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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 In the Matter of ) ) Annual Assessment of the Status of ) CS Docket No. 96-133 Competition in the Market for the ) Delivery of Video Programming ) THIRD ANNUAL REPORT Adopted: December 26, 1996 Released: January 2, 1997 By the Commission: Table of Contents Paragraph I. Introduction. . . . . . . . . . . . . . . . . . . . . . . 1 A Scope of this Report . . . . . . . . . . . . . . . . 2 B. Summary of Findings. . . . . . . . . . . . . . . . . 4 II. The Telecommunications Act of 1996. . . . . . . . . . . . 5 III. Competitors in Markets for the Delivery of Video Programming 11 A. Cable Industry . . . . . . . . . . . . . . . . . . 11 B. Direct Broadcast Satellite Service . . . . . . . . 36 C. Home Satellite Dishes. . . . . . . . . . . . . . . 49 D. Wireless Cable Systems . . . . . . . . . . . . . . 51 E. Local Exchange Carriers . . . . . . . . . . . . . 67 F. Satellite Master Antenna Television Systems. . . . 80 G. Broadcast Television Service . . . . . . . . . . . 86 H. Other Entrants . . . . . . . . . . . . . . . . . . 95 IV. Market Structure Conditions Affecting Competition . . . 114 A. Horizontal Issues in Markets for the Delivery of Video Programming 114 B. Vertical Integration in the Cable Industry . . . . 140 C. Technical Advances . . . . . . . . . . . . . . . . 170 V. Issues. . . . . . . . . . . . . . . . . . . . . . . . . 185 A. Legal and Regulatory Obstacles . . . . . . . . . . 185 B. Competitive Responses. . . . . . . . . . . . . . . 201 VI. Administrative Matters. . . . . . . . . . . . . . . . . 234 Appendices A. List of Commenters B. Cable Industry Tables C. DBS and HSD Tables D. FCC MDS Auction Information E. Top Ten SMATV Operators F. Horizontal Issues Tables G. Vertical Integration Tables H. Program Access Matters Resolved I. INTRODUCTION 1. Section 628(g) of the Communications Act of 1934, as amended, ("Communications Act") requires the Commission to report annually to Congress on the status of competition in the market for the delivery of video programming. Congress imposed this annual reporting requirement in the Cable Television Consumer Protection and Competition Act of 1992 ("1992 Cable Act"), as one means of obtaining information on the competitive status of markets for the delivery of multichannel video programming delivery that would aid both Congress and the Commission in determining when there was competition sufficient to reduce or eliminate many of the regulatory restraints imposed on the cable industry by that legislation. This is the Commission's third annual report ("1996 Report") to Congress submitted in compliance with this statutory requirement. In this 1996 Report, we update our two prior reports and provide data and information that summarizes the status of competition in the market for the delivery of video programming. In the two prior reports we described the methodology and theory underlying our competitive analysis. We do not repeat that information in this report other than in an abbreviated fashion, and provide reference to the relevant discussion in prior reports. The information and analysis provided in this third report are based on publicly available data, filings in various Commission rulemaking proceedings, and information submitted by commenters in response to a Notice of Inquiry ("Notice") in this docket. A. Scope of this Report 2. Section II of this report contains a brief review of the Telecommunications Act of 1996 ("1996 Act"). In Section III we examine the cable television industry, existing multichannel video programming distributors ("MVPDs") and distribution technologies, and potential competitors to cable television. Among the alternative distribution technologies and providers discussed are direct broadcast satellite ("DBS") services and home satellite dishes ("HSDs"), wireless cable systems using frequencies in the multichannel multipoint distribution service ("MMDS") or local multipoint distribution service ("LMDS"), local exchange telephone carriers ("LECs"), satellite master antenna television ("SMATV") systems, and broadcast television service. We also consider several other existing and potential distributors of and distribution technologies for video programming, including electric utilities, the Internet, and interactive video and data services ("IVDS"). 3. In Section IV of this 1996 Report, we examine market structure and competition. We evaluate horizontal concentration and vertical integration between cable television systems and programming services. We also discuss in this section program access and technological advances. In Section V we discuss some evidence of potential obstacles to the emergence of a freely competitive multichannel video programming distribution ("MVPD") marketplace, and evidence of competitive responses by industry players that are beginning to face competition from other MVPDs. B. Summary of Findings 4. In this 1996 Report, the Commission makes the following findings: þ The 1996 Act embodies Congress' intent to promote a "pro-competitive national policy framework" and eventual deregulation of markets for the delivery of video programming. Several of the 1996 Act's provisions are intended to build on prior efforts, particularly the 1992 Cable Act, by removing additional barriers to competitive entry in these markets and establishing market conditions that promote the process of competitive rivalry. Many provisions of the 1996 Act, and the Commission's actions to implement them, have the potential for fostering increased competition. The Commission has adopted rules to implement the open video system provisions of the 1996 Act and has adopted rules to implement the 1996 Act provision which preempts certain local government and non-government restrictions on reception devices, including antennas and dishes for reception of over-the-air broadcast, wireless cable and DBS signals. The Commission has adopted similar rules with respect to certain home satellite dish services. A change in the definition of a cable system made by the 1996 Act now permits SMATV operators to serve buildings regardless of ownership without being subject to regulation as cable operators, provided that public rights-of-way are not used in the process. þ We find that incumbent franchised cable systems continue to be the primary distributors of multichannel video programming, although other MVPDs, particularly those using alternative technologies (e.g., DBS, wireless cable and SMATV systems), continue to increase their share of subscribers in many markets. Subscribership for distributors using technological alternatives to traditional cable service now accounts for 11% of total MVPD subscribership. Non-cable MVPD subscribership has been increasing an average of 22% per year since 1990, with cable subscribership currently down to 89% of all MVPD subscribers. Notwithstanding this decrease in cable systems' share of total MVPD subscribers, the actual number of cable subscribers continues to increase. In fact, since the 1995 Report, the number of cable subscribers increased by two million compared to the increase in combined subscribership