NEWS December 20, 1994 CHAIRMAN HUNDT DISCUSSES CABLE'S TRANSITION TO COMPETITION In an address today before the Washington Cable Club, in Washington, DC, FCC Chairman Reed E. Hundt discussed issues facing the cable industry as it transitions to competition and away from regulation. Hundt first noted the cable industry had done a "terrific job" in adapting to the new regulatory environment, noting that since the new rules became effective on July 15, subscribership has risen beyond expectation and revenues and capital investment have also increased. And this is before the impact of the Commission's cable "going-forward rules," he pointed out. These rules, adopted last month, will permit operators to offer New Product Tiers at any price the operator chooses and to increase subscriber rates for new programming channels on the enhanced basic tier. Chairman Hundt noted that according to Wall Street bankers, under the new rules, "the industry can expect an estimated $1 billion in additional revenues." Hundt noted that despite financial good news, the industry was justifiably concerned about changes in the competitive marketplace. To help that adjustment Hundt proposed specific actions related to small systems and upgrades for improvements in quality. The biggest issue facing cable, Hundt said, is potential competition. He described that potential competition and then said, "The issue then is . . . will there come a time when the Commission should declare that the cable operator's enhanced basic package is 'not unreasonably' priced because of market conditions and therefore the Commission does not need to set rates for that package?" Hundt addressed the claims of some who, in contrast to a market-oriented approach, suggest that government should provide more incentives for specified investments. He enumerated three arguments against that suggestion. First, government should not be telling industry how to spend its money; second, if we let all single sellers of much-valued essential products raise their prices to consumers to get extra money for investment, to be fair we'd have to do the same thing for local telephone companies and for the local electric utilities; and third, consumers would be highly dissatisfied with this notion of being forced to pay more today for today's enhanced basic in return for being offered something hard-to-define in an uncertain future." - FCC - CHAIRMAN REED E. HUNDT SPEECH BEFORE THE WASHINGTON CABLE CLUB WASHINGTON, D.C. December 20, 1994 Beyond Going Forward: The Transition to Competition Thank you John for inviting me to today's lunch. I'd like to acknowledge the presence of Commissioner Susan Ness, who has worked hard with me on the exciting issues before the Commission. I have been in my job as chair of the FCC for just over a year. Whatever I bring to my job comes from my private sector experience. Before going to the Commission I spent almost 20 years as a litigator in private practice, first in Los Angeles and later in Washington, where I grew up. I represented plaintiffs and defendants in federal and state courts in almost every single state of the Union. I worked on just about everything a lawyer and litigator can work on -- except, of all things, lobbying the FCC. That field seemed to be pretty much occupied by the time I got to town. In all these cases and experiences, I learned again and again the importance of simply listening: listening to witnesses, listening to judges, listening to opposing counsel, even listening to the expressions on jurors' faces. I have never needed the skills of listening more than in the job I now have. Today I'd like to share with you some of what I have heard about cable -- about its complex past and its very promising future. What I've been told about the past, and what I've experienced, has its lessons for the future. And what I'm now being told about the future is what I hope you will correct or corroborate. Let's start with the past. I won't go back to the 60s and 70s, except to recognize the hard work cable operators like yourselves put in back then in achieving the success you later obtained. Ten years ago, Congress passed the 1984 Cable Act. This lifted all local rate restrictions and barred telephone companies from entering the cable programming business. Congress wanted to help the cable industry become part of the information highway, a term no one used back then. Congress also sought to make cable a viable competitor to broadcasting. The Act had the desired effects. Earnings went up. Cable companies used the earnings to invent their own programming and to finance the buildout of the cable system to almost every home in America. We're the only country in the world where the majority of homes -- over 96% -- are reached by cable. But in only a few short years, cable was a victim of its own success. Consumers began to feel that cable was not an option but was a necessity among their monthly purchases. And prices began to go up far faster than inflation. Within just four years of the effective date of the 1984 Cable Act, Congress was considering new action to respond to consumer complaints. This effort culminated just over two years ago when Congress passed the 1992 Cable Act with the bipartisan support of 74 senators, including 24 Republicans, and 308 members of the House, including 77 Republicans. As everyone knows, the Cable Act was the only legislation passed over President Bush's veto. Against the background of the '84 Act, the 1992 Cable Act was received with apprehension and dismay by the cable industry. The 1992 Act delegated substantial responsibility to the Commission, and in 1993, the industry sought to persuade the Commission not to apply the Cable Act to all cable operators or all cable consumers. The Commission in effect went along with this argument when it adopted the benchmark formula in 1993. Unfortunately, under the 1993 benchmark order, operators raised rates for about one-third of all cable subscribers in the country. The consumer reaction was on almost every newspaper's front page. For example, a Houston Chronicle