Cable and Other Pay Television Services

Industry Snapshot

The cable television industry--valued at over $86 billion in 2008--was developed in the United States in the late 1940s to serve small communities unable to receive conventional television signals due to difficult terrain or physical distance from television stations. Cable also provided improved television reception to remote areas. The original systems were centered around a collective antenna for regions with poor or nonexistent reception. Cable systems located their antennas in areas where reception was good, picked up broadcast signals, and relayed them by cable to subscribers for a fee.

In 1950, cable systems operated in only 70 communities and served 14,000 subscribers. By 1995, there were approximately 11,800 cable systems with 62 million subscribers (65.3 percent of all television households) in the United States. The average cable system provided 30 or more channels, as well as other services such as custom programming and pay-per-view options. By the late 1990s, through digital compression, cable operators gained the ability to offer more than 100 channels. As of 2008, total cable subscriber counts amounted to approximately 63.1 million, a household penetration rate of nearly 61 percent. Digital cable subscribers amounted to 41.5 million at the end of 2008.

During the late 1990s and early 2000s, satellite television services made their presence felt in the pay television industry by providing an alternative to increasingly expensive cable service, which was increasing in price faster than the rate of inflation. Providers dramatically reduced setup costs and eventually offered free equipment and installation to consumers who agreed to annual service contracts. Viewers received many more channels for a monthly fee that rivaled cable rates. The biggest drawback to satellite television was its inability to carry local broadcast channels, but this limitation was removed by federal legislation toward the end of 1999. Satellite services claimed only 4 percent of the market in 1996. The fastest growing segment of the satellite service industry was direct broadcast satellite (DBS), which grew from 2.3 million subscribers in 1995 to 8.2 million subscribers in 1998. By 2007, this total had mushroomed to 31.7 million.

Organization and Structure

Traditional underground cable lines are just one of several methods used to transmit video signals from the broadcaster to the home. Pay television companies must decide which transmission method or combination of methods is the most effective in serving their customers. Overall, there are four basic ways to broadcast a video signal. In the terrestrial method, a transmission tower on the ground sends a picture directly to a television aerial. This is easy to install but reception is often poor and only a few channels can be carried. This was the method traditionally used to broadcast network channels. In the coaxial or fiber-optic cable method, TV signals travel through an underground cable. Installation is time-consuming and expensive, and it was used primarily in densely populated urban areas. In the microwave, multichannel method, a multipoint distribution system (MMDS) carries signals from a television studio to a microwave transmitter, which then relays them to rooftop receivers on apartment blocks. These receivers are relatively small dishes that are easy to install and maintain. Microwave transmission is a low-cost alternative to cabling and is feasible in areas where there are large distances between transmitting stations and subscribers, such as South America. In the satellite method, a broadcaster uplinks a signal to a transponder on a satellite, which retransmits either to home dishes or to a satellite master dish (SMATV) located on the roof of a high-rise block. Satellite transmission is common in remote rural areas. Subscribers pay hookup and access fees to the satellite owners.

Cable television operators rely primarily on revenue from advertising, installation services, basic cable subscriptions, and premium channel subscriptions. In 2008, the industry estimated earnings were $86.3 billion in subscriber revenue and $26.6 billion in advertising revenue. Even with increasing competition from the satellite industry, cable operators expected to enjoy a trend of increasing subscription and advertising revenues in the foreseeable future.

Cable Regulation.
The domestic cable industry is highly regulated by the U.S. government. Regulations affect cable system ownership, rate structures, channel limits, types of programming, and permission to access programming. This involvement is due to the high fixed investment in installation, the fact that the industry lends itself to being a natural monopoly with limited competition, and the sensitive nature and importance to national security of communications technology.

Ownership in the cable television industry is fragmented because of the regulatory environment in which companies compete. The Federal Communications Commission (FCC), the government agency empowered to regulate cable TV companies, has given municipalities the authority to grant cable licensing contracts on a geographic basis. Municipalities generally bid out these contracts and grant exclusive franchise rights to provide service in a given area in return for a commission of three to five percent of revenue.