for all other MVPDs of 2.3 million. þ Local markets for the delivery of video programming generally remain highly concentrated, and structural conditions remain in place that could permit the exercise of market power by incumbent cable systems. Overall, our conclusion concerning competition in markets for the delivery of multichannel video programming remains unchanged from last year -- it remains difficult to determine to what extent these markets will be characterized over the long term by vigorous rivalry among multiple MVPDs offering closely substitutable services or, conversely, the extent to which many of these markets will remain dominated by one or two providers facing less vigorous rivalry from MVPDs offering highly-differentiated or niche programming services. þ We find a growing but still very limited number of instances where incumbent cable system operators face competition from MVPDs offering services with very similar attributes (i.e., overbuilds/wired delivery). Where such competition exists, such as in Dover Township, New Jersey, the effects of competition are readily apparent. We also find a substantially increased presence of MVPDs deploying somewhat differentiated services, particularly DBS service providers. Increased competition among DBS service providers has led to lower equipment prices and, possibly, increases in the number of cable subscribers choosing to drop or reduce cable services in favor of DBS services. Moreover, some cable system operators appear to be taking steps to improve their service offerings in response to the availablity of DBS service. MVPDs using other distribution technologies, such as MMDS, have not posted comparable increases in subscribership, but are in the process of testing digital technology that has the potential to significantly improve the competitiveness of their services. Consequently, it remains difficult to predict the extent to which competition from MVPDs using non-cable delivery technologies will constrain cable systems' ability to exercise market power in the future. þ As a result of acquisitions and trades, cable multiple system operators ("MSOs") have continued to increase the extent to which their systems form regional clusters. The number of clusters of systems serving at least 100,000 subscribers increased from 97 to 137, and these clustered systems now account for service to approximately 50% of the nation's cable subscribers. þ Nationally, concentration among the top cable MSOs has continued to increase, but still remains within the moderately concentrated range at 1326 (an Herfindahl-Hirschman Index ("HHI") between 1000 and 1800). If all MVPDs are included in the calculation, national concentration falls just above the threshold of the moderately concentrated range with an HHI of 1013. DBS providers DIRECTV and PRIMESTAR rank among the ten largest MVPDs in terms of nationwide subscribership with over 2.0 and 1.5 million subscribers, respectively. þ Vertical integration of national programming services between cable operators and programmers declined from last year's total of 51% to just 44% this year. We find, however, insufficient evidence to make any determination of the effect to date of these developments. The decline is due largely to the sale of Viacom's cable system assets. In addition, of the 16 programming services that were launched since the 1995 Report, 10 are not vertically integrated. Access to programming remains one of the most critical factors for the successful development of competitive MVPDs. Competing MVPDs have complained about the potential unavailability of programming distributed by means other than satellite or produced by programmers that are not vertically integrated with cable systems. To the extent that it appears that the denial of access to programming serves to deter entry of competitors in markets for the delivery of video programming, we will be concerned about these developments. þ Technological advances are occurring that will permit MVPDs to increase both quantity of service (i.e., an increased number of channels using the same amount of bandwidth or spectrum space) and types of offerings (e.g., interactive services). MVPDs continue to pursue new system architectures, upgraded facilities, use of increased bandwidth and deployment of digital technology. þ Our findings as to particular distribution mechanisms operating in markets for the delivery of video programming include the following: Cable Systems: The cable industry has continued to grow in terms of subscriber penetration, average system channel capacity, the number of programming services available, revenues, audience ratings and expenditures on programming since the 1995 Report. DBS Service Providers: Subscribership to DBS services increased from 1.7 million homes last year to nearly 4 million homes at the end of October 1996. This increase is attributable in part to the development of competition from two new DBS services in the last year -- AlphaStar and EchoStar -- and price competition among providers that has significantly lowered the cost of receiving equipment. Wireless Cable Systems: Although wireless cable systems showed some growth in subscribership, the most significant development in 1996 was MMDS systems' preparation for the deployment of digital systems in 1997. This will increase the number of channels that MMDS systems can offer and permit them to be more competitive with incumbent cable systems. Throughout most of the year, LECs continued to expand their investment in the wireless industry, but some have recently cut back on that investment. We also observe a continuation of the trend toward increased consolidation among wireless companies. SMATV Systems: SMATV subscribership increased 10.5% over the past year in systems that serve MDUs. Industry analysts attribute the growth, among other things, to technical improvements that increased operating efficiencies and to expanded product offerings, i.e., security features and diverse programming. Broadcast TV: Broadcast service continues to serve as both a transmission medium for many households, and a primary source of programming for most viewers regardless of distribution media. Regulatory changes and technological advances may, at some point in the future, permit the use of broadcast television and other existing and potential video technologies, such as low power television, for distribution of multichannel video programming. LEC Entry: The 1996 Act expands opportunities for LECs to enter markets for the delivery of multichannel video programming. Since adopting rules implementing the 1996 Act's open video system ("OVS") provision, we have certified the conversion of Bell Atlantic's Dover, New Jersey, video dialtone system to an OVS and authorized two additional OVS operators. In the last year, some LECs have continued to expand franchised cable operations, both within and outside their telephone service areas. Utilities: Section 103 of the 1996 Act removes regulatory barriers to entry in telecommunications and video markets for "registered" public utility holding companies. On September 12, 1996, the Commission adopted final rules to implement Section 103, and, to date, has granted all 18 applications filed thus far under the 1996 Act. II. THE TELECOMMUNICATIONS ACT OF 1996 5. The Telecommunications Act of 1996, enacted February 8, 1996, marks a fundamental shift toward competition throughout the entire telecommunications marketplace. Congress specifically stated its intent to establish a "pro-competitive de-regulatory national policy framework" for the telecommunications industry. Consistent with this philosophy, the 1996 Act contains several provisions that focus on removing barriers to competitive entry and on establishing market conditions that promote competitive firm rivalry. In addition to encouraging competition in the local telephone exchange market, the 1996 Act also encourages competition in the market for the delivery of multichannel video programming. 