater than the programming costs, shall be deducted from the per channel adjustment. This deduction will apply on a channel by channel basis. (iii) License Fee Reserve. In addition to the rate adjustments permitted in subsections (i) and (ii) of this paragraph, operators that make channel additions on or after May 15, 1994 may increase their rates by a total of 30 cents per month, per subscriber between January 1, 1995, and December 31, 1996, for license fees associated with such channels (the "License Fee Reserve"). The License Fee Reserve may be applied against the initial license fee and any increase in the license fee for such channels during this period. An operator may pass-through to subscribers more than the 30 cents between January 1, 1995, and December 31, 1996, for license fees associated with channels added after May 15, 1994, provided that the total amount recovered from subscribers for such channels, including the License Fee Reserve, does not exceed $1.50 per subscriber, per month. After December 31, 1996, license fees may be passed through to subscribers pursuant to paragraph (d) of this Section, except that license fees associated with channels added pursuant to this paragraph (3) will not be eligible for the 7.5% mark-up on increases in programming costs. (iv) Timing. For purposes of determining whether a rate increase counts against the maximum rate increases specified in paragraphs (i) - (iii), the relevant date shall be when rates are increased as a result of channel additions, not when the addition occurs. (4) Deletion of Channels. When dropping a channel from a BST or CPST, operators shall reflect the net reduction in external costs in their rates pursuant to paragraphs (d)(3)(i) and (ii) of this Section. With respect to channels to which the 7.5% mark-up on programming costs applied pursuant to paragraph (d(3)(xi), the operator shall treat the mark- up as part of its programming costs and subtract the mark-up from its external costs. Operators shall also reduce the price of that tier by the "residual" associated with that channel. For channels that were on a BST or CPST on May 14, 1994, or channels added after that date pursuant to paragraph (2), the per channel residual is the charge for the tier, minus the external costs for the tier, and any per channel adjustments made after that date, divided by the total number of channels on the tier minus the number of channels on the tier that received the per channel adjustment specified in paragraph (3). For channels added to a CPST after May 14, 1994, pursuant to paragraph (3), the residuals shall be the actual per channel adjustment taken for that channel when it was added to the tier. (5) Movement of Channels Between Tiers. When a channel is moved from a CPST or a BST to another CPST or BST, the price of the tier from which the channel is dropped shall be reduced to reflect the decrease in programming costs and residual as described in paragraph (4) above. The residual associated with the shifted channel shall then be converted from per subscriber to aggregate numbers to ensure aggregate revenues from the channel remain the same when the channel is moved. The aggregate residual associated with the shifted channel may be shifted to the tier to which the channel is being moved. The residual shall then be converted to per subscriber figures on the new tier, plus any subsequent inflation adjustment. The price of the tier to which the channel is shifted may then be increased to reflect this amount. The price of that tier may also be increased to reflect any increase in programming cost. An operator may not shift a channel for which it received a per channel adjustment pursuant to paragraph (3) from a CPST to a BST. (6) Substitution of Channels on a BST or CPST. If an operator substitutes a new channel for an existing channel on a CPST or a BST, no per channel adjustment may be made. Operators substituting channels on a CPST or a BST shall be required to reflect any reduction in programming costs in their rates and may reflect any increase in programming costs pursuant to paragraph (d)(3)(i), (ii). If the programming cost for the new channel is greater than the programming cost for the replaced channel, and the operator chooses to pass that increase through to subscribers, the excess shall count against the License Fee Reserve or the Operator Cap when the increased cost is passed through to subscribers. Where an operator substitutes a new channel for a channel on which a 7.5% mark-up on programming costs was taken pursuant to paragraph (d)(3)(xi), the operator may retain the 7.5% mark-up on the license fee of the dropped channel to the extent that it is no greater than 7.5% of programming cost of the new service. (7) Headend Upgrades for Small Systems. When adding channels to CPSTs, independent small systems, as defined in Section 76.901(c) of this Subpart, and small systems owned by small multiple system operators, as defined in Section 76.922(b)(5), may choose among the methodologies set forth in this paragraph and in paragraphs (2) and (3). Operators choosing the methodology of this paragraph may increase rates to recover the actual cost of the headend equipment required to add up to seven channels to CPSTs, not to exceed $5,000 per additional channel, plus any applicable programming costs. Rate increases pursuant to this paragraph may occur between January 1, 1995, and December 31, 1997, as a result of additional channels offered on those tiers after May 14, 1994. Headend costs shall be depreciated over the useful life of the headend equipment. The rate of return on this investment shall not exceed 11.25 percent. In order to recover costs for headend equipment pursuant to this paragraph, small systems must certify to the Commission their eligibility to use this paragraph, the level of costs they have actually incurred for adding the headend equipment and the depreciation schedule for the equipment. (8) Sunset Provision. Paragraph (e) shall cease to be effective on January 1, 1998 unless renewed by the Commission. * * * * * 3. Section 76.964 is amended to redesignate this Section to read as follows: Sec. 76.964 Written notification of changes in rates and services ***** 4. Section 76.981 is amended to replace the existing section and to read as follows: Sec. 76.981 Negative option billing. (a) A cable operator shall not charge a subscriber for any service or equipment that the subscriber has not affirmatively requested by name. A subscriber's failure to refuse a cable operator's proposal to provide such service or equipment is not an affirmative request for service or equipment. A subscriber's affirmative request for service or equipment may be made orally or in writing. (b) The requirements of paragraph (a) of this Section shall not preclude the adjustment of rates to reflect inflation, cost of living and other external costs, the addition or deletion of a specific program from a service offering, the addition or deletion of specific channels from an existing tier or service, the restructuring or division of existing tiers of service, or the adjustment of rates as a result of the addition, deletion or substitution of channels pursuant to Section 76.922 of this Subpart, provided that such changes do not constitute a fundamental change in the nature of an existing service or tier of service and are otherwise consistent with applicable regulations. (c) State and local governments may not enforce state and local consumer protection laws that conflict with or undermine paragraphs (a) or (b) of this Section or any other sections of this Subpart that were established pursuant to Section 3 of the 1992 Cable Act, 47 U.S.C  543. 