In 1986, the FCC decided to allow cable companies to freely set monthly service rates and rate increases in any market that already provided at least three over-the-air broadcast signals to nonsubscribers. Prior to 1986, cable companies were limited to a mandated 5 percent cap on annual rate increases. Re-regulation was proposed in 1992 because various groups claimed that the cable industry abused its privilege to set monthly rates by gouging consumers. Congress, under pressure from consumer groups, haggled with President George H.W. Bush, who was against reregulation. After a failed attempt by the FCC to control the situation by redefining some rules, Congress overrode the president's veto and passed the controversial Cable Television Consumer Protection and Competition Act of 1992. This bill reversed cable companies' freedom to set rates. However, local governments were given the power to regulate rates for basic cable programming in their areas.

The act also contained programming regulations. Programming could no longer be denied to competitors and had to be offered at "fair terms." The bill required cable companies to pay royalties to over-the-air broadcasters. Networks have complained for years that cable companies were in essence charging subscribers for network-developed programming that was free to them and pocketing a subscriber fee. One other provision of this bill limited the size of multiple-system operators and the number of channels a system could devote to programming in which it had an interest.

New technologies prompted cable companies to team with telecommunication companies in order to provide interactive services to subscribers. In 1992, the FCC permitted Tele-Communications Inc. (TCI) and Cox Enterprises to buy Teleport Communications Group, a company that connected long distance carriers and provided large corporations with private fiber-optic communications networks. This ruling opened the door by allowing cable companies to enter the telecommunications business and vice versa.

Telephone companies were slow to react to this decision, primarily due to regulatory concerns. Not until February 1993, when Southwestern Bell Corp. announced that it agreed to purchase two cable TV systems in the Washington, D.C., area, did a telephone company move into traditional cable markets. This action led other telephone companies to search for cable acquisitions.

A regulation implemented in June 1992 allowed the television networks to buy local cable TV systems. However, a TV network's cable holdings could not exceed 10 percent of the nation's homes that are passed by cable wire or 50 percent of the households in a single market. In addition, a 1984 ruling stated that a company cannot own a TV station and a cable system in the same market. The intended effect of these rulings was to quicken the unraveling of traditional network and affiliate relationships. The resulting alliances between cable and over-the-air industries would impact the competitive environment among entertainment providers.

The Telecommunications Act of 1996 also did much to deregulate cable television, with the hope of further stimulating competition in the television industry. The act revised 62 years of telecommunications law and eliminated some features of the 1992 Cable Act that were seen as punitive by the industry. Most notably, fees for upper service tiers were deregulated on March 31, 1999, in large cable systems, while such services were deregulated immediately in smaller franchises. The bill also eliminated the 1984 restriction that prevented individual companies from offering cable and phone services to the same market.

Government regulations have a significant impact on the ways in which cable companies compete. In the mature cable TV market, revenue growth comes primarily from rate increases. Government regulations impact existing companies by limiting revenue growth from this source. In the long run, the industry is expected to benefit from being pushed to develop other revenue resources. The regulatory environment is constantly changing, and there are gains that will accrue to the companies best able to influence and adjust to new regulatory initiatives. In 2005, the U.S. Congress embarked on efforts to rewrite telecommunications laws with opposition from industry associations, notably the National Cable & Telecommunications Association.

Investment in Fiber Optics and Digital Compression.
Investment in fiber-optic technology and digital compression allowed cable providers to expand channel capacity, offer interactive services, and carry voice, data, and video signals simultaneously on a single line. Each of these areas represents a significant opportunity to increase revenue. Both technologies, however, required an enormous investment for cable companies. Installation of fiber-optic cable and the introduction of digital boxes in cable homes was a gradual process.