headline at the time read: "Cable Rates Rising Despite New Rules -- Angry Consumer Protests Spur Survey." The rate increases also drew a response from Congress. In a September 1993 letter to Jim Quello, 133 members of the House voiced concern about increased cable rates. Chairman Quello also responded at oversight hearings to concerns that the Commission's 1993 benchmark did not comply with Congress' intent in passing the Cable Act. Jim Quello said in a speech that October that he was concerned about the reported increases in cable rates, and he pledged that the Commission would work with Congress to resolve rate problems, set reasonably competitive rates, and assure that the Cable Television Consumer Protection and Competition Act remained true to its name. As part of this effort, on November 15, 1993, the Commission extended the freeze on all cable prices until it could take another hard look at the regulations to assure they complied with Congressional intent. This was the situation when I arrived at the Commission. I want to make special mention of the prodigious work my predecessor, mentor and friend, Jim Quello, did in implementing this Act. In November 1993 it was obvious to Jim and everyone at the Commission that something had to be done to re-do the rate regulations. In addition, we had to issue cost-of-service and going-forward rules. We felt tremendous time pressure because we knew the freeze was doing harm to the industry. In an inflationary economy it acted as a hidden but ongoing price decrease in real dollar terms. We created a Cable Bureau and put some of the experienced hands in with new folks to get a team big enough to handle the issues. Then we all worked around the clock for about 100 days. I myself had 32 separate meetings with industry leaders on cable issues in those first months. By unanimous vote on February 22, 1994, the Commission issued going-forward rules, cost- of-service rules and a revision of rate regulation. We provided for a phase-in of the rules, with rate regulation not taking place until July 15. We created exceptions to rate regulation such as those for small systems and low-price systems. But we did base our decision on this fact of economic life: wherever cable operators were the only sellers they could be expected to charge more than if they faced competition. Therefore where cable operators were the only sellers, we ruled that all had to lower their prices to some degree in order to meet the Congressional requirement that prices be "reasonable" for basic and "not unreasonable" for enhanced basic. We settled on a 17% reduction in the following manner. Our statistics showed that prices would be between 16% and 38% lower if operators faced even a single competitor. We thought the high price-or low reduction-end of this range would be enough to deem regulated prices as "reasonable" or "not unreasonable." We also felt it would be best to allow a 3.5% inflation increase at about the same time to partially offset the extra 7% price reduction. In the few months since the July 15 effective date of the 1994 decisions, the industry has already done a terrific job adapting to these rules. As prices dropped, subscribership has risen beyond expectations. CableWorld magazine says that subscribers are now being added at the "best basic growth rates in recent memory." Revenues are up. The Commission's competition report, issued last September, reported that the industry generated 28% more in revenues in 1993 than it did in 1990. Revenue appears to be up again for 1994, with revenue increases due to increased subscribership more than offsetting the drop in regulated rates. Margins are probably lower than they would have been if not for regulation. Yet in 1993 cable operators posted the highest operating income margin of any segment of the communications industry: over 20 percent. (Veronis, Shuler & Associates) For most companies, 1994 earnings appear likely to be about the same as 1993. There's been a great increase in capital investment in the cable industry since 1992. Some of that is because the economy is performing well. But some on Wall Street tell me that the Cable Act may have stimulated investment because increased earnings must be sought from new subscribers and that requires adding new capacity and doing new marketing instead of raising prices on static products sold to the same base of customers. At least large cable operators are having little trouble borrowing. Multichannel News reported this increased lending is not necessarily based on anticipated new services, but rather "can be readily supported by operators' core basic and premium services over the next decade." (Multichannel News, Oct. 31, 1994, at 3, 43.) Most say the picture for cable will get even better. A recent headline in CableWorld said that "3d Quarter Results Could Signal a Cable Industry Comeback". And this is before the impact of our going-forward rules. Under these new rules, which we adopted last month, operators can now offer New Product Tiers. In short, there is no regulatory barrier to offering any new products at any price the operator chooses. The going-forward rules also increase an operator's incentive to add channels to enhanced basic. For each new channel added, subscriber rates can be increased by the cost of the programming plus 20 cents up to $1.50 caps over the next two years. Wall Street bankers have told me the industry can expect an estimated $1 billion in additional revenues. But notwithstanding this news, the cable industry is still troubled by the Cable Act. And undoubtedly this concern is exacerbated by the industry's need to address momentous, anxiety-producing questions relating to its future. People from the cable industry and their competitors have told me cable faces a number of difficult questions as it faces the future: How should cable invest? Should the money go into installing switches for telephony and interactive services? Or would it be better to buy PCS licenses and entering the brave new world of mobile communications? Should money be spent on rebuilding systems into