5. Section 76.986 is amended to replace the existing section and to read as follows: Section 76.986 "A la carte" offerings (a) Collective offerings of unregulated per-channel or per-program ("a la carte") video programming shall be regulated as CPSTs pursuant to Section 76.922 of this Subpart. For purposes of this Section, "multiplexed" channels shall be treated as one channel. (b) A discounted package price offered by a cable system is not unreasonable with respect to any collective offering of channels if the component channels' collective offering also have been continuously available on the system on a per channel basis since April 1, 1993. (c) A collective offering of per channel offerings may be treated as a New Product Tier if (i) the collective offering meets the conditions set forth in Section 76.987, or (ii) the operator had reasonable grounds to believe the collective offering involving only a small number of migrated channels complied with the Commission's requirements as of the date it was first offered. (d) In reviewing a basic service rate filing, local franchising authorities may make an initial decision addressing whether a collective offering of "a la carte" channels will be treated as a cable programming service tier that is an NPT under Section 76.987 of this Subpart or a CPST that is regulated under Section 76.922 of this Subpart. The franchising authority must make this initial decision within the 30 day period established for review of basic cable rates and equipment costs in Section 76.933(a) of this Subpart, or within the first 60 days of an extended 120 day period (if the franchise authority has requested an additional 90 days) pursuant to Section 76.933(b). The franchising authority shall provide notice of its decision to the cable system and shall provide public notice of its initial decision within seven days pursuant to local procedural rules for public notice. Operators or consumers may make an interlocutory appeal of the initial decision to the Commission within 14 days of the initial decision. Operators shall provide notice to franchise authorities of their decision whether or not to appeal to the Commission within this period. Consumers shall provide notice to franchise authorities of their decision to appeal to the Commission within this period. (e) A limited initial decision under paragraph (b) shall toll the time periods under Section 76.933 within which local authorities must decide local rate cases. The time period shall resume running seven days after the Commission decides the interlocutory appeal, or seven days following the expiration of the period in which an interlocutory appeal pursuant to paragraph (b) may be filed. (f) A local franchising authority alternatively may decide whether a collective offering of "a la carte" channels will be treated as an NPT as a part of its final decision setting rates for the basic service tier. That decision may then be appealed to the Commission as provided for under Section 76.945 of this Subpart. 6. Section 76.987 is added to read as follows: Section 76.987: New Product Tiers (a) Operators may establish a category of CPSTs, referred to as "new product tiers" ("NPTs"), and offer these tiers to subscribers at prices they elect. (b) In order to be eligible to offer NPTs, cable operators must meet the following conditions: (1) Operators offering NPTs are prohibited from making fundamental changes to what they offer on their BSTs and CPSTs offerings on September 30, 1994. Operators may drop channels or move channels between BSTs and/or CPSTs or to an a la carte offering so long as the aggregation of such changes do not constitute a fundamental change in their BST or CPSTs. (2) Operators may not drop channels that were offered on their BSTs or CPSTs on September 30, 1994 and move them to NPTs unless they wait at least two years from the date the channels were dropped from the BSTs or CPSTs. Time shifted versions, slightly altered versions or renamed versions of channels offered on BSTs and CPSTs on September 30, 1994 shall not be exempt from this restriction. (3) Operators must market their BSTs and CPSTs so that customers should be reasonably aware that (1) those tiers are being offered to the public; (2) the names of the channels available on those tiers; and (3) the price of the tiers. A subscriber may not be charged for an NPT unless the cable operator has obtained the subscriber's affirmative consent. Changes to the fundamental nature of an NPT must be approved by subscribers in accordance with  76.981. (4) Operators may not require the subscription to any tier, other than a BST, as a condition for subscribing to an NPT and operators may not require subscription to an NPT as a condition for subscribing to a CPST. These restrictions will not apply to cable operators prior to October 5, 2002, if such operators lack the capacity to offer BSTs and NPTs without also providing other intermediate tiers of service as provided in Section 76.900(c) of this Subpart. (c) Operators may offer the same service on NPTs as are on one or more BSTs or CPSTs. A channel that occupied a CPST or BST part-time on September 30, 1994 also may be offered full-time on an NPT as long as it continues to be offered at least part-time on the CPST or BST, under substantially the same conditions as before it was offered on the NPT. If a channel occupies a BST or CPST (regulated pursuant to Section 76.922 of this Subpart) full-time on September 30, 1994, and is subsequently reduced to part-time on the BST or CPST, that channel may not be offered on an NPT full-time. Operators that offer a channel both on an NPT and a BST or CPST will have a continuing obligation to ensure that subscribers are aware that the channels are available on the CPST or BST. (d) Operators may temporarily place new channels on CPSTs for marketing purposes and then move them to NPTs. In order for an operator to move a channel from a CPST to an NPT pursuant to this paragraph, the channel must not have been offered on a BST or CPST prior to October 1, 1994. (e) After initially electing to offer an NPT, a cable operator may cease to provide the NPT, upon proper notice to subscribers pursuant to Section 76.964 of this Subpart. If an operator drops an NPT and subsequently determines to reestablish that tier, at the time of the reestablishment it must comply with the conditions for offering NPTs set forth in paragraph (b). (f) If the Commission receives a complaint about an NPT, the operator need not file the rate justification provided in Section 76.956 of this Subpart, but shall within the time period provided by that rule file documentation that the NPT meets all the conditions set forth in this Section. (g) Within 30 days of the offering of an NPT, operators shall file with the Commission, a copy of the new rate card that contains the following information on their BSTs, CPSTs and NPTs: (i) the names of the programming services contained on each tier, and (ii) the price of each tier. Operators also must file with the Commission, copies of notifications that were sent to subscribers regarding the initial offering of NPTs. After this initial filing, cable operators must file updated rate cards and copies of customer notifications with the Commission within 30 days of rate or service changes affecting the NPT. APPENDIX C TECHNICAL APPENDIX INTRODUCTION In this Technical Appendix we describe the analysis and statistical methodology we used to inform our choice of the specific numerical values of the going forward price cap structure. Under our new, alternative going forward rules, an operator may raise rates for CPSTs when it increases the number of channels offered on those tiers. These rate increases are designed to cover the cost of providing this additional programming to consumers. Specifically, these costs include the cost of an operator's capacity used to provide programming, the fees paid for programming, and marketing costs. In order to protect consumers from the exercise of market power by a cable operator that elects to use the new going forward rules, rate adjustments to CPSTs will be governed by a price cap which limits the amount of the permitted rate increase according to the following rules: 1. For each channel added to CPSTs between January 1, 1995 and December 31, 1997, an operator may not increase the monthly per subscriber charges, for non-programming costs, more than $0.20. The $0.20 per channel limit is the per channel adjustment factor. 2. For all channels added to CPSTs between January 1, 1995 and December 31, 1996, an operator may not increase the monthly per subscriber charges, for non-programming costs, by more than $1.20. The $1.20 is the operator's cap. 3. An operator may use any portion of the operator's cap to pay for programming costs. In addition, an operator may charge an additional amount of programming costs to subscribers during the first two years. This additional amount is limited to $0.30 for new channels added to CPSTs. The $0.30 is the license fee reserve. Thus the total increase in the monthly per subscriber charges for CPSTs cannot exceed $1.50 over the period from January 1, 1995 through December 31, 1996. This $1.50 includes both amounts due to application of the per channel adjustment factor (i.e., the $1.20 operator's cap) and amounts due to application of the license fee reserve. 