Fiber-optic cables improve signal quality and range. Companies that invested in fiber optics to improve transmission quality gained an edge in the bidding process used to award franchise rights for geographic areas. The greater the number of franchise rights, the greater the number of subscribers, and the greater the amount of revenue for a company. During the 1990s, four of the largest players in the industry (TCI, Time Warner, Continental Cablevision Inc., and Cablevision Systems Corp.) invested heavily in this strategy. TCI invested $2 billion in the mid-1990s, a clear indication that the industry viewed investment in fiber optics as a critical component in ensuring long-term financial success.

Expanded channel capacity allows cable providers to increase revenue by offering additional programming and pay-per-view channels. The creation of new cable networks strained the existing cable carriage space in 1997, as CBS, A&E (Arts and Entertainment), Rainbow Programming, and BET (Black Entertainment Television) all prepared to start major cable networks. The need to expand channel capacity was underscored by the fact that many new networks were finding their first home on satellite television, where a greater number of channels are offered.

Expanded channel capacity also allows cable companies to offer advertisers more options. Traditionally, broadcast networks have demanded the highest advertising dollars and yet have devoted less on-air time to commercials than cable networks. During the mid-1990s, however, cable advertising revenues increased, and the cable networks began increasing the minutes-per-hour devoted to advertising. Between 1990 and 2006, advertisers increased their spending on cable television from $1.1 billion to $23.7 billion.

Studies revealed that the total time Americans spent viewing television was rising, while the audience share of the three major networks was declining. Viewers began spending a larger proportion of their viewing time watching cable channels as opposed to network programming. This increased viewership positioned cable companies to gain a large percentage of increasing advertising dollars.

Ability to Influence and Respond to Regulation.
Because regulations change so frequently, the ability to influence and leverage new regulations becomes a crucial success factor. If a company can dictate how a regulation is written or interpreted in order to exploit an internal core competency, then it will be best positioned to profit from the change. Conversely, cable companies can be negatively affected by regulations that restrict their ability to expand service areas, affect rate structures, and introduce new products.

During the late 1990s, cable operators and telephone companies entering the television business were not only adjusting to the new FCC guidelines set by the Telecommunications Act of 1996, they also faced the demands of local governments that tried to maintain local control of rates and public rights-of-way. An April 1996, ruling eliminated rate regulation in areas where a cable company had non-DBS competition. Local governments complained that better proof of the new competition's effectiveness was needed in each case before rate deregulation was allowed. Squabbles over the use of public rights-of-way also cropped up, as in the case where the city of Troy, Michigan, required TCI to obtain a telecommunications franchise when it wanted to create a new system. Such arguments prompted cable and telephone companies to join in asking the FCC to rein in local regulators.

Economies of Scale.
Size is necessary to achieve economies of scale and to provide cash flow for investments into research and development, development of new programming and markets, and acquisitions. Large companies can gain economies of scale in purchasing equipment, satellite time, and programming. In addition, by being large enough to be able to purchase its own satellite, a cable company gains significant control over costs and programming. Through ownership of large libraries of information (music, video, etc.), the cable company not only controls costs, but also drives other competitors through access to that programming. Finally, programming consists mainly of large fixed costs. With a large cable company, this fixed cost is spread over a larger base, resulting in increased profits. This is particularly important for the development of fiber optics.

Satellite and Telephone Company Competition.
Customer dissatisfaction and rising cable costs served to feed the growing satellite television industry with new viewers. At the beginning of 1999, direct broadcast satellite (DBS) had about 10.5 million subscribers compared to cable's 67 million, but it was growing 26 percent a year in spite of not being able to provide local broadcast channels. At the end of 1999, that roadblock was removed when the U.S. Congress passed legislation that would allow DBS to offer local channels, thus giving satellite subscribers access to broadcast network programming.

Satellite television also experienced major changes among its key players in the late 1990s. Primestar, the second largest DBS provider with 2.3 million subscribers, was sold in January 1999 by its cable company owners to industry leader DirecTV. However, the sale did not guarantee that DirecTV would pick up all of Primestar's subscribers, thus leaving the door open to EchoStar, which moved up from third to second in the industry and was regarded as the fastest growing DBS company. EchoStar had recently acquired the assets from Rupert Murdoch's failed satellite venture. In December 1998, DirecTV acquired United States Satellite Broadcasting, which provided top-of-the-line premium services that customers could order on top of the 185 channels offered by DirecTV. By 1999, neither DirecTV nor EchoStar were profitable, and EchoStar was carrying nearly $2 billion in debt. However, the demand for satellite television was in full swing by 2008, with DirectTV (18 million U.S. customers) and EchoStar's DISH Network (13.8 million customers) leading the way.

