NEWSReport No. DC-2679 ACTION IN DOCKET CASENovember 10, 1994 COMMISSION ACTS ON CABLE TELEVISION "GOING FORWARD" ISSUES TO ENSURE THAT CONSUMERS HAVE ACCESS TO NEW PROGRAMMING AND SERVICES AT REASONABLE RATES (MM DOCKETS 92-266 AND 92-215) The Commission has adopted new "going forward" rules for the cable television industry that provide cable operators with additional incentives to expand their services and facilities in a way that both ensures that cable rates are reasonable and expands the opportunities for cable programmers to reach viewers. These incentives (1) allow cable operators to offer new product tiers priced as operators elect, provided certain limited conditions are met; (2) permit cable operators to add new channels at reasonable prices to existing cable programming services tiers (often called "expanded basic"); and (3) create an additional option pursuant to which small cable operators may add channels to cable programming services tiers. The new "going forward" rules continue the implementation of the Cable Television Consumer Protection and Competition Act of 1992. These rules follow two rate orders (April 1, 1993 and February 22, 1994) that have already led to significant savings for cable television subscribers nationwide. The 1992 Cable Act addresses the problems arising because cable operators currently have market power over the distribution of video programming in virtually all geographic markets. That market power may allow the operator to limit access for programmers and to pay less than competitive prices for programming. The cable operator's market power also may allow the operator to restrict the supply of programming to consumers and to charge higher than competitive prices for programming. Thus, the Commission is concerned with the possible exercise of market power by operators in two markets: (1) the purchase of programming from programmers and (2) the sale of services to subscribers. Under the 1992 Cable Act, the Commission must reconcile and accomplish the goals of ensuring that cable rates are reasonable and expanding opportunities for cable programmers to reach viewers. These goals must be pursued with regard to current unused channel capacity and with regard to capacity that may be added by operators in the future. The Commission is convinced that for most cable operators, the current rules, under which they may increase rates when adding channels to reflect their increased costs and obtain a 7.5% mark-up on new programming costs, by themselves do not create a sufficient incentive for adding channels to either unused or new, future capacity. (over) 2 The Commission recognizes that under current industry practices, new programming typically must be offered in packages or bundles if it is to obtain sufficiently high subscription rates to be commercially successful. Therefore, this new programming must be added to a cable operator's basic service tier ("BST"), to a cable programming services tier ("CPST") or offered in a new package. However, in developing additional incentives for adding channels to a cable operator's offerings, the Commission is mindful that consumers are entitled to reasonable prices, set by regulation pursuant to the 1992 Cable Act, for basic and cable programming services. New Product Tiers. In order to accommodate the introduction of new packages of channels, the Commission has determined that cable operators may offer a new type of CPST called a new product tier ("NPT"). The Commission will permit operators to price these tiers as they elect. The Commission has determined that NPTs and current CPSTs will compete with each other, ensuring that the price for NPTs will not be unreasonable. The conditions for offering NPTs are: (1) cable operators must continue to offer their current BST and CPST service at prices set by the Commission's rate regulations; (2) cable operators may not weaken the status of current tiers as reasonably priced competitive alternatives to NPTs by removing channels from existing tiers and offering them on NPTs; (3) cable operators must continue to offer NPTs and current CPSTs in such a manner that subscribers should reasonably be aware that they may choose whether or not to subscribe to the NPT; and (4) a subscriber may not be charged for an NPT unless the cable operator has obtained the subscriber's affirmative consent. Operators generally may not require consumers to subscribe to a CPST as a condition for subscribing to an NPT. Under these rules, operators may offer the same channel simultaneously on both a CPST and an NPT. This option gives the operator flexibility to market NPTs and to offer subscribers choice. Furthermore, operators may place new programming services on existing CPSTs and then at any time move them to an NPT. In addition, operators may add any channel to an NPT that was previously on a BST or CPST, if the channel was dropped from the BST or CPST before September 30, 1994, or at least two years before being added to the NPT. In short, the rules governing NPTs ensure that subscribers may obtain additional programming at reasonable rates. In addition, the rules are clear and simple. Cable operators are not required to complete any forms or obtain any regulatory approval to offer NPTs, and they may set the price for the tier at the level they elect. 