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Sunday, April 1, 2007

Cable-Franchise Reform: Deregulation or Just New Regulators?

Cable-Franchise Reform Reduces Costs and Improves Choice for Consumers, but Government Regulation Is Still Problematic

Adam Summers is a policy analyst at the Reason Foundation.

There is much hand-wringing and teeth-gnashing among politicians who decry businesses for maintaining monopolies that harm consumers. Yet in a free market such businesses will find any monopoly position fleeting. If they charge too much or fail to provide suitable quality in their products and services, other entrepreneurs will recognize a profit opportunity and jump in to take market share away from them. It isn’t enough to obtain a dominant position in an industry; even a “monopolist” faces competitive pressures if it wants to keep that position.

There is an exception to this rule, however: government-protected monopolies. If other businesses are prevented from competing with the monopolist through laws, regulations, or exclusive agreements (such as franchise agreements) with the government, there really is no chance of competition. In this case, consumers are harmed because the monopolist has little incentive to provide the lowest prices, the highest quality, or the most innovative products so long as the necessary lobbying is done and tribute paid to the government. This is not a free market. Thus one could say that the only “bad” monopoly is a government-protected monopoly.

Today at least one type of government-sanctioned monopoly is starting to break: the cable-television market. Cable-television companies typically have to negotiate with local governments and pay them a portion of their revenues and other compensation for the exclusive right to offer cable services in an area. Few parts of the country have allowed any competition at all in local cable markets, but that is starting to change.

In the past two years state governments have attempted to streamline the cumbersome and costly process of obtaining numerous local government video franchises by allowing cable and telecommunications companies to apply for a single franchise issued by the state. These reform efforts also remove the local monopoly protection, permitting multiple competitors. The change is intended to open up competition, particularly to telephone companies such as AT&T and Verizon Communications, which have been trying to break into the cable market, and to offer consumers greater choice and lower bills.

It should be noted that even where franchise rules prevent competition among cable providers, they may face competition from satellite providers. According to J.D. Power and Associates surveys, satellite providers have increased market share from just 12 percent of U.S. households in 2000 to 29 percent in 2006. During this period, cable providers have seen their share fall from 66 percent to 58 percent. A December 2006 Federal Communications Commission (FCC) report found that satellite competition did not appear to affect cable prices. But this may be because satellite providers often offer more channels and premium services than cable providers do or better new-subscriber promotions, such as free installation and equipment. If so, consumers are getting more for the same prices they would pay for cable. In any case, that cable is steadily losing market share to satellite indicates that many consumers feel they are better off with the added competition and services.

State and Federal Reform Efforts

Michigan most recently passed cable-franchise reform when Governor Jennifer Granholm signed the Uniform Video Services Local Franchise Act in December. Consumers and telecommunications companies won another significant victory when California passed the Digital Infrastructure and Video Competition Act of 2006 last September, opening up the state’s sizeable market to competition. Under the previous franchise structure in California , a potential cable provider would have needed to gain approval of over 500 separate franchises from local governments to provide service across the entire state. The video-franchising process typically took six to 18 months, resulting in significant costs from business lost during the negotiation process and the time and energy spent on the negotiations themselves, not to mention concessions required by municipal governments as a condition of obtaining the franchise. In response to the California law, AT&T announced that it would invest an additional $1 billion in California through 2008 to upgrade its telephone network and launch an Internet-protocol video entertainment that will compete with cable-television providers. Verizon similarly announced additional investments of “hundreds of millions of dollars” to expand its fiber-optic network, which will allow it to provide television, as well as Internet and telephone, service. These investments are expected to result in the creation of thousands of jobs in the state.

Texas began the reform trend in 2005. In 2006 similar reform measures were passed in California, Indiana, Kansas, Michigan, New Jersey, North Carolina, and South Carolina . Arizona and Virginia also passed reforms, but these measures did not establish statewide franchise authority. In Connecticut and Oklahoma , officials ruled that telephone companies that offer video services through their networks (such as Internet protocol television, or IPTV, platforms) are not subject to local franchise regulation. In addition, a cable-franchise reform bill made it to the desk of Louisiana Governor Kathleen Blanco, but she vetoed it because she feared it would adversely affect municipal-government finances. Still other video-franchise reform measures have been under consideration in Iowa, New York, Pennsylvania, and Tennessee.

On the federal level Congress took up cable-franchise reform last year but failed to pass a bill. In June the House of Representatives passed the Communications Opportunity, Promotion, and Enhancement (COPE) Act of 2006, which included a provision that would allow companies to apply for a nationwide television-service license. However, the Senate telecommunications bill, S. 2686, was bogged down by debate over an unrelated “Net neutrality” provision, which concerns whether Internet service providers (ISPs) may charge website owners fees to load their sites more quickly than those of nonpayers, and the measure died.

Action on similar legislation in the new Congress is uncertain, although the momentum built up at the state level could lead Congress to address the issue again. A key factor may be whether cable-franchise reform, which has pretty broad support, will be separated from Net neutrality. Democrats are more likely to call for mandates on this, while ISPs, including telephone and cable companies, want to maintain the flexibility and freedom to offer the services they like and set their prices as they see fit.

The FCC entered the fray in December when it voted 3–2 to pass a set of cable franchise-reform rules. The rules require local governments to act on video-franchise applications from new potential competitors within 180 days and within 90 days if the applicant has already secured access to local rights of way. The rules also prohibit local governments from requiring competitors to build out their video networks faster than existing cable companies.