4. Finally, in the third year of the three-year period, the operator's cap rises by $0.20 to a total of $1.40. Hence, the increase in the monthly per subscriber charges for CPSTs, for non-programming costs, cannot exceed $1.40 over the three-year period. The license fee for the channels added in the third year will be subject only to the Commission's general rate rules, and will not be constrained by the license fee reserve. In this Appendix, we present the data and analysis we used to inform our choice of the specific numerical values of: (1) the per channel adjustment factor, (2) the operator's cap, and (3) the license fee reserve. The rationale for the addition of a seventh channel in the third year is discussed in the section on the operator's cap. In addition to describing the data and methodology employed by the Commission in its own study, this Appendix also reviews the studies submitted to the Commission by commenters filing in response to the Fifth Notice of Proposed Rulemaking in MM Docket No. 92 - 266. We review the studies submitted by outside parties and describe the approach taken by the Commission for each of the key variables in the price cap structure. 1. THE PER CHANNEL ADJUSTMENT FACTOR The per channel adjustment factor is the maximum permitted rate increase (for non- programming costs) for each channel an operator adds to its system's CPSTs. The adjustment factor reflects the cost that an operator facing effective competition would incur. There are two possible approaches to estimating the adjustment factor. One is to construct the number directly from cost data. The other approach is to estimate the competitive costs. In its current rules, the Commission takes a hybrid approach: programming costs are granted external cost treatment, while other costs are included in the per channel adjustment factor based on our examination of operator behavior. Commenters generally supported some variant of our hybrid approach. We believe that this hybrid approach serves the public interest. It avoids the administrative costs of conducting a full study to identify all costs, while ensuring that the parameters of our rules are empirically based, and serves both to protect consumers and to encourage systems to add channels. As stated in the Order, we are convinced that for most cable systems our current per channel adjustment factor (based on a cross-sectional analysis of the Commission benchmark survey data) is too small. As a result, the current factor does not create sufficient incentives for adding new channels. Several programmers that submitted comments urged the Commission to provide increased incentives to cable systems. These commenters told us that our 7.5 % markup scheme disadvantaged new services, which generally had minimal or no license fees. The commenters also said that the 7.5 % mark-up did not cover the costs incurred to add new channels. Out of concern that the current per channel adjustment factor is too low to provide adequate incentives for most systems to add channels, we re-estimated the value of the per channel adjustment factor. In their comments, three parties proposed specific methodologies for determining some or all of the numerical values in the Commission's price cap structure. These parties are: Tele-Communications, Inc. (TCI), the National Cable Television Association (NCTA), and Continental Cablevision, Inc. (Continental). We begin by reviewing and evaluating the two studies submitted by TCI and NCTA, since they are based on the same general approach that we followed. We then describe our own study. Finally, Continental's proposal, which takes a different approach, is discussed. As do the TCI and NCTA studies, we examined rate changes associated with channel changes in a sample of systems between two points in time. It is appropriate to examine changes over time because the price cap structure applies to changes in the number of channels over time. Thus, our time-series approach is more appropriate than a cross-sectional approach, which would examine differences among systems at a point in time rather than changes over time. We estimated the per channel adjustment factor using publicly available data and commonly accepted statistical techniques. We drew a sample of 500 systems that is representative of the systems that have insufficient incentives to add channels under our current rules. Although our sample is statistically valid, there are also other statistically valid samples. Differences between data sources and statistical techniques yielded different estimates of the elements of our formula. The estimates provide upper and lower bounds within which the exact value of the per channel adjustment factor lies. Having estimated these bounds, the Commission exercised its discretion to choose the value of the per channel adjustment factor that will best achieve the policy goals of the 1992 Cable Act. Our basic methodology in examining the per channel adjustment factor was to estimate the current cost of adding a new channel under competitive conditions. It was not possible to observe these costs from current data, since comprehensive industry cost data are not available. Therefore, we estimated the cost of a channel addition from historical data. We first recognized that the historical data that were available to us were in the form of rates or prices charged, rather than in the form of costs. To go from rates to a system's costs of adding a new channel, we adjusted the data for inflation, market power, and programming costs. This approach can be explained in terms of the generic per channel adjustment equation as shown below: per channel adjustment factor = where, R2 = Subscriber-weighted average monthly rates in year 2 for all relevant tiers, adjusted to 1994 dollars. R1 = Subscriber-weighted average monthly rates in year 1 for all relevant tiers, adjusted to 1994 dollars. N2 = Subscriber-weighted average number of channels in year 2. N1 = Subscriber-weighted average number of channels in year 1. MPA = Market power adjustment. LF2 = Average monthly programming cost per subscriber in year 2, adjusted to 1994 dollars. LF1 = Average monthly programming cost per subscriber in year 1, adjusted to 1994 dollars. The variables in the per channel adjustment equation are expressed above in general form. To make them more specific, several choices are necessary. We now explain the key choices behind each variable. Differences among the TCI Study, the NCTA Study, and our own Cable Services Bureau Study generally reflect different choices about how to measure the key variables in the per channel adjustment factor equation. The key choices that determine the per channel adjustment factor are as follows: (1) the data set, including: the period covered, the tier or service used to count channel additions, the type of channel additions counted, and the weighting scheme; (2) the inflation index; (3) the market power adjustment (MPA); and (4) the method of estimating programming costs. To define the subscriber-weighted average monthly rates (R) and the number of channels (N), the key choices are the weighting scheme and the type of channels to be counted. R and N make up the first term of the equation: R2 - R1 is the change in rates and N2 - N1 is the change in number of channels. Thus, assuming an increase in the number of channels, (R2 - R1) / (N2 - N1 ) is the increase in rates per channel added. The first adjustment made to the historical data was for inflation. The per channel adjustment factor is intended to cover the costs of adding a new channel. Since the rate data include price increases for inputs such as labor and materials associated with old channels, one must subtract these cost increases from the historical data. To adjust for such inflationary input price increases, a price index (e.g., the Gross Domestic Product Price Index or the Consumers' Price Index) is used. Another adjustment was for market power. If