fiber-coax hybrids? Should the focus be on expanding capacity to 750 mhz or even 1 ghz? Or should operators concentrate on digitizing their signals, multiplying channels by 4, 5, or 6 times? But if that is the right way to go, then who will finance the digital boxes in the homes? And what about small systems? What is their future? Behind these issues are the structural questions: should cable operators spend their resources on horizontal acquisitions, or clustering? Or should they move vertically, going into the content or software business? And what about the telco-cable buyout strategy? Is there any exit for cable companies or are they all going to be pushed into competition in all markets? These are important questions not only for cable but for the country. Some people tell me that therefore the government should have opinions about these questions. They tell me the Commission's policies should help answer these questions. I have a two-part response. The first part is that we should admit that government cannot know better than industry how that industry should invest its money. The history of government intervention in business investment decisions is a long and repetitive history of unfortunate decisions. Perhaps the most pertinent example is the joint government-business decision in the mid-80s to invest in the analog version of High Definition Television. Hundreds of millions were wasted in pursuit of that idea. It turns out that the digital format is infinitely better and will within a year be adopted in this country, I believe, and then worldwide. Fortunately for us in America, that wrong decision was made in Japan. I have great admiration for those in the business community who must make the hard investment calls that have to be made as part of the communications revolution. I admire the people in the cable business who put their money on the line in tackling tough decisions as they face the future. And I am quite sure that the government should not make these decisions for or in partnership with business. The FCC is not and should not become the FIACC, the Federal Investment Advisor in Communications Commission. The second part of my response is that in answering the big questions that confront cable, the industry and its investors all need to be able to rely on clear, long-term policy decisions so that they can patiently endure and succeed the many years of hard work necessary to make long-term investments pay off. That is why Congress needs to fix the Communications Act of 1934 with a simple, straightforward, workable, pro-competition, anti-subsidy law passed, I hope, in 1995. The new Congressional leaders, Congressman Bliley and Fields, and Senators Pressler and Packwood, have the vision and energy to get that job done, and I wish them the best. The need for clear, long-term, reliable public policy is also why the Commission should continue to work hard to answer the questions presented by the supple and flexible 1992 Cable Act. To this end, there are at least three issues we at the Commission need to address as soon as possible. First, people have made very clear to me that small systems face particular problems because of the demands of technological change. We're going to move quickly to revise our going forward rules related to headend costs in order to fully reflect the business necessities of small systems. We will also move on a proposal that enables small systems and their franchisors to work out agreements regarding their rates. And we are actively evaluating petitions regarding the potential expansion of the definition of small systems. The pleading cycle closed on that issue just last week. In addition, I've asked our Bureau Chief, Meredith Jones, to set up a committee of local government officials and cable operators to simplify and reduce forms and rules. A second step we need to take is to address the issue of the quality of the signal. Some operators say that they would like to raise the price of basic and enhanced basic a small amount to cover expenses incurred in improving signal quality and reducing outages. Such gains in quality add value to the consumer. On the other hand, the same upgrades that raise quality may actually lower costs and increase margins even without price increases. Nevertheless, we are interested in discussing whether at least limited increases in basic and enhanced basic rates might be justified by quality increases. Third, we need to have a candid, open and constructive discussion about the policy impact of potential and actual competition on cable in the next several years. Let me report what I'm now being told by the industry and some of its competitors. -- Overbuilds of cable are going to be as small a part of cable's future as they have been in the past. Out of 16,000 cable franchisees, less than 1% face a second franchisee as a competitor. -- Wireless cable currently has about 500,000 subscribers as compared to about 65 million cable subscribers. However, even in the next twelve months at least several million cable subscribers can look to wireless cable as offering real choice of substitutable products at price-competitive levels. -- A number of telephone companies have offered a couple of dozen plans for delivering video over their networks to certain customers within the next several years. Even if we approved all of these plans as written (which we aren't going to do) and even if they all worked as planned (which would surprise even their authors), these Video Dialtone proposals would reach no more than 8 percent of American homes. But those homes that they would reach would receive substantial choice in multichannel video programming. -- DirecTV, United States Satellite Broadcasting, and Primestar have launched their DBS services. Even with dishes and installation prices approaching $1000 and monthly rates about 50% higher than the average price of enhanced basic, the satellite dishes are off to a good start. DBS providers tell me that they think they'll have enough subscribers to force at least some high-priced cable systems to compete on price within