3 A La Carte Package Offerings. Under the 1992 Cable Act, video programming offered on a per channel or per program (a la carte) basis is not subject to rate regulation. The Commission has determined that some cable operators have attempted to evade rate regulation by purporting to offer channels a la carte, when in fact the individual offerings were not a realistic service offering. This determination has lead the Commission to conclude, contrary to prior decisions, that a la carte packages are CPSTs within the meaning of Section 3(l)(2) of the 1992 Cable Act. As such, the packages are subject to rate regulation. The Commission recognized that there are sound policy reasons to treat as reasonable any price offered for a package of channels (such as "premium" channels like HBO and Showtime) that traditionally have been offered on a per-channel basis. The Commission stated that it cannot envision circumstances in which any price for a collective offering such as the commonly offered "HBO/Showtime" package would be found to be unreasonable. Rate Adjustments for Channels Added to BSTs and CPSTs. The Commission's existing rate regulation rules permit operators to increase rates by a per channel amount when channels are added to BSTs and CPSTs, with the per channel amount decreasing as the number of channels on a system increases. These rules also permit operators to pass through to subscribers the costs of obtaining programming plus a 7.5% mark-up on new programming costs. The comments the Commission received provide evidence that these existing rules may not provide sufficient incentives for systems with more than 12 current channels to add new channels (especially new channels with low license fees) to CPSTs. Because appropriate incentives for adding new channels serves the statutory goal of providing "the widest possible diversity of information sources and services to the public," the Commission concluded that the rate regulations ought to be supplemented to incorporate a flat fee mark-up for adding new channels to a CPST. The revised regulations may be used to adjust rates after December 31, 1994, for channel additions occurring after May 14, 1994. For operators electing the revised rules, the Commission allows a per channel mark-up of up to 20 cents for each channel added to CPSTs. This 20 cent per channel adjustment represents the Commission's best estimate of the average amount by which operators in a competitive environment would adjust rates for the addition of a new channel, exclusive of programming costs. 4 Operators may add channels under this rule at any time during the three year period beginning January 1, 1995. But they may not make per channel adjustments to monthly rates totalling more than $1.20 per subscriber over the first two years of the three-year period for new channels added on CPSTs (the "Operator's Cap") and more than $1.40 over the full three-year period. Operators may use the additional 20 cents in the third year only for channels added in that year. Operators electing to use the 20 cent per channel adjustment may not take the 7.5% mark-up on programming cost increases for channels added after May 14, 1994. The Operator's Cap is based on the Commission's observations of cable industry behavior prior to the 1992 Cable Act, adjusted for the lack of effective competition prevalent in the industry, so as to replicate a competitive market. The Commission believes the Operator's Cap will provide an adequate incentive to operators to add new services to CPSTs while protecting consumer interests by keeping overall regulated rates reasonable. Operators may use any portion of the Operator's Cap to pay for license fees. The Commission also decided that operators may add an additional amount of not more than 30 cents per subscriber for programming costs (i.e., license fees paid to programmers) associated with adding new channels (the "License Fee Reserve") during the first and second years the Operator's Cap is in effect. The License Fee Reserve, which is in addition to amounts added under the Operator's Cap, is necessary because, without one, operators would have excessive incentives to add no-cost or low-cost channels to CPSTs. The Commission believes that the rate regulations should not distort market incentives for cable operators to add channels that subscribers are most likely to desire, whether high-cost or low-cost, and the License Fee Reserve accomplishes this goal. In the third year, license fees will not be subject to special rules, but will be subject to our general rate rules. Small System Relief. The revised rules allow independent small systems and small systems owned by small MSOs to pass through to subscribers the costs of new headend equipment for adding not more than seven new channels to CPSTs over the next three years. The amount the qualifying small system may recover is limited to the actual cost of the headend equipment necessary to add a channel, not to exceed $5,000 per channel, plus the channel's licensing fee, if any. The cost of headend equipment must be amortized over the useful life of the equipment and operators will be allowed an 11.25% return on the undepreciated expense. Alternatively, small systems may use the current or revised channel addition rules that are available to all operators. 5 Negative Option Billing. The Commission affirmed that an operator's decision to add, delete or replace channels on tiers is exempt from the negative option billing prohibition of the 1992 Cable Act -- so that the cable operator does not have to obtain each subscriber's affirmative consent before making a change -- if the channel changes do not alter the fundamental nature of the tier. Specifically, the Commission determined that the affirmative consent requirements of the 1992 Cable Act do not apply: (1) when a cable operator raises its rates as a result of passing through external costs or inflation adjustments under the Commission's rules or (2) when a cable operator changes its rates as a result of the addition, deletion or substitution of channels pursuant to the Commission's "going forward" regulations, unless there has been a change in the fundamental nature of a tier. The Commission determined that additions of a relatively few channels to a tier such as are permitted by the revised channel addition rules will not, except in the case of an unusually small tier, change the fundamental nature of a tier and accordingly do not require affirmative consent. The Commission also determined that state or local consumer protection laws that conflict with or undermine the rate regulation rules established pursuant to Section 3 of the 1992 Cable Act may not be enforced. Affiliate Transactions. The Commission declined to adopt a proposal to limit the application of a prevailing company price as a measure of a reasonable price for an affiliate transaction. The proposal would have allowed the use of prevailing company prices only for affiliate transactions in which the affiliate sells at least 75% of its output to nonaffiliates. The record demonstrates that many programming services that have achieved widespread distribution among cable operators would be unable to establish a prevailing company price under the proposed rule because of their association with multiple system operators. The Commission believes it would not be in the public interest to bar such programmers from using their prevailing price because there is no basis in this record to conclude that cable operators are paying excessive amounts for services from those unregulated affiliates. The Commission will, therefore, retain its existing rule which provides that an operator may value an asset or service at the prevailing company price if the affiliated provider has provided the same kind of asset to a substantial number of third parties. 