Business Obstacles to Cable
Despite its early and substantial lead in providing RBB services, cable faces business challenges. Many of these challenges emanate from the beginnings of cable when "quick and dirty" solutions were the order of the day. Now it is time to create highly scalable and redundant systems. The potential challengers to cable are deep-pocketed and the stakes are high. Finally, cable has taken on the task of providing full service networking capability, that is, supporting Internet, telephone, and broadcast TV services. This is a big plate to fill.
Upgrade Costs
Cable operators are faced with a large bill for HFC, two-way, and data service upgrades yet to come. The cost components are HFC upgrade, two-way upgrades, head-end data equipment, head-end digital video equipment, and customer premises equipment. An estimate of capital cost per subscriber is as follows:
| HFC upgrade ($40,000/mile; 50 homes passed/mile; 62.5 per take rate) | $500 |
| Two-way upgrade | $20 |
| Head-end equipment (CMTS, video and Web servers, and management systems) | $200 |
| Subscriber equipment | $250 |
| Test equipment, tools, training, and initial marketing | $30 |
| Total costs | $1000 |
The Cost of Digital TV
Despite the fact that analog TV does not afford as many additional channels as digital, MSOs may elect to upgrade to analog instead of digital because of cost. Going digital would add an incremental $200 per set top above the cost of an advanced analog set top and a $3 million to $5 million investment at the head end to capture, convert, edit, and store local content in digital format and to support ad insertion from analog source materials.
Improving analog TV would provide up to 550 MHz of forward bandwidth for up to 80 channels and would add new features such as electronic program guides. MSOs in the United States have ordered more than 4 million new, advanced analog set tops through 1997.
An operator could either deploy the cheaper advanced analog TV service and risk losing a percentage of subscribers to DBS and wireless cable or could spend the millions and retain the same subscribership. Depending on customer erosion, determined by customer satisfaction with advanced analog, the operators might stay with analog. This strategy works if DBS sales level off and MSOs are capable of repairing their balance sheets over the next few years.
Competition
DBS is currently the greatest competitive problem for the cable industry for three reasons. The first is the possibility that cable subscribers will disconnect and subscribe to DBS instead. This occurred after cable rate increases in 1996, and after the Telecom Act of 1996 passed. Interestingly, a majority of DBS subscribers continue to subscribe to cable to retain local programming. But the defections occurring after the 1996 rate increases show that there is limited room for price increases before consumers will choose DBS over cable.
A second competitive problem for cable is that DBS subscribers tend to be high-income households. In a national survey, the Los Angeles Times reported in December 1996 that for families with household income of more than $75,000 per year, cable take rates declined in the calendar year 1996 from 75.8 percent to 71.1 percent. High-income households are the ones that tend to opt for more expensive programming packages. When they turn to DBS for premium programming, they either cancel cable altogether or scale back to the basic cable service. Currently, more than 70 percent of cable subscribers accept some form of pay programming. If the percentage drops significantly, this would negatively affect the cash flows of the MSOs. In short, DBS gets the premium service subscribers, who generate better margins. (As a point of comparison, the average DBS subscriber spends about $52 per month, whereas the average cable subscriber spends about $35 per month.)
Finally, with regard to DBS competition, there tends to be less churn among DBS subscribers. Churn refers to a customer's changing from one service or service provider to another. In many cases, DBS subscribers have prepaid for a year or more of service. Besides, if you pay a few hundred dollars for a dish, it is unlikely that you will terminate service, even if you do not sign an annual programming agreement. At any rate, recent surveys conducted by Nielsen Media Research and Primestar indicate that DBS subscribers tend to be very satisfied with their service.
In addition to competition from DBS, there is the prospect of digital TV offered by wireless cable operators. They have begun slowly, but have attracted the interest of large telephone companies and are now better capitalized to compete against cable. The technology of wireless cable is largely the same as that for cable and satellite, and significantly less cost is involved in building the infrastructure.
Finally, there is the prospect of digital over-the-air broadcast. This has the potential to provide many more channels of free television. It remains to be seen what would happen to programming and subscription television if there were 30 or more free digital channels per metropolitan area with a healthy measure of HDTV intermingled.
Market Saturation
Even without competition from satellite or telcos, cable take rates have not increased substantially since 1991 when they first topped 60 percent. Subscription has been less than 2 percent annually since then. It seems that every American TV household that wants cable has it. Cable's task is to get more revenue from households that already have it. This is the problem raised by DBS, with its big gains in pay-per-view and premium sports packaging and its superior penetration of high-income households.