only several years. -- At some point in the future broadcasters may seek to use Advanced Television to deliver as many as five times more channels than are available today. This could cause all of us to rethink the competitive relationship between broadcast and cable. Looking at the future of competition for cable, not much is clear just now, but the summary seems to be that for the next few years the majority of cable consumers probably will not be presented with meaningful choice of competitively priced, substitutable cable packages. However, it is possible that much sooner some cable consumers -- particularly those in upscale, densely populated areas -- may well be given such choices. The issue then is this: when and if cable and satellite and telcos and others offer multichannel packages in a given market, will there come a time when the Commission should declare that the cable operator's enhanced basic package is "not unreasonably" priced because of market conditions and therefore the Commission does not need to set rates for that package? To be more specific, in applying the 1992 Cable Act, if we see evidence of real choice in specific markets among substitutable multichannel products offered to consumers, shouldn't we decide that market forces and not regulation will cause cable operators to price all CPS tiers, including enhanced basic, at "not unreasonable" rates? In our going-forward decision this was the rationale that led us not to set a price for the New Product Tiers that cable can now invent. That is because they will be offered as a choice on a rate card along with enhanced basic, which is fairly priced through regulation. Therefore, we concluded, the new product tiers will be "not unreasonably" priced by definition. Therefore the Commission would not need to set a price for such tiers. Using the same rationale, but in a different context in the not-too-distant future, it may be that in some markets wireless cable, or VDT packages, or DBS packages can create such consumer choice that the economic evidence could assure us that cable operators will not be able or willing to charge customers "unreasonable" prices for enhanced basic. Then we can cease rate regulation of all CPS tiers in those markets. We anticipated this possibility in our video dialtone ruling last October. We indicated that where video dialtone services are deployed, cable operators may be able to demonstrate that market forces will restrain their prices. And that is one of the reasons we are working hard in moving forward on the Section 214 applications submitted by a number of telephone companies. In contrast to this market-oriented approach to the cessation of rate regulation of enhanced basic, some cable representatives have told me that they want to be able to charge more money for enhanced basic today in order to obtain extra earnings for the purpose of investment. Specifically, they suggest that the Commission should permit them to increase the price of enhanced basic perhaps as much as 15% to 25% in order to give the industry more revenue for the purpose of investment. It has also been suggested to me that the additional revenue could be tied by governmentally attached strings to some particular kind of investment: for example, the industry might agree to use it to move to digitization or to increase capacity or to install switches. Here are the problems that I see with this line of argument: First, as I noted above, we should all be against government telling industry what to do with its money directly or indirectly. For example, if the best way for a cable operator to maximize future earnings is to invest American consumers' dollars into cable in the United Kingdom, as some are now doing, then that's what cable ought to do. There is no way that our government here should keep you from making profitable investments there. Second, if we let all single sellers of much-valued essential products raise their prices to consumers to get extra money for investment, to be fair we'd have to do the same thing for the local telephone companies and for the local electric utilities. But these companies, with almost 100% penetration, would have a much bigger base to draw on, and I don't think the cable industry would in the short or long run be the beneficiary of such a policy. At least you wouldn't benefit unless and until we let all communications companies merge into some huge form of Ma Bell Redux. And that's not the competition policy everyone seems to favor. Third, I'm very concerned that consumers would be highly dissatisfied with this notion of being forced to pay more today for today's enhanced basic in return for being offered something hard-to-define in an uncertain future. Let's not minimize that issue. Look at what consumer dissatisfaction caused in 1992. By contrast, I hope and believe that the Commission-endorsed increases of 7.5% in the average price of enhanced basic effective this coming year will be welcomed by consumers because they will receive about three times more channels along with these price increases than they would have received historically in the absence of the Cable Act. So let's go beyond going forward. Let's move forward to state in the next few weeks and months a clear vision of the policy goals relevant to your future. Because your future is part of the future of this country. The cable industry is the sole proprietor of one of the fast lanes of the information highway, offering a service that informs, entertains, and links the nation together. What you offer is now considered a necessity, not a discretionary purchase. And you ought to take that as good news. Whether anyone else can sell products that really compete with what you have invented remains to be seen. All this gives you a special role, and special responsibility, in the public debate. Most of all let's listen to each other in a productive discourse and setting long-term policy goals that all go to keeping the communications revolution rolling in our great country. I hope you and your families have a very happy and healthy holiday season.