an operator has market power, it is able to charge subscribers a price above the competitive cost for new channels offered. Thus, one must estimate the MPA and multiply [(R2 - R1) / (N2 - N1 )] by the MPA. Since market power raises rates above competitive costs, the MPA is less than one, and this adjustment reduces the change in rates per channel. The last term in the per channel adjustment equation accounts for programming costs (LF). These costs are subject to external cost treatment and thus should be excluded for purposes of setting the per channel adjustment factor. Since the observed monthly rates per channel include programming costs (e.g., license fees), these costs must be deducted from our estimates. To adjust the change in rates per channel to remove programming costs, we must compute the change in LF per channel added. The change in license fees per channel is defined as (LF2 - LF1) / (N2 -N1). Having described the per channel adjustment factor in general form, we next consider two commenters' studies that estimated this factor. The TCI Methodology TCI used two data sources to estimate the per channel adjustment factor. The following table lists the choices TCI made in their estimating procedure. R2 = Subscriber-weighted average monthly rates in 1991 for the "most popular service", adjusted to 1994 dollars. R1 = Subscriber-weighted average monthly rates in 1986 for the "most popular service", adjusted to 1994 dollars. N2 = Subscriber-weighted average number of channels in 1991. N1 = Subscriber-weighted average number of channels in 1986. MPA = 0.83 = (1 - 0.17) = Market power adjustment LF2 = Average monthly licensing fee per subscriber times number of satellite channels in 1991, adjusted to 1994 dollars. LF1 = Average monthly licensing fee per subscriber times number of satellite channels in 1986, adjusted to 1994 dollars. TCI used two different approaches to estimate the per channel adjustment factor. The key choices in the first approach are summarized in Table 1, row 1 (labeled TCI 1). One key choice was their use of GAO data. TCI used data from the 1986 and 1991 GAO cable rate surveys. The GAO surveys report average rates, total channels, satellite channels, and other variables for the most popular service and the lowest price service. TCI used the most popular service figures. The most popular service is defined by GAO as the one to which the most customers subscribe. It may be the basic tier or it may be basic plus expanded basic on different operators' systems. TCI also estimated average monthly programming costs by multiplying the subscriber-weighted average costs by the average number of satellite channels. TCI derived its per channel adjustment factor as follows. First, TCI calculated changes in inflation-adjusted most-popular tier rates for the relevant time intervals. Second, TCI divided the rate changes by the corresponding change in the number of channels. To adjust for market power, TCI then multiplied the per channel rate change by 0.83, reflecting the competitive differential that the Commission identified in its rate regulation proceeding. Then, TCI subtracted the estimated change in programming costs per channel added to derive a per channel adjustment factor of $0.211 for the November 1986-April 1991 period. TCI refers to its first approach as the "same-cost method".{{{(R_2 - R_1)} over {(N_2 - N_1)}}~~~bold-~~~{{(LF_2 - LF_1)} over {(N2 - N_1)}}} As an alternative approach, TCI used the FCC benchmark data set to estimate the per channel adjustment factor. This second approach is summarized in Table 1, row 2 (labeled TCI 2). TCI began with separate calculations of the inflation-adjusted annual rate change between November 30, 1986 and September 30, 1992 for each non-competitive system in the FCC benchmark sample. For each non-competitive system, TCI calculated a rate increase per channel added. These figures were combined with the same programming cost data used in the GAO data set calculations to derive the per channel adjustment factor using the same-cost method. The per channel adjustment factor under this method is $0.30. Although we believe TCI's overall methodology is reasonable, both of TCI's approaches have shortcomings. The first approach does not properly estimate the costs of adding new channels to the system. It does not adequately distinguish between adding a new channel and switching an established channel from one tier to another. TCI started with monthly rates from the GAO surveys for the most popular service in 1986. Between 1986 and 1991, however, the most popular service changed because of tier restructuring. Tier restructuring involves the movement of channels between tiers, not the addition of new channels to the system. Yet, the price cap structure relates only to new channels added to an operator's system. Hence, GAO data on the most popular service give an inaccurate picture of the number of new channels added to an operator's system. Failing to account for such restructuring can bias the estimates of the per channel adjustment factor. The tier restructuring problem inherent in the GAO data is not easily corrected. GAO data on cable rates are based on types of services offered rather than on specific tiers of service. Hence, use of GAO data for estimating the cost of adding a channel to a tier would require converting service-based rates to tier-based rates. The information needed to do this conversion is not available. In its second study, TCI applied its methodology to data from the FCC benchmark survey. While this second study does not suffer from the tier restructuring problem, it is subject to a different limitation. TCI took a weighted average of rates across systems. This is single weighting. However, TCI did not also take a weighted average of rates across tiers within each system. Doing both types of weighting is double weighting. Both weighting schemes need to be considered. Each provides a useful check on the results of the other. TCI should have at least attempted the double-weighting scheme, and explained why it was not applicable. The NCTA Methodology NCTA submitted a study that used data on municipal and overbuild systems from the FCC benchmark survey. NCTA calculated a per channel adjustment factor ranging from 30 cents to 77 cents. The 30 cent estimate is the median and the 77 cent estimate is the average. NCTA's rationale for using this sample was that the systems met the statutory definition of effective competition, and thus the pricing of these systems represented competitive behavior. The following table lists the choices NCTA made in estimating the per channel adjustment factor. R2 = Average monthly regulated revenues per subscriber in 1992 for all regulated tiers, in 1992 dollars. R1 = Average monthly regulated revenues per subscriber in 1986 for all regulated tiers, adjusted to 1992 dollars. N2 = Number of channels in 1992 (total channels). N1 = Number of channels in 1986 (total channels). MPA = By selecting a competitive sample, NCTA removed the effect of market power. LF2 = Average licensing fee per subscriber times the number of satellite channels in 1992, in 1992 dollars. LF1 = Average licensing fee per subscriber times the number of satellite channels in 1986, adjusted to 1992 dollars. Table 1, row 3 shows the NCTA choices. Unlike the first TCI study, the NCTA study avoided the problem of tier restructuring. However, the NCTA study has two limitations. First, NCTA used data that pertain largely to a single year to estimate the per channel adjustment factor, which relates to changes over time. Because the benchmark data set is missing observations for 1986, NCTA could not properly use it to calculate changes in rates and number of channels between 1986 and 1991. However, the benchmark data set contains sufficient observations for 1991 to estimate the competitive differential, which we used as our market power adjustment. As explained in the Commission's Second Order on Reconsideration, the competitive differential is the average difference in rates between systems subject to effective competition and systems not subject to effective competition. A second limitation of the NCTA study is the exclusion of compulsory license fees from estimated programming costs. Compulsory license fees are the royalty payments made by cable operators to