6. Eliminating a significant statutory barrier to entry, the 1996 Act removes the statutory provision that prevented local telephone companies from providing video programming services directly to subscribers in their telephone service areas. The 1996 Act also directs the Commission to eliminate all of its video dialtone rules and attendant policies, and to eliminate the requirement that a common carrier obtain authorization pursuant to Section 214 of the Communications Act for the provision of video programming. In place of these provisions, the 1996 Act provides for a new "open video system" or "OVS" framework for the provision by telephone companies and others of multichannel video programming. The Commission has promulgated rules pursuant to this new statutory provision, including extending the program access requirements to common carriers providing video programming pursuant to Section 302(b)(1)(A) of the 1996 Act. 7. Several other provisions of the 1996 Act focus on eliminating regulatory barriers to entry into markets for the delivery of video programming. For example, pursuant to Section 207 of the 1996 Act, the Commission has implemented rules preempting certain local government and non- government restrictions on reception devices, including antennas for reception of over-the-air broadcast, wireless cable, and DBS. Section 301(a)(2) of the 1996 Act redefined the statutory exceptions to a cable system so as to permit more efficient operation by SMATV operators. Pursuant to Section 202(f)(1) of the 1996 Act, the Commission has revised Section 76.501 of the rules to permit the common ownership of a cable system and a broadcast television network. 8. In addition to removing statutory and regulatory barriers to competition among actual and potential MVPDs, the 1996 Act also contains a number of provisions that directly affect competition in the cable industry. For example, Section 304 of the 1996 Act contains provisions affecting cable system operators, such as multiple dwelling unit ("MDU") bulk discounts and uniform rate structure rules. Section 301(c) of the 1996 Act contains immediately effective deregulatory provisions for small cable system operators and Section 301(b) of the 1996 Act contains deregulatory provisions for large cable system operators that take effect within three years of enactment of the 1996 Act. In addition, Section 301(b)(3) of the 1996 Act broadens the definition of effective competition so as to increase the ability of cable operators to assert the existence of effective competition and avoid rate regulation. Section 301(f) of the 1996 Act, addressing cable equipment compatibility, provides for narrowly drawn compatibility requirements that do not adversely affect the features, functions, protocols or other products and services options of such equipment other than those specifically specified in the equipment compatibility requirement. 9. The 1996 Act also contains provisions to encourage open competition in MVPD equipment markets. Section 304 of the 1996 Act tasks the Commission with adopting regulations to assure the commercial availability of converter boxes, interactive communications equipment and other equipment used by consumers to access multichannel video programming services. The 1996 Act also provides for the sunset of these provisions when the Commission determines: (1) the market for MVPDs is fully competitive; (2) the market for converter boxes and interactive communications equipment is fully competitive; and (3) elimination of the regulations would promote competition and the public interest. 10. Finally, we note there are additional provisions aimed at encouraging market entry. Pursuant to Section 101 of the 1996 Act, the Commission has instituted a proceeding to identify and eliminate market entry barriers for entrepreneurs and other small businesses in the provision and ownership of telecommunications services. Pursuant to Section 103 of the 1996 Act, the Commission established rules that enable public utility holding companies to enter into telecommunications markets and has approved exempt telecommunications company status for 18 companies. III. COMPETITORS IN MARKETS FOR THE DELIVERY OF VIDEO PROGRAMMING A. Cable Industry 11. This section addressing the performance of franchised cable system operators is divided into three categories: (1) general performance -- both quantitative measures of the current amount of cable industry services that are being produced and qualitative measures of the nature of the service; (2) financial performance -- the revenues and cash flow that are generated by the industry's general performance; and (3) capital acquisition and disposition -- the amount of funds that companies have been able to raise and use to improve their existing physical plant and acquire new systems, and how they have chosen to allocate those funds. In addition, this section reports on the status of overbuilding, one of the first forms of competition to the cable industry. The term "overbuild" refers to a situation in which two or more wireline cable television systems directly compete for subscribers in a local video programming delivery market. 1. General Performance 12. During 1996, the cable industry's total basic subscribership, total homes passed, basic penetration, and premium channel subscriptions have reached all-time highs. The industry is also offering more channels, a greater number of individual program services than at any time in the past, and higher audience levels. 13. Cable Industry Capacity and Subscribership. Since release of the 1995 Report, the cable industry has continued to expand. The number of homes capable of receiving service from a cable system (commonly referred to as homes passed) grew from approximately 91.6 million at the end of 1994 to approximately 92.7 million at the end of 1995, a 1.2% increase. Thus, at year end 1995, cable service was available to 96.7% of all television households in the United States. 14. Subscribership grew from a total of 59.7 million at the end of 1994 to 62.1 million at the end of 1995, a 4.0% increase. This increase is reflected in the industry's basic cable penetration level, which rose by 2.8% -- from 65.2% to 67.0% of homes passed. This increase in penetration is the second largest annual increase since 1977. According to at least one analyst, industry subscribership appears to be growing at approximately a 3% growth rate during 1996. 