7.5% Markup on Increases in License Fees for Existing Programming. The Commission asked for further comment on whether operators should continue to receive the 7.5% mark-up on increases in license fees on programming carried on systems prior to May 15, 1994. Action by the Commission November 10, 1994, by Sixth Order On Reconsideration And Fifth Report and Order (FCC 94-286). Chairman Hundt, Commissioners Quello and Ness, with Commissioner Chong dissenting in part and Commissioner Barrett dissenting; Commissioners Quello, Barrett, Ness and Chong issuing separate statements. - FCC - News Media contact: Morgan Broman (202) 416-0852; Cable Service Bureau contacts: Paul D'Ari and Joel Kaufman at (202) 416-0800. SEPARATE STATEMENT OF COMMISSIONER SUSAN NESS Re: Going Forward Rules (MM Docket Nos. 92-266 and 93-215) Today's decision represents an important piece of a larger puzzle. The cable industry, like the telephone industry, is preparing to undergo a radical transformation, a transition to a competitive market that promises both opportunity and risk. Our efforts to formulate "going forward" rules must recognize the circumstances, needs, and aspirations of the cable industry. Equally important, we must faithfully carry out our consumer protection responsibilities, as set forth in the 1992 Cable Television Consumer Protection and Competition Act. The rules we adopt today are carefully crafted to encourage the cable industry to do more of what it already does so well, yet also protect consumers against unbridled rate increases. I believe we have struck an appropriate balance. In my prior life as a media lender, I financed a wide variety of cable and programming companies, large and small. From that experience, I believe that the New Product Tier introduced today embodies the entrepreneurial spirit characteristic of the cable industry. This tier gives cable operators the freedom to design innovative programming packages at market prices that will best attract subscribers and reward operators. Competition from alternative video delivery media will, in time, allow us to end regulation of cable rates. But "effective competition," as required by the 1992 Cable Act, has not yet arrived. While we manage the transition to competition, we must not stifle the production of quality new program networks nor curtail the operators' flexibility to offer programming in ways that best meet subscribers' demands. The New Product Tier (NPT) is a win-win-win opportunity. It enables an operator that has the additional capacity to create new packages of programming, knowing that the rules are simple to follow and that the packages will not be price regulated. Programmers benefit from the flexibility offered by the NPT, to offer programming in unique and innovative ways. And consumers benefit from the additional choices NPTs provide at reasonable, market-driven prices. The structure of the New Product Tier is simple. To offer a New Product Tier, an operator must meet four conditions: - Preserve the fundamental nature of its regulated tiers. - Agree not to migrate channels from existing regulated tiers to NPTs. - Continue to actively market its regulated tiers. - Affirmatively market its NPTs. The New Product Tier not only provides operators with price freedom but also reduces administrative burdens. No forms need be filed, nor rate calculations continually revised, in order to offer an NPT. The New Product Tier is flexible. The range of options available to the operator for structuring its programming packages is broad. A cable operator may offer, as a New Product Tier, existing popular channels "cloned" (not migrated) from the regulated tier along with brand new programming services and price the offering as the operator chooses. For example, "news junkies" may have the option of buying a package of CNN, political talk shows and news programs. A New Product Tier may also be structured as a tier of a la carte offerings, permitting consumers to choose some or all of the services on the tier, again priced at the operator's discretion. The New Product Tier is innovative. It gives the operator freedom from price regulation and gives the consumer maximum choice. Because New Product Tiers will be offered side by side with price regulated tiers, and therefore compete with them for the consumer's dollar, market pressure, not government regulation, will influence the pricing of NPT offerings. Consumers will be able to choose among packages competing with each other, both in content and price. But many cable systems lack addressability or have only limited additional capacity. The New Product Tier may be of limited value to them in the near-term. For that reason, the "going forward" order provides incentives to add new services to invigorate existing regulated tiers. We also recognize that many programmers seek the wide audience that regulated tiers provide. The rules we adopt today provide ample incentive for operators to add new programming to regulated tiers. The data show that cable operators historically have added between two and three new channels per year. The new formula gives an operator the flexibility to add channels at a rate consistent with historical practices. Most importantly, we want to ensure that, when new programming is added to regulated tiers, subscribers are not subjected to unreasonable rate increases. Where NPTs are not available, subscribers to regulated tiers have no choice but to pay the higher price attributable to new programming which they may or may not want or drop cable