copyright holders for retransmission of television broadcast signals. NCTA estimated programming costs using annual basic license fee data from Paul Kagan Associates. The per-subscriber license fee was obtained by dividing the annual fee by the number of basic tier subscribers which, in turn, was divided by 12 to get the monthly per- subscriber license fee. Next, the monthly per-subscriber license fee was divided by the number of satellite channels to get the average monthly license fee per satellite channel. NCTA calculated the programming costs of each of the 17 systems by multiplying the average monthly license fee per satellite channel by the number of satellite channels in each system. This method underestimates total license fees because it excludes the compulsory portion of the license fee. As a result of underestimating the license fee, the estimate of the per channel adjustment factor is too high. Cable Service Bureau (CSB) Study Our approach is similar to TCI's approach, with two exceptions. Whereas TCI used GAO's most popular service, we used all regulated tiers. Also, we weighted our sample by the number of subscribers in each tier and by the number of subscribers for each operator. By contrast, TCI weights their sample by subscribers by operator. The CSB approach can be summarized using variables in the per channel adjustment equation as follows: R2 = Subscriber-weighted average monthly rates in 1991 for all regulated tiers, adjusted to 1994 dollars. R1 = Subscriber-weighted average monthly rates in 1986 for all regulated tiers, adjusted to 1994 dollars. N2 = Subscriber-weighted average number of channels in 1991 (total channels). N1 = Subscriber-weighted average number of channels in 1986 (total channels). MPA = 0.83 = (1 - 0.17) = Market power adjustment LF2 = Monthly licensing fee expenditures per subscriber in 1991, adjusted to 1994 dollars. LF1 = Monthly licensing fee expenditures per subscriber in 1986, adjusted to 1994 dollars. In the remainder of this section we spell out the Commission's approach in detail. The Data Set In order to estimate the elements of the going forward rule structure, we considered three sources of data: the GAO Survey of Rates and Services Offered by Cable Television Systems (hereafter called GAO data set); the FCC's benchmark survey (hereafter called the benchmark data set); and data from the Television and Cable Factbook (hereafter called the Cable Factbook data set). We believe that the Cable Factbook is the best suited data set to estimate the elements of the price cap structure for three reasons. First, the Cable Factbook data set includes data for each year for the 1986 to 1991 period. This time series allowed us to analyze changes in rates and in the number of channels. We used these changes to estimate the per channel adjustment factor. Because the benchmark data set is missing observations for 1986, we could not use it to calculate changes in rates and number of channels between 1986 and 1991. However, the benchmark data set contains sufficient observations for 1991 to estimate the competitive differential, which we used as our market power adjustment. Second, the Cable Factbook data set includes all tiers, and allowed us to identify new channel additions to each system. Thus, we could separate new channel additions from channels moved between tiers. This eliminated the problems caused by tier restructuring. As a result, our estimates of the per channel adjustment factor are correctly based only on new channels added to the system. Established channels that were switched from one tier to another did not affect our estimates of the per channel adjustment factor. Unlike the Cable Factbook data set, the GAO data set did not allow us to distinguish new channel additions from channels switched between tiers. The data set contains rates only for the most popular service and the lowest price service. As noted above in our discussion of the first TCI study, the GAO data set could bias the estimated cost of adding a new channel to a system. Third, the Cable Factbook data set includes all large systems. This ensured that our estimate of the per channel adjustment factor achieves our goal of providing adequate incentives for systems to add channels. The existing rules allow for different per channel adjustments for large and small systems. However, the existing rules provide inadequate incentives for systems to add channels. Our new rules provide adequate incentives for small systems, such as the headend cost adjustment. When we estimated the per channel adjustment factor, we wanted to ensure that large systems also have adequate incentives. Thus, we used a data set that included all large systems. Our sample of cable systems included 500 systems which were in operation both in 1986 and 1991. We used a stratified random sampling method to select our sample. We had nine distinct strata based on the number of subscribers on the system. Table 2 shows the composition of our sample. This sampling method weights systems with a larger number of subscribers and those with a smaller number of subscribers in proportion to their relative shares in the total number of subscribers in the industry. Accordingly, we included most of the top 200 cable systems. In addition, 31.92% of our sample is made up of systems with more than 50,000 subscribers. Weights for the remaining strata were in proportion to their percentage of the total number of basic tier subscribers in the industry as published in NCTA's Cable Television Developments booklet, dated April 1994. The benchmark data set consists of a sample of cable service rates for 1986 and 1991. The rates are for all tiers: basic, extended basic, and all others. The data set consists of a random one percent sample of approximately 3,000 systems. There is no emphasis placed on large systems. In the data used to estimate the competitive differential rate adjustment, the sample includes only 16 of the 100 largest systems. Appropriate to the task of formulating general going forward rules, which contain separate, specific provisions for small operators, we placed greater emphasis on larger system data over smaller system data. The record strongly suggests that small systems operate under different parameters than large systems and, as a result, have higher administrative and operating costs. Our analysis avoids overestimating the cost of channel additions that would result from an oversampling of these higher-cost systems. The Time Period We estimated the per channel adjustment factor using Cable Factbook data on rates during the pre-regulation period (1986-1991). Cable systems were subject to rate regulation only by local franchising authorities between 1974 and 1984. The 1984 Cable Act deregulated the cable industry. By the end of 1986, deregulation was largely completed. Moreover, we believe that a sufficient percentage of cable systems were deregulated by the beginning of 1986 for us to consider all of 1986 deregulated. Even before then, rate regulation by local franchising authorities was not fully effective. Further, local franchising authorities could regulate only basic rates where effective competition was absent. Thus, extended-basic rates were not subject to regulation. As a result, we consider 1986 as the start of the deregulation period before passage of the Cable Act of 1992. We selected a deregulated period because we wanted to observe unregulated market behavior. Free of the influence of regulation, such data enabled us to estimate the competitive cost of adding a channel. This estimate provided the basis for the per channel rate adjustment factor. However, we could not observe costs directly. What we could observe were historical rates. We therefore looked at historical rates and adjusted them for market power to provide an estimate of costs. The Weighting Scheme We considered two types of weighting schemes: (a) single weighting and (b) double weighting. Both schemes yielded subscriber-weighted averages for rates and for the number of channels. To obtain a simple (unweighted) average rate, one starts with rates by tier on each system for a given year. The tier rates are then summed and divided by the number of tiers to obtain the average rate for the system. The average rates are then summed for all systems and divided by the number of