15. The total number of subscriptions to premium channels grew by 6.1% from approximately 51.1 million at the end of 1994 to approximately 54.2 million at the end of 1995. The number of homes subscribing to at least one premium channel was approximately 28.1 million in 1994. No estimates of this statistic are available for 1995 at this time. 16. Cable Industry Services. During 1995, both the number of systems with large channel capacity and the number of subscribers served by such systems continued to increase. In 1994, cable systems with the capacity to offer 30 or more channels accounted for over 78% of all cable systems. The equivalent figure for 1995 was 79.4%. As a result of upgrades over the last year, 123 more systems, or 14% of all systems, now offer 54 or more channels. The percentage of all systems which offered 12 or fewer channels declined from 6.7% in 1994 to 5.4% in 1995. 17. During 1995, the number of subscribers served by high capacity systems (54 or more channels) grew to 27.7 million (47.9% of all subscribers). This represents growth of 20.3% over the 23 million subscribers recorded in 1994. Moreover, the number of subscribers receiving service from systems with at least 30 channels rose 4.6% to 56.3 million at the end of 1995, which accounted for 97.3% of all subscribers. 18. Over the past decade, the number of television viewing hours of non-premium cable programming networks has grown. Comparing the 1984-85 and 1994-95 seasons, the combined, full-day audience of cable networks increased from an 11% share to a 30% share of television viewing hours. Comparing the same two periods, the combined audience of the network-affiliated, independent, and public broadcast television stations has decreased from an 87% share to a 72% share of television viewing hours. This growth in the viewership of the cable networks has continued into the 1996/1997 season. The total prime time share of the cable networks for the first week of the 1996/1997 television season increased 11.1% over the first week of the 1995/1996 season to 30% of television viewing hours. A comparison of the same two periods shows that the four largest broadcast networks had their total prime time share decrease by 5.8% to 65% of viewing households. 19. License fees paid by cable system operators to non-premium cable network programmers increased by 19% from approximately $2.233 billion in 1994 to approximately $2.658 billion in 1995. License fees paid by cable system operators to premium cable network programmers increased by 2.1% from $1.9 billion in 1994 to $1.94 billion in 1995. Copyright fees paid by cable system operators for broadcast signal carriage under Section 111 of the Copyright Act increased 2.2% from $161 million in 1994 to $164 million in 1995. 20. Consumer Satisfaction. In March 1995, the cable industry, through the National Cable Television Association ("NCTA"), launched a new on-time guarantee program to improve consumer satisfaction. Under this program, operators promise that: (1) if an installation appointment is not performed on time, the installation will be done for free, and (2) if a service appointment is not performed on time, the customer will receive a $20 refund. According to NCTA, this program has been adopted by cable systems serving 25 million subscribers. This year, NCTA reports that the on-time performance of individual MSOs participating in the program has ranged between 76% and 99%. 2. Financial Performance 21. The supply and demand statistics described above provide an important indicator of the state of the cable industry. However, these statistics alone do not reveal how the subscribership changes have influenced the industry's financial health. This section examines revenue and cash flow for the cable industry and shows that in 1995 these two key financial indicators performed well. 22. Cable Industry Revenue. Financial analysts who follow the cable industry report that after showing slight growth in 1994, the industry's revenue increased by 10.8% in 1995, growing from $22.79 billion to $25.1 billion. Using these figures, it is estimated that the cable industry generated $411.90 in annual revenue per subscriber served in 1995. This figure is $22 higher than the $389.50 annual revenue per subscriber generated in 1994. When total cable system revenue is broken down by source, between 1994 and 1995, it is estimated that: MSO revenue from regulated tiers (referred to by the Commission as the basic service and cable programming service tiers) increased by 11.1%; MSO revenue from premium services increased by 12%; and MSO revenue from advertising, pay-per-view, and home shopping grew 18.9%, 68.0%, and 13.4% respectively. 23. For purposes of this report, the Commission calculated its own estimates of the annual, industry-wide total revenues from 1992 to 1995. Based on these estimates, it appears that the industry generated revenue of over $21.07 billion in 1992, $22.59 billion in 1993, $23.09 billion in 1994, and $24.46 billion in 1995. Based on the Commission's estimates, the industry's annual revenue increased 6.0% from 1994 to 1995. 24. In Table 8A of Appendix B, we present detailed, quarterly revenue results for 14 publicly held MSOs, including the eight largest. For each quarter of 1994, 1995, and the first two quarters of 1996, total revenue growth over the same quarters of the previous year is calculated for these MSOs based on their filings with the Securities and Exchange Commission ("SEC"). As of December 31, 1995, these 14 MSOs served over 66.9% of the industry's 62.1 million subscribers. Based on their combined revenues, an estimate of the total industry revenue was made for each quarter and is also presented in Table 8A. 25. Revenue increased in each quarter of 1995 and showed increases over the equivalent quarters in 1994. The industry generated 2.9% more revenue in the first quarter of 1995 than in the first quarter of 1994; 4.5% more in the second quarter; 8.1% more in the third quarter; and 10.6% more in the fourth quarter. While this trend continued into the first quarter of 1996 (when revenue growth was 11.4% over the first quarter of 1995), the pace slowed slightly in the second quarter, with industry revenues 9.9% higher than in the second quarter of 1995. 26. Cable Industry Expenditures and Earnings Before Interest, Taxes, Depreciation, and Amortization. Measurements of earnings before interest, taxes, depreciation, and amortization ("EBITDA"), commonly referred to as "cash flow" by the industry, are often used to value the financial position of cable firms. Financial analysts who follow the cable industry report that after declining by 1.6% to $9.94 billion in 1994, industry wide cash flow increased 13.1% in 1995 to $11.2 billion. Using these figures, the cable industry generated approximately $184.53 in annual cash flow per subscriber served in 1995, about $15 higher than the $169.85 generated in 1994. Based on these estimates, the ratio of cash flow to revenue ("cash flow margin") increased from 43.6% in 1994 to 44.8% in 1995. 