service -- take it or leave it. Today's order reflects the Commission's effort to balance subscriber protections against the needs of operators and programmers. I am mindful that there will be upward pressure on cable rates every year, from inflation and from increased programming cost pass-throughs from existing program networks, in addition to the increases we permit for new channels. Consumers will not care about the source of the rate increase; they will care deeply about how it affects their pocketbooks. In light of this, I think our rules provide as much flexibility to operators as we can reasonably allow. The going forward proposal is not complete. While the introduction of New Product Tiers will allow opportunities for future expansion, until we address the proper regulatory treatment of upgrades of cable systems, we have not provided the industry proper incentives for the long term. Additional capacity will be critical for cable to compete with telephone companies in the provision of video programming as well as telephony. The cable industry promises to be a key player in the development of the National Information Infrastructure. We must move expeditiously to provide operators with the regulatory certainty they need to invest in their infrastructure. Our recent decision on video dialtone makes this all the more imperative. I intend to work diligently toward that end. SEPARATE STATEMENT OF COMMISSIONER RACHELLE B. CHONG DISSENTING IN PART Re: In the Matter of Implementation of Sections of the Cable Television Consumer Protection and Competition Act of 1992: Rate Regulation (MM Docket Nos. 92-266, 93-215) My overriding goals in this cable "going forward" proceeding have been (1) to provide incentives to cable operators to add new programming services to their systems, consistent with our obligation under the 1992 Cable Act to ensure that cable rates are reasonable, (2) to provide the cable industry with maximum flexibility to respond to consumers, and (3) to provide the industry and the Commission with certainty by adopting clear, understandable rules. I support most of this item because I believe it is consistent with these goals. However, I do not think the going forward price cap structure for regulated tiers (or "channel adjustment formula"), is consistent with these goals, or my most basic regulatory tenet -- simple pragmatic regulation. Therefore, I respectfully dissent to this portion of the item. The channel adjustment formula we adopt today allows a cable operator a 20 cent per channel adjustment for each new channel added to a regulated tier, subject to a cap. I support the 20 cent mark-up, and believe it will provide needed incentive to an operator to add channels to its regulated tiers. I have serious concerns about other aspects of the formula, however. Although my colleagues and I have sought to achieve consensus, it has not been possible due to basic philosophical differences. First, I believe the formula is exceedingly complex. Already, members of the cable industry, particularly small operators, have registered complaints with me about the difficulties they have understanding and complying with the current cable rules. I would have preferred a simpler mechanism that is more readily understandable and lends itself to more predictability in its application and effect on rates. Second, I would have preferred a formula that gives a cable operator the maximum flexibility to respond to consumer demand in its local service area. For example, the level of the "operator's cap" established in this decision is based on an understanding of past practices of the cable industry. While I certainly agree that we should factor past practices into our decision, I do not believe this should be our primary basis on which we make decisions for the future. We should also consider the programming market, as well as new competition entering the video distribution market. This decision also limits a cable operator's flexibility by imposing a 30 cent "license fee reserve." I am not convinced that this reserve will have the desired effect given the level of the maximum rate increase allowed under the new rules over a three year period. I prefer that this agency avoid that level of regulation. I have approved the rest of this item. A few other areas deserve comment. This item discusses the treatment of packages of programs offered on a per channel or per program basis. The decision we make here today represents a change from earlier Commission decisions, in that we exert jurisdiction over such packages. With my lawyer hat on, I have carefully studied the relevant portions of the 1992 Cable Act and the legislative history on this point. Based on my analysis of the Act and congressional intent, I have come to support this portion of the decision because I believe this is the correct reading of the statute. I come to this decision reluctantly. I recognize that some will perceive this as needlessly imposing further government regulation on the cable industry. Nonetheless, I am obliged to effectuate the plain meaning of the statutory text. My concern about this aspect of the decision is alleviated to some extent by the creation of "new product tiers." Under this scheme, new programming services are packaged and cable operators are allowed to set rates for such packages based on what they believe the market will bear. If an operator offers new product tiers, it must continue to offer its basic and expanded basic tiers of programming, the latter of which are rate regulated to ensure reasonableness under the 1992 Cable Act. I believe the competition between new product tiers and the regulated tiers will result in a reasonable rate being set for the new product tiers. This new scheme is more consistent with my regulatory philosophy because it relies on market forces to set rates. Finally, I support the provision in this item that seeks to accommodate the particular problems faced by small cable systems. We adopt a special streamlined cost-of-service procedure for small systems that upgrade their headend equipment. It is my hope that this procedure will allow small systems to add new channels so they, too, can offer new programming services to their subscribers.