systems to obtain the average rate for all systems. To obtain a subscriber-weighted average rate, weights are applied based on the number of subscribers across tiers, systems, or both. A single weighting scheme weights only once, across either tiers or systems. A double-weighting scheme weights twice, across both tiers and systems. In our study, we used a double-weighing scheme that weights across tiers by the number of subscribers on each tier, for a given system, and then weights across systems by the total number of basic subscribers on each system. We selected double weighting because this method gives a more accurate picture of the experience of the largest number of subscribers on each system. This is desirable because the price cap structure can benefit more subscribers if it is based on the experience of the largest number of subscribers. For example, the double-weighting scheme first weights the individual tier rates by the number of subscribers on each tier. CPSTs are thus emphasized less than basic tiers, reflecting the fact that CPSTs have fewer subscribers. The double- weighting scheme then sums the subscriber-weighted tier rates for each system in a given year. Then, the double weighing scheme weights each system's rate for all tiers by the number of subscribers on the system. Finally, double weighting sums the subscriber-weighted rates for all systems. The resulting sum is a subscriber-weighted average rate for the year. Adjustments to the Data Set We made three adjustments to the rates from the Cable Factbook data set. First, we adjusted the rates to remove the effects of inflation. Next, we computed observed changes in rates per channel added from one year to the next. Subsequently, we adjusted rate changes to remove the effects of market power. Finally we subtracted the monthly programming expense from the rate increases per channel added. The resulting adjusted rate increase per channel added provided our estimates of the per channel adjustment factor. Adjustment for Inflation This adjustment was made using the Department of Commerce's Gross Domestic Product Price Index (GDP-PI). We use the GDP-PI as an adjustment factor because it is a broad-based index that includes all goods and services, including those that cable operators purchase as inputs. In contrast, the Consumer Price Index (CPI) is more representative of the market of goods and services commonly purchased by households. The rates for each year were multiplied by the value of the 1994 GDP-PI inflator for the same year. This allowed us to express all the rates in 1994 dollars, thereby removing the effect of inflation. Adjustment for Market Power The exercise of market power was another reason rates increased between 1986 and 1991. Such rate increases were in addition to the costs of adding a channel incurred in a competitive environment. Consequently, we reduced observed monthly rates in non- competitive markets by the "competitive differential" found in the FCC's revised benchmark calculation. This reduction was called for in the 1992 Cable Act, which sought to give cable subscribers the benefits of competition (i.e., reduced prices and improved service), when competition does not exist in their local market. The benchmark calculation estimated the average difference between competitive and noncompetitive rates at 17 %. Hence, we reduced the average monthly rate by 17 % to account for the exercise of market power. Failure to adjust the average rate for market power would overestimate the per channel adjustment factor. Because it is an average, we applied the 17 % adjustment to all systems rather than estimating an individual adjustment factor for each system. We recognize that 17 % may be too large an adjustment for some systems and too small an adjustment for others. In addition, because 17 % was estimated using historical data on existing channels, it may differ from the market power adjustment for existing and newly added channels. Despite these qualifications, we believe that any errors introduced by the use of this market power adjustment do not have a significant effect on the estimates of the per channel adjustment factor. Adjustment for Programming Costs We considered two alternative measures of programming costs: "average" license fees and "compulsory plus basic" license fees. The average license fee represents license fees paid by cable operators for a majority of the top twenty cable channels. It takes into account volume discounts and other discounts received by cable system operators. We obtained the data for average license fees for the years 1989 to 1991 from the Paul Kagan Associates Cable TV Programming newsletter (April 1992). Annual average license fee data were converted to monthly data by simply dividing by 12. Since average license fees do not include all possible cable programming expenses, they underestimate the total programming expense incurred by an operator. To compensate for this underestimating effect, we used our second measure, the "compulsory plus basic" method. Our second measure of programming cost, compulsory plus basic license fees, is made up of two parts. The basic portion of the license fee is actual programming costs incurred by operators. We obtained annual basic license fee data from Paul Kagan's Cable TV Programming newsletter (March 1992). These license fees are annual expenditures which operators pay to programmers for non-broadcast cable programming services. We then divided annual fees by the number of basic subscribers to get the per-subscriber rate, and then divided by 12 to get monthly data. The second part is compulsory license fees. These are the semi-annual royalty payments that each operator must make for retransmission of TV broadcast signals by its systems. We added compulsory license fee data to basic license fee data to obtain total programming costs incurred by operators. We converted annual compulsory license fee payments data from the U.S. Copyright Office, Library of Congress. We this converted annual data to monthly per subscriber data by dividing the annual compulsory license fee data by the number of basic subscribers and then by 12. All programming cost data were then adjusted for inflation using the GDP-PI. These two methods provided us with an upper and lower bound for estimating programming costs. Estimates of the Per Channel Adjustment Factor To estimate the per channel adjustment factor, we calculated the change in monthly rates (net of programming costs) between 1986 and 1991 and divided by the change in the number of channels between 1986 and 1991. Because of differences in data sources and statistical techniques, the estimates we obtained can provide only an upper bound and a lower bound for the per channel adjustment factor. To obtain the upper and lower bounds, we varied the sources of programming costs. Our estimates of the per channel adjustment factor are summarized in Table 3. The estimates in Table 3 were obtained using different data sources for programming costs. The first row in the table presents the results using basic plus compulsory license fees to adjust for programming costs. The second row presents the results using average license fees to make this adjustment. The columns in Table 3 show how the per channel adjustment factor is calculated. Column 1 shows the per channel change in average monthly rates. These rate changes are already adjusted for inflation and market power, and are divided by the change in the number of total channels. Column 2 shows the per channel change in programming costs. The estimated per channel adjustment factor is shown in column 3. It is calculated by subtracting the estimated programming cost per channel in column 2 from the per channel rate change in column 1. As shown in Table 3, our two estimates of the per channel adjustment factor are 21.9 cents and 18.7 cents. The average of these estimates is 20.4 cents. Within the lower and upper bound estimates of the per channel adjustment factor (18.7 and 21.9 cents), the Commission has exercised its discretion and selected 20 cents as the value that will best achieve the goals of the 1992 Cable Act. Based on historical experience, we believe that a 20 cent per channel adjustment factor will encourage systems to add new channels to their CPSTs, while at the same time protecting subscribers