27. For purposes of this report, the Commission has also calculated an estimate of annual, industry-wide cash flows from 1992 to 1995. Based on Commission estimates, the industry generated cash flow of $9.72 billion in 1992, $10.31 billion in 1993, $10.05 billion in 1994, and $10.63 billion in 1995. The Commission's 1995 estimate represents a cash flow increase of 5.7% from 1994. 28. An analysis of the industry's cash flow for any one year may not provide a complete picture of the trend in the industry's performance. A more informed analysis may be provided by comparing each quarter of 1994, 1995, and the first two quarters of 1996, with the same quarters of the previous year. These quarterly growth rates are shown in Appendix B, Table 8B. As in Appendix B, Table 8A, we present detailed quarterly cash flow for the same 14 publicly held MSOs. After exhibiting slow year-over-year cash flow growth in the first two quarters of 1995 (2.1% and 1.5% respectively), year-over-year cash flow growth was much stronger in the third and fourth quarters of 1995 (10.1% and 9.4% respectively). In the first two quarters of 1996, year-over-year cash flow growth slowed to 5.6% and 8.0% respectively. 3. Capital Acquisition and Disposition 29. In 1995, the cable industry displayed an increased ability to acquire financing from a variety of public and private sources. The industry also made some of the most substantial capital investments ever. In recent months, however, there have been reports that some cable operators have been having difficulty financing the significant capital investments that they had been planning to make. For example, on October 24, 1996, TCI president John Malone was reported to have said that "[t]he days of heavy capital spending on cable are behind us" during a presentation to institutional investors at which he explained TCI's plans to cut back on system upgrades in its systems that are small or less-threatened competitively. 30. Cable Industry Financing in 1995: The cable industry has typically relied on various combinations of private and public financing, with the exact distribution of these combinations varying greatly from year to year. Redemptions caused private debt financing (i.e., debt held by banks, insurance companies, and institutional investors) to decrease by $808 million in 1995, while public debt financing increased by $4.5 billion. The remaining industry financing is obtained through a mixture of private equity (i.e., individuals, venture capital firms, investment banks, limited partnerships) and public equity offerings (i.e., stock markets). New private and public equity offerings totalled $1.1 billion and $4 billion, respectively, in 1995. Overall, the cable industry obtained $8.8 billion in new financing in 1995, which is an increase of $2.1 billion over the 1994 total. This growth in new financing during 1995 helped increase combined cash flow and new investment to the highest level ever. The $20 billion total combined figure in 1995 ($11.2 billion from cash flow plus $8.8 billion from new financing) was an increase of 20.1% over the $16.7 billion reported in 1994. 31. Cable Industry Financing: Recent Developments. The cable industry appears to be on a pace that will result in it obtaining significantly less in new capital in 1996 than in prior years. Cable operators are reported to have raised approximately $1.6 billion in capital during the first half of 1996. Included in this total was a net redemption of $1.6 billion of privately held debt; $2.6 billion raised in the bond market; and $626 million raised in the public equity market. If the industry continues to obtain new financing at this rate, it will raise a total of $3.2 billion in new financing for 1996, which is less than 45% of 1995's total. 32. Capital Expenditures. In 1995, the cable industry invested $5.4 billion in construction of new plant and equipment (including maintenance, inventory, system upgrades, converters, passing of new homes, and rebuilding of existing systems). This was a 42% increase over the $3.8 billion spent on construction in 1994. This also represents the third consecutive year that cable industry capital expenditures experienced double-digit growth. Of the $5.4 billion in capital expenditures, the industry spent $3.4 billion on the upgrade and build-out of existing systems. Approximately $1 billion was spent on new set-top converters and other inventory. In contrast, it was recently reported that TCI is going to reverse this pattern, and will begin spending more on set-top converters and less on system upgrades over the next few years. 33. Cable System Transactions. The number of mergers, acquisitions, and exchanges between MSOs increased from 64 in 1994 to 128 in 1995. The information for 1995 also marks a change in the seven year trend reported in prior reports that while total number of subscribers served by systems sold increased, the number of systems sold declined. This past year, the number of subscribers to, and homes passed by, the systems changing hands in these transactions both increased, by 46% and 38%, respectively. In addition, the total dollar value of the transactions increased 43% between 1994 and 1995. Consistent with the trend begun in 1994, however, the average dollar value per subscriber of these transactions decreased, in 1995 by 1.8% (from $1,869 to $1,836) and the average cash flow multiple decreased, in 1995 by 5.8% (from 10.3 to 9.7). Overall, the transactions announced in 1995 involved more subscribers and higher purchase prices than in any year since 1982. 34. For the nine months from January to September of 1996, 81 transactions were announced, involving 7.5 million subscribers, 12.1 million homes passed, and purchase prices totaling $15.6 billion dollars (which represents $2,078 per subscriber). While these totals all represent decreases over the first nine months of 1995, it is worth noting that this year's transactions, on average, have been much larger than those announced last year. Moreover, the price per subscribers is, on average, much higher thus far in 1996 than it was in 1995 ($2,078 versus $1,836). These results, however, appear to be largely the result of a single transaction, U S West Media Group's ("U S West") purchase of Continental Cablevision. 4. Status of Overbuilding 35. Finally, as we noted above, overbuilding was one of the first competitive situations experienced by incumbent cable operators. Since the 1995 Report, the development of new overbuilds by non-LEC entities continues to be limited. We are aware of only two new such non- LEC overbuilding plans. In the last year, the city of Raleigh, North Carolina, granted Fiber South a franchise to overbuild its incumbent operator, Time Warner. In addition, the city of Chicago, Illinois, granted 21st Century Cable TV a franchise to overbuild parts of the city encompassing 270,000 homes. B. Direct Broadcast Satellite Services 36. Direct broadcast satellite ("DBS") operators are like other MVPDs in that they: (1) downlink programming from many different satellites pursuant to contracts with programmers; (2) package the programming into service offerings; and (3) make those service offerings available to subscribers over a proprietary facility. However, DBS services use satellites instead of broadband wires or terrestrial microwave stations to transmit their programming to subscribers. In addition, we note that DBS operators have a public interest obligation to reserve between 4% and 7% of their channel capacity for noncommercial programming. 