Benefits of Cable-Franchise Reform

Cable-franchise reform benefits consumers in a number of ways. The reduction in costs from seeking numerous franchises from local governments opens up competition to other providers. This competition will lead to greater choice and reduced cable and broadband prices for consumers. (Note that “cable” or “video” services include not only cable television but also data and voice services such as high-speed Internet access and Voice over Internet Protocol [VoIP] telephone service—and perhaps other services not yet anticipated.)

Competition has resulted in significant savings to consumers where it has been allowed to flourish. A study analyzing FCC data on competitive and noncompetitive cable markets found that subscription rates for basic and expanded basic services averaged 16 percent less in competitive markets. In addition, a Bank of America study concluded that when new competitors enter a cable market, existing providers drop prices 28 to 42 percent.

The longer we wait to deregulate, the greater the forgone cost savings. A Phoenix Center study, “The Consumer Welfare Cost of Franchise Reform Delay,” estimated that if cable competition were to be delayed another four years, consumers would end up spending $30 billion more nationwide than under a more open market with franchise reform, including $3.1 billion just in California. A March 2006 study by George Mason University professor Thomas Hazlett estimated even greater consumer savings of $9 billion per year from wireline video competition.

Some have argued that franchise monopolies and current regulations are not such a big problem because Congress prohibited local governments from granting exclusive franchises after December 4, 1992. Yet monopolies persist in most areas because of the artificially high barriers to entry created by unnecessary existing regulations. Today only a small percentage of households nationwide are in areas with multiple video operators, largely because of the high costs of entering the market. It should come as no surprise that, according to a 2006 FCC annual report on cable services, between 1995 and 2005, cable rates increased 93 percent while interstate telephony prices decreased nearly 40 percent and wireless charges fell almost 80 percent.  In discussing the survey’s findings at a December 2006 meeting, FCC Chairman Kevin J. Martin concluded: “In recent years, consumers have had limited choice among video service providers and ever-increasing prices for those services, but, as was just demonstrated in our annual price survey, cable competition can make a difference and can impact cable bills. Again, it found that only in areas where there was competition from a second cable operator did average prices for cable services decrease.”

The Downside of Cable-Franchise Reform

The benefits of cable reform notwithstanding, the legislation that has passed is not without a number of drawbacks. While it eliminates the city-to-city quest for franchise approval, it merely centralizes franchise approval authority in a state (and potentially federal) government agency. Thus providers still must seek the government’s permission merely to conduct business—only they must do so at the state level instead of the local level.

Cable providers are also typically still subject to numerous “public interest” regulations. They are forced to maintain a number of “public, educational, and government” (PEG) channels (or contribute a portion of their gross revenues to support such programming) that their viewers may not want and/or that may not be economically justifiable. Furthermore, government often continues to dictate where providers may offer their services through “anti-redlining” provisions that force providers to offer all services to all areas, not just higher-income neighborhoods. Competition and technological advances—including satellite-television services—make this less of a concern today than 30 or 40 years ago anyway, but companies should have the right to do business where they want and offer new, experimental, or higher-quality services to higher-income areas to test new technologies and more quickly recoup their investment costs before rolling them out to the rest of their service areas. After all, digital and on-demand cable service is hardly an unalienable right.

Perhaps the greatest concern, however, is that the concentration of franchise power in the state government could actually lead to higher franchise costs and more burdensome regulation in the long run. One of the common complaints of cable and telephone companies is that local governments often engage in extortion by conditioning franchises on payments for numerous pet projects or social causes that may have nothing to do with the franchisee’s business.

At the December FCC meeting, Chairman Martin decried the local government practice of conditioning franchise awards on “extraordinary in-kind contributions” (some would call it blackmail or graft) such as requiring applicants to build public swimming pools and recreation centers. Martin made special mention of Lynbrook, N.Y., which required Verizon to provide video equipment for filming a visit from Santa Claus in return for allowing the company to offer services. An October 28, 2005, Wall Street Journal article detailed several other examples of the in-kind “contributions” local governments were requiring of Verizon for the privilege of serving their residents. They range from the frivolous to the outrageous. Holliston, Mass., wanted free television for all houses of worship. Massapequa Park, N.Y., wanted $27,000 to plant wildflowers on the median of a four-lane highway and to hang flower baskets to decorate old-fashioned street lights in the village center. Others demanded high-speed Internet for sewage facilities and junkyards, fiber connections to traffic lights for traffic-flow monitoring, and free Internet connections for poor elementary students. When Verizon asked Tampa, Fla., for permission to offer television services, the city presented it with a $13 million “wish list” including money for an emergency communications network, digital editing equipment, and video cameras to film a math-tutoring program for kids.

What would happen if these practices continue at the state level? Imagine that because a state is experiencing a budget crunch or an influential politician has a program he wants others to pay for (I know it’s a stretch), you could not do business within the entire state unless you agreed to pay the requisite tax (sorry, “fee”). If federal legislation passes, will bureaucrats and influential politicians be able to prevent a company from doing business in the entire country if it doesn’t jump through the requisite hoops? Herein lies the problem of allowing politics to interfere with market forces.

While cable-franchise reform like California’s and Michigan’s represents a step in the right direction, it does not address the heart of the problem: government regulation itself. Replacing one set of regulations with another set of slightly more efficient or less burdensome regulations is always welcome, but this still preserves the general regulatory structure that has led to artificially high prices and stifled both consumer choice and cable and broadband investment. To truly benefit consumers and businesses alike, policymakers must strike at the root of the problem and eliminate such unnecessary regulation altogether.

  • Adam is a free-lance writer and public policy consultant living in sunny San Diego, California. He did his undergraduate work at UCLA and recieved his Masters from George Mason University in Virginia.