Cable MSO management apparently agrees that it is necessary to get more from each subscriber. Since the passage of the Telecom Act of 1996, cable operators have taken the opportunity to raise subscription rates more than twice as fast as the consumer price index, clearly not a strategy for getting new households. Rates were raised an average of 6 to 7 percent in the summer of 1996, with further increases in the first quarter of 1997. It remains to be seen how well the operators can continue to hold share in the face of these rate increases and increased competition.
Operational Issues
HFC brings significant improvements in field operations and network design. Even so, a wide-area HFC plant is difficult to operate. The following are some recurring issues:
Amplifier maintenance— If you adjust one amplifier, others need changing. Maintenance is also temperature-dependent.
Power— Fiber and amplifiers in the field need electrical power. This can be supplied centrally or in a distributed manner. In either case, there are issues of battery maintenance, selecting proper voltage levels, safety, and corrosion.
Topological redundancy— This is expensive in a tree and branch topology. Generally, route diversity is not available between head ends and fiber nodes.
Remote network management— Automated, remote management is generally not available for RF components. Troubleshooting is largely a manual process requiring experienced staff.
Staffing— Upgrades are dependent on a pool of trained operations engineers. Cable wages for field engineers are roughly 10 to 20 percent less than unionized counterparts in the telephone industry.
See Table 3-5 for failure rates of some system components [Large].
| Component | Annual Failure Rate (%) |
|---|---|
| Fiber optic cable | 0.06%/mile |
| Coaxial cable | 0.12%/mile |
| Drop cable | 1.5%/drop |
| Power supplies | 5% |
| Amplifiers | 3% |
| Fiber transmitters and nodes | 7% |
Franchise Fees
Cable franchise fees levied by cities make up about 5 percent of gross revenue. Whether or not this franchise fee would apply to data services is not clear; for the moment, however, data and cable operators seem to be paying it. In addition to franchise fees, some cities levy their charges based on the amount of wiring done in the city. In Troy, Michigan, the home of an early and contentious legal argument over municipal franchise fees, the initial charges are 25 cents per foot per year for overhead wiring and 40 cents for underground. Note that cable operators do not pay municipal franchise fees for telephone service because these franchises are established by agreement with the state public utility commissions. The Telecom Act of 1996 precludes excessive regulation and charging of fees by municipalities, with the view that such impositions would illegally restrict competition. Therefore, the act preempts certain state and municipal rights. Whether the Troy, Michigan, ordinance is unnecessarily restrictive is to be determined in court. Cities argue that they are entitled to compensation for the digging occurring on municipal property. Digging shortens the useful life of streets, and having wiring underground complicates and slows the maintenance process for other city services, such as sewage, which uses conduits close to those used by telecommunications operators.
Must Carry Rules
Must Carry rules are a particular problem for the cable industry. The 1992 Cable Act required cable operators to carry local broadcasts—that is, local over-the-air stations. In part, this Cable Act was enacted to protect the viability of small stations that were threatened by the possible loss of more than half their available audience if they were not on cable. Note that because DBS does not carry local broadcast stations, Must Carry rules do not apply to it.
Because their analog cable networks are strained for channel capacity, cable operators view Must Carry rules as an economic burden. Many want to drop locally produced governmental, public access, educational, and religious programming in favor of, say, more shopping or pay-per-view channels.
The cable industry attacked the provision in federal court, and the case eventually went to the U.S. Supreme Court. The Supreme Court had jurisdiction because the case is framed by the cable operators as a First Amendment, free speech case. The cable operators argued that being forced to carry stations is an unconstitutional abridgment of their free speech rights. In a 5 to 4 decision handed down in April 1997, however, the court ruled against the cable operators, stating that the imposition on local broadcasters, who would be forced out of business, was greater than the imposition on the cable operators.
Closed Captioning and Emergency Broadcasts
Like over-the-air broadcast, cable will be subject to increased responsibilities for closed-captioning and emergency broadcasts. There is a requirement that all content be closed-captioned by the end of 2005. Cable operators estimate that this will cost $500 million or more.
Until now, cable has been exempt from participating in the nation's emergency broadcast system. This changed in July 1997 and will present new operating problems to cable operators. Requirements to participate in local and state emergency notification services are also possible. These services are surprisingly complicated and will require millions of dollars to implement.
Programming Fees
Cable operators are growing weary of rising programming costs in general, but nowhere are they being hit harder than in sports, in which teams are looking to television rights to be their savior from escalating player salaries. Cable operators pay 70 to 75 cents per subscriber per month for ESPN. But ESPN is proposing an increase to $1 to hang onto its half of the National Football League cable package it now shares with TNT. Cable operators pass these fees on to subscribers. When cable rates are raised accordingly, consumer groups protest, which causes political problems for the industry.