37. For the purposes of this 1996 Report, we include Primestar Partners, L.P. ("PRIMESTAR") and AlphaStar as DBS providers even though they currently do not use high- powered Ku-band frequencies allocated for DBS service as defined under the Commission's rules. Instead, they provide programming using medium-powered Ku-band frequencies allocated pursuant to the Commission's Fixed Satellite Service. Nonetheless, PRIMESTAR's and AlphaStar's services share many of the same attributes of the multichannel video programming services offered by the other DBS operators, and it appears that consumers and industry participants view their services as close substitutes for the services of MVPDs using DBS frequencies, such as DIRECTV and EchoStar. 38. Since we issued the 1995 Report, DBS subscribership has increased substantially, to the point that DBS systems have a higher combined subscribership than any other MVPD alternative to incumbent cable systems. As discussed below, it appears that the advent of price competition among DBS providers has contributed to the increase in DBS subscribership, with initial equipment costs dropping to as low as $199 plus installation costs. However, DBS providers continue to be unable to provide local broadcast network signals (and network programming), requiring DBS subscribers to obtain those signals over the air or through basic cable subscriptions. In addition, the first-year annual cost of DBS service remains significantly higher than for cable service and, if cable joins DBS systems in the use of digital encryption, many cable systems will be able to offer substantially more programming than can be offered by DBS systems. Nonetheless, most observers project continued strong growth for the DBS industry through the end of the decade. For example, two industry analysts recently projected that there would be a total of 13-15 million DBS households by the year 2000. Another observer projects that DBS operators will account for service to over 20% of all MVPD subscribers by the year 2000. 39. Subscribership. Subscribership to DBS services continued to increase rapidly over the past year. In the 1995 Report, the Commission noted that, according to industry reports, nearly 1.7 million households subscribed to DBS services at the end of September 1995, an increase of approximately 1.1 million subscribers from the previous year. Based on the revised total of 1.6 million households, it appears that DBS subscribership increased by approximately 2.0 million households during the twelve months between the end of September 1995 and the end of September 1996, to a total of nearly 3.6 million households. As of the end of October 1996, there were 3.82 million DBS subscribers. 40. Since DIRECTV and USSB began offering service in June 1994, DBS services have grown at a rate making DBS receiving equipment one of the most successful new consumer electronics product introductions in history in terms of units sold. DBS subscribership is anticipated to continue to grow rapidly over the next few months, with some reports over the summer projecting that over 5 million households may be receiving DBS service by the end of 1996. The DBS industry appears to have experienced somewhat slower growth in recent months, however, with DIRECTV and PRIMESTAR each revising downward their projections two times in recent months, and industry observers now projecting a year-end total of between 4.3 and 4.5 million DBS subscribers. These lower projections may not necessarily indicate a slower overall growth rate. As demonstrated in the tables in the appendix to this report, monthly increases in DBS subscribership have fluctuated significantly. In its relatively short history, the DBS industry has experienced two periods of significantly enhanced monthly increases in subscribership--October- December, 1995, and June-July, 1996, possibly due to heightened marketing during those periods. 41. Individual DBS Service Providers. DBS subscribers generally use relatively small dishes (18-24 inches for DIRECTV/USSB and EchoStar, and 36-39 inches for PRIMESTAR and AlphaStar) to receive the programming from the individual orbital location from which the DBS operator is transmitting the service. Both services and equipment are available to subscribers from a variety of retail outlets, including large national consumer electronics retailers. Two more DBS operators, EchoStar (18-24 inch dishes) and AlphaStar (36-39 inch dishes), initiated service since the 1995 Report was released. Consumers may now choose DBS services from four different sources (DIRECTV and USSB are treated as a single product offering for this purpose since they are complementary products).  DIRECTV offers a high power DBS service to subscribers throughout the continental United States. Subscribers receive the service using the Digital Satellite System ("DSS"), which uses an 18-inch receiving dish "sold under the RCA, SONY, GE, HNS Insight, Proscan, Panasonic, Toshiba and Uniden brand names." DIRECTV reported that it served approximately 1.6 million subscribers at the end of June 1996, which is an increase of 167% over the 600,000 subscribers it reported serving at the end of June 1995. DIRECTV had 2.03 million subscribers at the end of October 1996.  United States Satellite Broadcasting Company, Inc. ("USSB") provides service to subscribers using the same DSS receiving equipment, and one of the same satellites, as DIRECTV. According to USSB, DIRECTV and USSB "share DSS and supporting technology and offer 200 channels of complementary programming," and "jointly market and promote DSS and share an overall goal of maximizing DSS penetration of U.S. television households." The programming that USSB offers (and DIRECTV does not) includes HBO, Showtime, The Movie Channel, Cinemax, FLIX, Lifetime, MTV, Comedy Central, Nickelodeon, and VH- 1. As of the end of June 1996, USSB was reported to have approximately 60% as many subscribers as DIRECTV (or approximately 960,000 subscribers), with only a "small portion" of those subscribers not included in DIRECTV's subscriber total.  PRIMESTAR PARTNERS, L.P. ("PRIMESTAR") currently offers service to subscribers throughout the continental United States using 36-inch dishes. PRIMESTAR is a joint venture of five cable MSOs, and GE American Communications, Inc. Using a satellite operating in the Fixed Satellite Service ("FSS"), PRIMESTAR provides 95 channels of programming. PRIMESTAR reported in its comments that it had 1,231,741 subscribers as of June 30, 1996, which is an increase of over 145% when compared with the approximately 500,000 subscribers it reported having in June 1995. PRIMESTAR had 1.55 million subscribers at the end of October 1996. PRIMESTAR commented that it "plans to continue its service on the medium power successor" to its current satellite, but it has been reported that PRIMESTAR may instead use eleven high-power DBS transponders to provide service using "developing compression technology that enables delivery of 150 channels to a dish 14 inches in size."  