GAO’s Cable Report Smacks Down A La Carte Regulation

October 28, 2003 • TechKnowledge No. 63

On October 24, the U.S. General Accounting Office released its long‐​awaited report on cable industry rate competition, “Issues Related to Competition and Subscriber Rates in the Cable Television Industry.” Despite earlier fears of many in the cable sector, the report ended up sending Congress a very clear message regarding cable industry rate reregulation: Don’t bother. In addition to confirming that cable industry deregulation has benefited consumers and resulted in increased competition in the video programming marketplace, the GAO report also makes it clear that the costs of reregulating the cable sector would far outweigh the benefits. Additionally, the report should serve as the nail in the coffin of rumored à la carte regulation of the cable sector, which would require that cable operators separate and sell each individual channel that they offer. A la carte regulation would represent backdoor rate reregulation of the cable sector and would completely upend the industry’s traditional business model and pricing structures. The clear implication of the GAO’s findings in this report is that deregulation of the cable sector has worked and that reregulation won’t improve consumer welfare. Consequently, Congress lacks grounds for reregulating cable in any capacity.

Stating the Obvious. Most of the findings in GAO’s report are fairly unsurprising and uncontroversial. For example, the report notes that the rise of the Direct Broadcast Satellite industry has become a formidable competitive threat to cable and helped encouraged intense rate and quality rivalry for video programming consumers. And in true GAO form, the report becomes overly preoccupied with government process. Specifically, the GAO is concerned about the reliability of the FCC’s annual cable rate survey and calls on the agency to take steps to improve the survey by providing more detailed information about cost changes in the industry so Congress can exercise better “oversight” of the industry.

But the real meat of the study involves a discussion about how cable operators currently package and price video programming options for consumers and the impact of those business models on overall rates. This is where the GAO could have easily tread into dangerous regulatory waters by endorsing either direct or indirect reregulation of cable rates. Instead, the GAO navigated the issue with surprising acumen and provided a balanced overview of the ins and outs of cable industry regulatory policy.

For example, the GAO report provides a very level‐​headed analysis of current cable industry rates. Although the report notes that cable rates rose faster than the general rate of inflation over the past five years, the GAO notes that many factors have contributed to the rising cost of cable service: increased programming expenditures (especially sports); substantial infrastructure investments and upgrades ($75 billion since 1996); and increased customers service expenditures. In other words, while nominal cable rates have risen over the past few years, the amount and quality of the service the industry has provided has increased. When the number of new channels and increased viewing time are taken into account, it becomes clear that the quality‐​adjusted price of cable programming is actually quite reasonable and that “cable viewers appear to be substantially better off now than they were six years ago” as Michigan State University economist Steven Wildman found in an important new study. Moreover, the GAO alludes to the fact that the inflation rate may not be a very meaningful yardstick by which to compare cable rates anyway. Indeed, the price of many goods and services routinely rise faster than the inflation rate during any given period, but that tells us little about consumer value or welfare.

Break Up the Tiers? Several of the channels that cable operators offer have become very expensive in recent years and contributed to the rising nominal cost of the various “tiers” of service from which consumers choose. In particular, skyrocketing sports programming costs and expensive new entertainment channels are major cost drivers for cable carriers. Ultimately, those costs will get passed on to consumers when they purchase a basic or enhanced tier of cable service that includes those stations. This fact has generated enough concern on Capitol Hill that legislation has been discussed‐​at least by Sen. John McCain (R-AZ), head of the Senate Commerce Committee‐​which would require cable operators to breakup their programming tiers and offer consumers the ability to choose channels on an individual basis. Such an à la carte mandate would presumably give cable subscribers more choice and help lower overall rates since consumers could reject more expensive channels that inflate that cost of any given tier.

In reality, however, mandatory à la carte regulation would have potentially devastating implications for the cable industry and consumers alike. Consider first the issue of the cost of time for both industry and consumers. Presumably, an à la carte mandate would require that cable operators provide each household a channel checklist (either on paper, online, or over the phone) that would need to be filled out. How long will this take? In a 500‐​channel universe, how many hours will consumers need to spend on their computers, or on the phone with cable representatives? Second, consider the technology upgrades that would be necessary to make à la carte a reality. An “addressable converter box” would need to be installed in each home to ensure that channel selections could be properly scrambled if they were not selected by the consumer. So say goodbye to “cable ready” TV sets; everyone will need a set top box under an à la carte system, and that means higher costs for many households since most currently do not have such boxes.

Third, à la carte regulation would undermine the economic model that has driven the success of the cable sector. A la carte proponents foolishly assume that program bundling hurts consumers when, in reality, the exact opposite is the case. Sometimes the whole is much greater than the sum of the parts. For example, newspapers bundle issue sections together instead of selling them individually because an à la carte approach would not attract as great a customer or advertiser base. The same is true of cable television. Programming tiers that include a diversity of channels increase value for advertisers and consumers alike. And if advertising dollars dry up, it means cable bills will likely increase as well.

Finally, à la carte regulation would likely curtail the overall amount of niche or specialty programming on cable networks. The current tiering approach keeps many smaller channels afloat. In fact, as a contractual matter, many programmers refuse to sell their channels to cable operators unless they are included in a specific tier. An à la carte regulatory mandate would need to nullify existing contracts in order to immediately offer consumers unrestricted channel choice. But doing so would likely cut back the overall range of consumer choices in the long term. And how would consumers even find new niche channels in an à la carte environment? As the GAO report notes that, “subscribers place value in having the opportunity to occasionally watch networks they typically do not watch.” In other words, viewers place a high value on channel surfing since it allows them to sample new channels and programs. But à la carte regulations would discourage that process and suppress the development of new niche programming options.

For these reasons, the GAO report argued that à la carte regulation would have unintended consequences and costs that would discourage consumer choice and likely result in increased rates for service. Let’s hope Senator McCain and other members of Congress heed this warning.

About the Author