Phone companies have invested in and upgraded phone lines to fiber optics for some time with the intention of transmitting video signals. Companies such as Tele-Communications Inc., U.S. West, AT&T, Time Warner, Microsoft, IBM, Sony Corp., Intel, and Silicon Graphics tried to position themselves as major providers of service and support in this emerging playing field. During the 1990s, even utilities were laying fiber-optic cable when they installed new lines in order to position themselves as water, gas, electric, voice, data, and video providers. The trend toward providing faster, more stable telecommunications with fiber optics continued into the 2000s.

Current Conditions

The cable television industry has proven to be very resilient. The industry successfully responded to recession, regulation and deregulation, and the entry of meaningful video service competitors such as telephone companies, direct broadcast satellite systems (DBS), and computer firms. The future appears to hold more of the same, although competition is increasing from DBS providers. The introduction of new technologies and system upgrades will continue to make it possible for cable firms to expand digital services and gain new subscribers. The cable companies that are leading the way in these developments are expected to reap the lion's share of success.

Despite weak economic conditions that had a negative impact on network television and radio broadcasting companies, as well as the print media sector, the cable industry fared relatively well during the 2000s. Figures from the National Cable & Telecommunications Association (NCTA) indicated that subscriber service revenues increased from $62.2 billion in 2005 to $86.3 billion in 2008. Advertising revenues also rose steadily from $20.9 billion in 2005 to $26.6 billion for 2008. The average price for basic cable was approximately $47.46 in 2008. Satellite prices are generally lower and satellite subscriptions offer more channels, which is part of the attraction for consumers.

Digital cable services, including emerging video-on-demand offerings and high-speed Internet services, continued to represent a prime growth area for cable providers, as the market for basic services became relatively saturated. Following significant infrastructure developments during the 1990s, digital cable services began taking off in 2000, when some 9.7 million subscribers took advantage of the service, according to the NCTA. By the end of 2008, this number had mushroomed to 41.5 million subscribers.

There was a lively debate between the National Association of Broadcasters (NAB) and the NCTA regarding the FCC Mass Media Bureau plan to speed up digital transmission. NAB asked that broadcasters be allowed to keep their analog channels until 85 percent of US households could receive digital signals. NCTA responded with a claim that cable operators in 155 markets across United States were voluntarily carrying HD programming mix. The FCC's date to completely end analog transmission was originally February 17, 2009, but it was later pushed to June 12, 2009. At that time, all television programs would be transmitted in digital format only. An FCC rule adopted on September 11, 2007, eased the transition for cable subscribers, allowing them continued access to local stations, at least until 2012.

Industry Leaders

The names of the industry leaders changed dramatically in the late 1990s, and industry rankings changed frequently as competitors sought to add more subscribers through mergers and acquisitions. Major mergers and acquisitions following passage of the Telecommunications Act of 1996 resulted in more subscribers for the top cable operators. Size and clout were becoming more significant factors, with new technologies such as wireless, fiber optics, and digital compression requiring large investments. By 2009, the top 10 cable companies were Comcast Cable Communications (23.9 million subscribers); Time Warner Cable (13.8 million); Cox Communications (5.3 million); Charter Communications (4.9 million); Cablevision Systems (3.1 million); Bright House Networks (2.3 million); Mediacom (1.28 million); Suddenlink Communications (1.263 million); Insight Communications (720,000); and CableOne (692,000).