EchoStar Communications Corp. initiated service in March 1996 under the name DISH Network, and offers over 100 channels of programming to subscribers throughout the continental United States. EchoStar passed the 200,000 subscriber mark in early October 1996, and served over 235,000 subscribers as of the end of October 1996. Directsat Corporation, an affiliate of EchoStar, launched its satellite on September 10, 1996, and the combined entity began delivering programming from the second satellite (which is at the same location--119ø) in November 1996. On August 30, 1996, the International Bureau granted an application filed by Direct Broadcast Satellite Corporation (DBSC) seeking permission to transfer to a wholly-owned subsidiary of EchoStar its DBS licenses at 61.5ø, which cannot be used to serve the entire continental United States. Instead, the licenses will permit EchoStar to use an additional eleven transponders to serve the eastern United States. EchoStar has stated that it intends to use those channels to provide "programming complementary to that offered by the DISH Network . . . [and] could also include Internet delivery applications, and in light of recent pronouncements from the U.S. Copyright Office, it may also be possible to include local programming to select large markets."  AlphaStar, a subsidiary of Tee-Comm Electronics, Inc., a satellite dish manufacturer, reportedly began offering service on July 1, 1996. According to one source, AlphaStar would not provide subscriber figures, but company executives told the source that the service was adding subscribers at a steady, albeit slow rate, and that the company projected that it would have between 100,000 and 150,000 subscribers by the end of 1996. It is estimated that AlphaStar had approximately 12,000 subscribers at the end of October 1996. 42. Several other entities plan to initiate DBS services within the next few years.  In January 1996, the Commission auctioned licenses for 28 DBS channels that could be used to provide approximately 150 channels of programming to subscribers throughout the continental United States using contemporary digital compression technology. MCI Communications Corp. won that auction, bidding $682 million for the licenses (EchoStar bid $650 million and TCI bid $298 million), and is expected to launch the first of two satellites in October 1997, with video programming service beginning on November 1, 1997 if the launch goes as planned. American Sky Broadcasting ("ASkyB"), a joint venture involving the FOX broadcast network and MCI Telecommunications, Inc., plans to offer a DBS service using MCI's satellites.  Continental Satellite Corporation ("CSC") has been assigned a total of 22 DBS channels. Eleven of those DBS channels can be used to serve the eastern and central United States, and the other eleven can be used to provide service to the western and central United States. On November 21, 1995, CSC was granted an extension of its conditional construction permit to August 15, 1999, which will allow CSC to construct, launch, and begin operating its DBS system at two orbital locations.  Dominion Video Satellite, Inc. has been assigned eight DBS channels that can be used to serve the eastern and central United States, and eight DBS channels that can be used to serve subscribers in the western and central United States. On October 7, 1996 Dominion withdrew its appeal of that assignment. 43. Last year, the Commission reported that the prices charged for DSS equipment used to receive programming from DIRECTV and USSB had started to decline, falling to as low as $597, and that equipment prices were expected to continue to decline as additional manufacturers began distributing their models. When EchoStar initiated service in June 1996, it offered receiving equipment for $199 to customers that signed up for a full year's programming (at $300), which was a significantly lower price than any of the prices offered for DSS equipment at that time. At least two DSS manufacturers, Thomson and Toshiba, lowered the prices for their basic models to $399 later in the summer, and DIRECTV announced on August 26, 1996 that it would offer a $200 rebate to subscribers that purchased any brand of DSS equipment and a one-year subscription to its "Total Choice" programming package. It has also been reported that price reductions are expected to continue, with one cable network CEO quoted as saying "[s]o far, we haven't heard too much about [DBS] cannibalizing major urban systems, . . . [b]ut from what they've told us, we expect [DBS] prices to fall even more and [cable erosion] to happen on a more significant basis beginning next year." 44. In addition to offering discounted prices, DBS providers are heavily marketing their services. According to one commenter, DBS companies are projected to spend a combined $300 million on advertising in 1996, as well as utilize affiliations with other major corporations to increase their market share. USSB, for example plans to launch a new advertising campaign on movie theater screens, and its dealers are giving new subscribers a $40 discount in addition to the one month's free programming when they buy USSB's 12 month programming package. PRIMESTAR reportedly indicated in October 1996 that it plans to spend over $20 million on promotional activities during the remaining months this year, including a renewal of its NASCAR sponsorship. 45. Over the past year, the trend toward bundling video programming with telecommunications and information services appears to have had an impact on the DBS industry. AT&T acquired a 2.5% interest in DIRECTV from Hughes with an option to increase its holdings by up to 30% during the next five years. AT&T ran a promotion from October 9 through October 14 during which it offered a $100 rebate on DIRECTV equipment to its long distance customers if they purchased one-year programming subscriptions for $354. On August 29, 1996, Cincinnati Bell announced agreements to market DIRECTV and USSB services and equipment to its customers. DIRECTV has also entered into an "agency agreement" with RCN, a SMATV operator using the assets that belonged to Liberty Cable to serve approximately 40,000 subscribers in New York City, whereby subscribers in buildings served by RCN can purchase programming from DIRECTV after they purchase a digital decoder box. 46. "Headend in the Sky" Service -- Providing Digital Direct Broadcast Service to MVPDs. Last year the Commission reported that TCI proposed to offer a "headend in the sky" ("HITS") service, which involved providing to other MVPDs the same programming feed distributed to PRIMESTAR subscribers. The subscribing MVPDs could then combine HITS service with local broadcast channels and transmit the programming package over the MVPDs' networks to their subscribers, who would use set top boxes to receive the service. The Commission also reported that other DBS operators, such as DIRECTV and EchoStar, suggested that they may also use their DBS facilities to provide service to MVPDs. In October 1996, TCI launched a test of HITS service delivering 80 channels of digital programming in addition to the analog programming that was already available to subscribers at a TCI system in West Hartford, Connecticut. The service is being offered without charge for a few weeks to months before a commercial test is initiated. 