from excessive rate increases. The Continental Cablevision, Inc. Methodology Before concluding the discussion of the per channel adjustment factor, we discuss the proposal of Continental Cablevision, Inc. Under the Continental proposal, the per channel adjustment factor was calculated separately for each system, equal to the system's average rate for all channels, net of licensing fees. Using this method, for example, a system charging $12.00 per month for a 10 channel tier with $2.00 in licensing fees would yield a $1.00 per channel adjustment factor [$1.00 = ($12.00 - $2.00)/10]. Continental argues that its approach is reasonable since it uses rates established under the Second Reconsideration Order. As specified by the Order, these rates are adjusted downward by 17 % to eliminate the effects of market power. Although these rates may be competitive, there is a serious shortcoming with Continental's proposal. Continental calculated the average charge per channel for all channels rather than the average charge per channel for new channels added to the system. Consequently, Continental's approach failed to account for economies of scale in the provision of services and the likely declining incremental value to subscribers from incremental services. Thus, there is strong reason to believe that Continental's estimates of the per channel adjustment factor are too high. As a result of this shortcoming, we have decided not to adopt the Continental proposal. 2. THE OPERATOR'S CAP In this section, we describe the procedure for establishing the operator's cap, which limits the amount by which cable system operators may increase monthly per subscriber charges for non-programming costs when they add new channels to their CPSTs. We begin by reviewing why such a cap is necessary. Where regulation under the 1992 Cable Act has pushed cable rates below their unregulated, profit-maximizing levels, systems under the new rules could have incentives to add low-value channels to regulated tiers to make up for the mandated price reductions, even when doing so raises the cost of programming more than the value of the added channels to subscribers. Based on a study conducted by Charles River Associates (CRA), the NCTA recommended a cap of $1.50 per year. The CRA study examined the historical increase in rates and found that the average increase in channels is approximately two channels per year with a corresponding increase in rates ranging from $0.21 per channel to $0.26 per channel. While ultimately accepting CRA's estimates, NCTA argued that the rate of channel additions between 1986 and 1991 was limited by a shortage of new programming. NCTA contended that the rapid growth in cable networks currently underway would result in systems adding new channels in excess of two per year in the future. The underlying approach taken by the Commission in setting the operator's cap was to ensure that systems could continue to add channels at the same rate they did during the deregulated period. This was done by first estimating the historical pattern of channel additions. Then we calculated what operator's cap amount will allow systems to add that number of channels, while charging the per channel adjustment factor for each additional channel plus an allowance for programming costs. This section focuses on estimating the historical rate of channel additions. There are several issues that we had to address in estimating this rate. For example, we had to consider the pattern of channel additions to ensure that average numbers are not misleading. To see this point, suppose that over a three-year period systems added an average of two channels per year. This average could be the result of each system steadily adding two channels per year. Alternatively, it could be due to two-thirds of the systems adding no channels in a given year, with the remaining one-third adding six channels that same year. Our approach to this problem is as follows. As a first step, we estimated the average rate of channel additions per year. Having found this average rate, we then looked at the distribution of systems whose historical pattern of channel additions fell within a cap based on three times the average rate. Based on the historical pattern of channel additions, we decided to allow systems the flexibility to offer the full complement of channels at any point in the next three years (that is, they will not be restricted by the one-year channel addition average in each year). Possible changes over time may have affected the historical rate of channel additions. Potential factors include the end of regulation (which might have led to a temporary increase in the rate of channel additions as a "cover" for rate increases), changes in the number and quality of cable services available for systems to add, and the imposition of the must-carry rules. In order to calculate the average rate of channel additions, as well as the range of channel additions, we had to select the proper sample. The key choices are the time period, the tiers included, and the nature of the channels counted. For the reasons given earlier, we find the time period from 1986 through 1991 to be reasonable for these purposes. In terms of the tiers included, we considered two approaches. One is to include all regulated tiers. Alternatively, one could examine only those channels added to CPSTs. One could argue that historical additions to basic should not be included, given that the operator's cap does not apply to additions to basic. Nevertheless, we believe that the maturation of the cable industry makes it reasonable to project that future additions to CPSTs will be at a rate similar to the past rate of additions to all regulated tiers. We decided to use total channels (satellite, broadcast, and local origination) to construct our estimate of the operator's cap. We made this decision so that the estimate of the operator's cap is consistent with our estimate of the per channel adjustment factor, which was estimated using total channels. One could argue that the historical pattern of satellite channel additions better reflects the rate of channel additions to CPSTs. We recognize that in the future, channels added to CPSTs will primarily be satellite channels. Our choice to use total channels will not hinder the growth of satellite channels on CPSTs. To obtain an upper and lower bound for the average number of channels added per year, we varied the weighting scheme. We estimated single-weighted and double-weighted changes in total channels. Our estimates ranged from a single-weighted average of 2.3 channels added per year to a double-weighted average of 2.5 channels added per year. Thus, our estimate of the average number of channels added per year is 2.4. These annual rates correspond to an average of five channel additions over a two-year period and seven channel additions over a three-year period. These numbers influenced our thinking about recovery of costs of a seventh channel in the third year under the price cap structure. For satellite channels, our estimates range from a single-weighted average of 1.9 channels added per year to a double-weighted average of 2.1 channels added per year. Since total channels added between 1986 and 1991 are slightly higher than satellite channels added, we are confident that our use of total channels to construct the operator's cap will not hinder the addition of satellite channels to CPSTs. If anything, it will better promote satellite channel growth on CPSTs. In determining the operator's cap, the Commission recognized that the addition of channels is "lumpy". In other words, in any one year a cable system may add more channels than the average, but then refrain from adding channels, or add below the average number of channels in a subsequent year. Setting the operator's cap to promote channel additions at the historical average rate may be too restrictive. Systems that want to add more than the historical average in any one year may be discouraged from doing so. To avoid discouraging systems from adding new channels, we set the operator's cap at a level that would provide enough added revenue to encourage channel additions at the historical average rate. Accordingly, the Commission has decided to set the operator's cap to promote the addition of an average of three channels