Comcast Corporation.
With almost twice as many subscribers as its nearest competitor, Comcast Cable continued to be the undisputed industry leader in 2009. Comcast's strong position within the industry is attributable to its acquisition of AT&T Broadband. According to the company, it is the leader in eight of the nation's top 10 markets, and about 70 percent of its subscribers live within the top 20 markets. Other acquisitions also have been key to Comcast's growth. For example, in 2006 the company acquired Adelphia Communications in a deal with rival Time Warner Cable. The acquisition increased Comcast's subscriber base by 2 million subscribers. Digital cable services and broadband access grew to approximately 12 million and 11 million, respectively.

Time Warner Cable.
Time Warner is the world's largest media and entertainment company. Time Warner Cable (TWC) is one of the many media/entertainment subsidiaries that deal with businesses ranging from Time Inc. (publishing) to Warner Music Group to HBO (programming). In 2009, TWC was the second largest cable operator in the United States, with 13.1 million subscribers. TWC has aggressively sought multiple cable systems within the same geographical locations. Known as "clustering," this process achieves superb operating efficiencies and economies of scale.

Known as the industry leader in fiber-optic cable installation and interactivity, TWC delivered the world's first interactive cable TV service to New York in 1991. The 150-channel system, called Quantum, provided locally targeted programming as well as 57 pay-per-view channels. As the industry leader in the percentage of subscribers in fiber-optic addressable systems (81 percent), Time Warner is poised to progressively bring its customers into the mainstream of advanced cable technologies. In 1999, the company began an aggressive national rollout of the first phase of its new digital cable service, and by 2009, it claimed more than 13 million digital video customers. TWC also offered high-speed Internet connections to 6.5 million customers through its own cable-based ISP, Road-Runner, and other providers.

Cox Communications.
In 1999, Gannett Co. exited the cable industry when it sold its cable subsidiary, Cablevision, for $2.7 billion to Cox Communications. Cablevision served about 522,000 subscribers in Kansas, Oklahoma, and North Carolina. Following a string of acquisitions for Cox, the addition of Cablevision's subscribers gave Cox a base of 6 million subscribers, putting it at the number five industry position. By 2007, Cox had grown to be the third largest industry player and was also engaged in high-speed Internet services. In addition, the company began making capital investments that enabled it to provide telephone services. In 2009, Cox offered basic cable to 5.3 million customers, including 2.9 million digital cable subscribers and 3 million Internet access subscribers.

Charter Communications.
Charter Communications is a relative newcomer to the cable industry. Founded in 1993 in St. Louis by Harold Wood, Barry Babcock, and Jerry Kent, who were former executives of Cencom Cable Associates, Charter Communications was the tenth largest cable operator in 1998 when it was acquired by Microsoft cofounder Paul Allen for $4.5 billion. Earlier in the year, Allen had acquired Marcus Cable for $2.8 billion. Marcus and Charter each had about 1.2 million subscribers at the time, giving Allen control of 2.4 million subscribers and making his company the seventh largest MSO. Additional acquisitions allowed Charter to become the fourth largest cable operator in 1999, and the third largest by 2002. At this time, the company served customers in 40 states and offered broadband services like other industry leaders. By 2009, it once again was the fourth-largest cable operator, with 4.9 million subscribers.

Direct Broadcast Satellite Companies.
Despite the fact that cable operators were positioned to benefit from the various service offerings, DBS providers were a significant source of competition in the 2000s. The Television Bureau of Advertising (TBA) reported that, according to Nielsen Media Research, penetration of so-called "alternate delivery systems" (ADS), which include DBS, were increasing while wired cable levels were declining, reaching a six-year low in early 2003. The TBA further explained that "national ADS penetration reached 16.7 percent in February 2003, up from 14.7 percent in February 2002. Direct broadcast satellite (DBS) delivery, the largest component of ADS, is estimated at 15.6 percent, up from 13.2 percent in February 2002. Over the same period, wired cable penetration fell from 70.3 percent to 68.6 percent--the last time wired cable was that low was in August 1996."