per year for the next two years. This rate corresponds to six new channels over the next two years. With the seventh added channel in the third year, an operator could collect additional revenue for an average of two and one- third new channels per year over the next three years. The operator's cap provides flexibility in the timing of channel additions. For example, the cap allows an operator to collect added revenue for up to six new channels in the first year, taking the full per channel adjustment factor on each. Moreover, systems that want to add more than seven channels in the next three years can do so by adding channels to NPTs. Alternatively, systems can add more channels to existing CPSTs by taking less than the full per channel adjustment factor on each channel. The flexibility provided by the operator's cap is consistent with the experience of systems during the pre-regulation period. On average, between 1986 and 1991, 71.6 % of systems added six or fewer channels during any two-year interval. On average during the same period, 61.4 % of systems added seven or fewer channels during any three-year interval. Based on the historical evidence, we believe that the operator's cap will not impose an unreasonable restriction on channel additions to CPSTs over the next three years. 3. THE LICENSE FEE RESERVE The license fee reserve is the final component of the cap structure that we estimated. At the same time that it protects consumers, the reserve must be set high enough to allow for programming costs associated with new channels added. As with the operator's cap, our choice of the value of the license fee reserve was informed by determining an appropriate per channel allowance and then multiplying this amount by a rate of channel additions that reflects the historical pattern. Given our earlier estimate of the historical rate of channel additions, our focus in this section is on the estimate of an appropriate allowance per new channel added. The first step in establishing the license fee reserve was to estimate license fees that operators historically incurred when they added channels to their systems. Conceptually, one wants to calculate the average license fee per subscriber for each channel added. We used two types of data to approximate the average license fee incurred per added channel. The first type included license fee expenditures for all programming, both new and old. We used two data sets: basic plus compulsory license fee expenditures and "average" license fee. We used these data to calculate the change in inflation-adjusted license fee expenditures per channel added between 1986 and 1991.{{(LF_2 - LF_1)}over{(N_2 - N_1)}} This calculation provided an upper bound because we were unable to exclude increases in license fee expenditures caused by price increases for programs already on cable systems. Our upper bound estimate is 12.9 cents. The second type of data contained the license fees for each new channel in the first year that the channel was introduced commercially. The data set includes all seven channels that were introduced commercially between 1985 and 1991. We used these data to calculate the average license fee (adjusted for inflation) per subscriber. By focusing only on the license fees associated with newly introduced services, we excluded license fee increases associated with channels already on some cable systems. In addition, we could better account for programmers' practice of discounting license fees in the year that a new service was introduced. Table 6 shows that the average of first-year license fees between 1985 and 1991 is 3.7 cents. The 3.7 cent estimate is a lower bound because it excludes programs that are new to the system but not to the industry. In addition to adding newly launched programming services, systems add new channels for programming services that are not new to the industry. The license fee reserve is intended to encourage systems to add new programming, including programming already on other systems. Since previously launched cable programming services may already be commercially successful on other systems, they are likely to be higher priced than the newly launched programming. Therefore, the 3.7 estimate is our lower bound for new programming costs. In sum, the two types of data provide a lower and an upper bound for the change in license fees per channel added. Our estimate of the lower bound is 3.7 cents. Our estimate of the upper bound is 12.9 cents. Based on the policies we adopt in the Order and our analysis of the data, we believe that a 30 cent license fee reserve will encourage operators to add new channels, while at the same time protecting subscribers from excessive rate increases. First, if operators add six new channels in the next two years, the license fee reserve alone will provide an average programming allowance of 5 cents per channel. This 5 cent allowance lies within our upper and lower-bound estimates of historical programming costs. Second, operators may use part of the operator's cap to pay programming costs. Third, our rules permit operators to add programming to NPTs, which are not subject to a rate cap. Finally, the license fee reserve will be in effect for only two years. In the third and subsequent years, new programming will be subject only to the Commission's general rate rules. Thus, new programming can be priced low to gain acceptance in the first two years and then priced higher to reflect its increased popularity in later years. APPENDIX A Petitions for Reconsideration in MM Docket 92-266 Bell Atlantic Commissioner of Baseball Eternal Word Television National Association of Telecommunications Officers and Advisors Et. Al. ("NATOA") Public Interest Petitioners United Video Viacom International (also errata) Comments/Oppositions to Petitions For Reconsideration in MM Docket 92-266 Arts & Entertainment and ESPN (also errata) Bell Atlantic City of Detroit Continental Cablevision Discovery Communications, Inc. Fox Basic GTE Service Corporation Liberty Media National Association of Telecommunications Officers and Advisors and the City of New York National Cable Television Association Time Warner Entertainment Co., L.P. Viacom International Replies to Comments/Oppositions to Petitions for Reconsideration in MM Docket 92-266 Bell Atlantic City of Detroit GTE Service Corporation United Church Public Interest Petitioners Comments to Fifth Notice of Proposed Rulemaking in MM Docket 92-266 Affiliated Regional Communications, Inc. Cable Telecommunications Association Cablevision Industries Corporation Cablevision Systems Corporation Continental Cablevision, Inc. Court TV Discovery Communications, Inc. E! Entertainment Co. GTE Service Corporation Jones Education Networks Liberty Media Corporation National Cable Satellite Network d/b/a C-SPAN Lifetime Television National Cable Television Association National Hockey League Pagosa Vision, Inc. Programming Providers - Ovation, Inc. and PBS Horizons Cable Network Providence Journal Company Et. Al. Rainbow Programming Holdings, Inc. Small Cable Business Association (also errata) Tele-Communications, Inc. The Times Mirror Company Time Warner Cable Turner Broadcasting System, Inc. USA Networks Viacom International, Inc. Reply Comments to Fifth Notice of Proposed Rulemaking in MM Docket 92-266 Affiliated Regional Communications, Inc. Commissioner of Baseball The Inspirational Network Liberty Cable Company, Inc. Liberty Media Corporation Lifetime Television National Cable Television Association National Hockey League New England Sports Newhouse Broadcasting Corporation Sammons Communications Inc. and TCA Cable TV Inc. Small Cable Business Association Summit Communications, Inc. Tele-Communications, Inc. Time Warner Cable USA Networks Viacom International, Inc. Comments to Further Cost Notice in MM Docket No. 93-215 Bell Atlantic BellSouth Corporation and BellSouth Telecommunications, Inc. Discovery Jones Education Networks, Inc. National Cable Television Association Rainbow Programming Holdings, Inc. Tele-Communications, Inc. Time Warner Entertainment Company, L.P. Turner Broadcasting Systems, Inc. Fred Williamson & Associates, Inc. Reply Comments to Further Cost Notice in MM Docket No. 93-215 Bell Atlantic Comcast Cable Communication, Inc. Liberty Media Corporation United States Telephone Association