The two leading DBS companies in the late 2000s were DirecTV Group Inc. and EchoStar Communications Corp. After acquiring Primestar, DirecTV had 7.8 million customers at the end of 1999. By 2009 this number had increased to 18 million. DirecTV posted revenues of $77.2 billion in 2008.

Headquartered in Colorado, EchoStar Communications Corp. was founded in 1980 and filed for a DBS license in 1987. It established EchoStar Satellite Corp. to build, launch, and operate DBS satellites, and in 1992, it was given a DBS orbital slot. In 1995, the company established the DISH (Digital Sky Highway) Network and launched its first DBS satellite. EchoStar achieved rapid growth during the early 2000s, expanding its customer base from 3 million in 1999 to nearly 14 million by early 2009. Echostar revenues were listed at $11.6 billion in 2008.

America and the World

The cable industry is highly regulated, not only in the United States but also overseas. As a result, high entry barriers exist, causing companies to compete on a national basis. U.S. companies serve U.S. subscribers, European companies serve European subscribers, and so on. Because the U.S. market is saturated, U.S. companies are trying to expand overseas to sustain growth. Asia, Latin America, and Europe have been identified as areas with high potential. The strategies companies are pursuing to break into overseas markets include joint ventures and alliances.

The major obstacles companies must overcome to become global are government regulation and lack of infrastructure. In Asia, for example, most governments still maintain tight control over the industry, which limits a foreign national company's ability to compete. They often restrict the screen time allotted to foreign programs and limit transponder hours. Cultural and industrial issues influence government regulation. Some countries worry that foreign programming could upset the country's social harmony, while local monopolies exert their influence to prevent competition.

However, market demands forced Asian governments to either loosen the grip of state broadcasting monopolies or set up new channels to meet the demands of viewers for higher quality programs. Similarly, regulations in Europe eased slightly. The presence of the European Union has allowed for the development of some unified standards. However, European countries were reluctant to allow U.S. companies to expand into their markets due to cultural differences.

Lack of capacity also was a major factor limiting U.S. companies' entrance into foreign markets. There is a need to develop a cable infrastructure in growth regions. For example, there simply are not enough satellite transponders servicing overseas locations. In the United States, there is one transponder for every 300,000 people. In Europe, the ratio is one per 1 million people, while in Asia it is one per 6 million people. Using the existing system can be costly to a broadcaster. The broadcaster can expect to spend $1 million to $1.5 million American dollars per year to rent a transponder. In addition, there are usually local government license fees, plus fees to landlords for the use of high-rise apartments.

The cable industry will never be more than a multidomestic industry as long as regulation denies ownership of all or a majority share of a local cable company by a foreign organization. The opportunities for growth in the emerging markets will be enjoyed by local companies, but the opportunities for cross-border operations still exist. A lack of technology and programming expertise provides opportunities for U.S. companies to partner with the regional operators to gain footholds in overseas markets, pre-empting European and Asian providers. However, as these new markets grow, they will develop the programming to cater to local preferences and culture. To stay competitive, U.S. companies will have to adapt and to develop programs for these new markets, instead of just offering dubbed-over U.S. programming.

Research and Technology

Although there have been a number of advances in cable technology, the most prominent was digital compression. Compression technologies enable broadcasters to squeeze several channels of video programming onto a single existing channel in much the same way as compression software conserves storage space on a computer. Compression converts the analog signals, currently used in broadcasting, to digital signals. This allows 10 channels to be transmitted along the same bandwidth of coaxial cable that would normally be capable of handling a single uncompressed signal. Compression would allow cable companies to offer more than 500 channels.

Even with the advent of compression technology, coaxial cable has drawbacks. Coaxial cable uses radio waves to transmit video images. Its drawbacks include a limitation on the number of signals that can be transmitted simultaneously and the distance that such signals can travel before they begin to degrade. Its advantage is that it is already installed in millions of homes across the country. Fiber-optic cable, on the other hand, uses light to transmit video images. It is superior to coaxial cable in terms of bandwidth or signal capacity, transmission speed, signal distance, and clarity. However, fiber-optic cable has a daunting limitation in that it is prohibitively expensive.