47. Preemption of Local Zoning Regulations. Section 207 of the 1996 Act directs the Commission to promulgate regulations prohibiting restrictions that "impair a viewer's ability to receive video programming services through devices designed for . . . direct broadcast satellite services." On August 6, 1996, the Commission fulfilled that requirement by adopting regulations that, among other things, prohibit restrictions, including state or local laws and regulations, that impair the "installation, maintenance, or use of" direct broadcast satellite antennas less than one meter in diameter or located in Alaska. 48. Developments Concerning Carriage of Local Broadcast Signals. DBS companies have commented in the past that they have a competitive disadvantage due to the fact that they cannot distribute local broadcast signals, because of technological and copyright law obstacles. They have been working on several possible solutions to those problems, including improved digital compression and spot beam technology that may permit the carriage of a large number of local broadcast channels within the spectrum available on a DBS satellite. With regard to the effect of copyright law on DBS operators' ability to carry local broadcast signals, in July 1996 ASkyB requested a declaratory ruling from the United States Copyright Office that DBS systems may, under the satellite carrier compulsory license, "retransmit the signals of network affiliated television broadcast stations to subscribers who reside within the local market served by those stations." Such a ruling would permit DBS operators to use some of their capacity to provide local broadcast programming in some major markets, which could address what has been identified as a substantial competitive disadvantage faced by DBS MVPDs. The Copyright Office replied: The Office has considered your arguments regarding localized retransmission of network stations, and we would not question the reporting of a network station that was retransmitted locally to subscribers. Such an opinion by the Office is not, of course, a resolution of the substantive rights of copyright owners or users, which, as I note above, must ultimately be determined by the federal courts. I am simply stating that inclusion of locally retransmitted network stations is not subject to challenge by the Copyright Office. It was reported that ASkyB will seek a reduction in copyright fees when the current fee schedule expires on July 1, 1997, and that it will also try to negotiate retransmission agreements with all of the local affiliates whose signals it plans to carry. C. Home Satellite Dishes 49. Unlike DBS subscribers, home satellite dish ("HSD") users employ relatively large (4-8 foot) dishes and often purchase programming through program packagers that are licensed by programmers to facilitate subscribers' receipt of their programming transmitted from various C-Band satellites. Because they are typically used to receive programming from satellites at several different orbital locations, most HSDs include motors that permit the receiving dishes to rotate and face the various satellites. HSD owners have access to more than 265 channels of programming placed on C-band satellites by programmers for receipt and distribution by MVPDs, of which 115 channels are scrambled and approximately 150 are unscrambled. HSD owners can watch the unscrambled channels without paying a subscription fee. To receive scrambled channels, however, an HSD owner must purchase an integrated receiver-decoder ("IRD") from an equipment dealer and pay a subscription fee to an HSD programming packager. Nationwide, approximately 30 program packagers offer packages of scrambled channels to HSD owners. Like DBS systems, however, HSD program packagers do not provide local broadcast station signals, which are generally not available on C-Band satellites. 50. As the Commission reported last year, it has proven difficult to obtain accurate estimates of the total number of HSD users, which includes: (1) viewers who subscribe to a packaged programming service, which affords them access to most of the same programming provided to subscribers of other MVPDs; (2) viewers who receive satellite programming services illegally without subscribing; and (3) viewers who receive only non-subscription programming. A recent estimate by industry analysts is that there are approximately 4.5 million HSD users overall, which is consistent with many estimates of last year's total, indicating little overall change in the number of HSD users. It is perhaps more illuminating to consider the number of subscribers to package programming services since they are the only C-band subscribers that can receive much of the same programming generally provided to cable subscribers. After reaching a peak of 2,379,900 authorized subscribers in December 1995, HSD package programming subscribership declined to 2,314,900 subscribers at the end of October 1996. Some observers attribute this decline to the growth of DBS services, citing in particular the fact that DBS equipment is substantially less expensive than the typical HSD, and has become much less expensive over the past year. D. Wireless Cable Systems 1. Multichannel Multipoint Distribution Service 51. Last year the Commission reported a trend among MMDS sytems toward the development of digital technology to boost channel capacity. That trend continues this year, with industry participants expressing their belief that digitalization will permit them to be more competitive with incumbent cable systems. Digitalized MMDS systems were authorized by the FCC in July and are just beginning to be deployed, with some predicted to become operational in the first half of 1997. Certain trends reported last year continue, including increasing subscribership and consolidations. LEC investment in wireless cable, which appeared to be increasing throughout the year, has recently become less certain due to Bell Atlantic's and NYNEX's announcement of the suspension of their agreement with CAI Wireless Systems, Inc. ("CAI"). 52. MMDS Auctions. On March 28, 1996, the Commission completed its auction of authorizations to provide MMDS in 493 Basic Trading Areas ("BTAs"), raising over $216 million after 181 rounds of bidding. The MMDS auctions were designed to distribute unused spectrum through competitive bidding while protecting the service areas of incumbent MMDS providers within the BTAs. As shown in Appendix D, Table 1, the ten leading bidders, in terms of their total amount bid, were eight publicly held and two privately held wireless cable companies. Interestingly, companies with LEC investment generally paid considerably more in this year's auction than did other MMDS companies, even after taking into account the size of the market and other factors. The top ten bidders made 77% of the total money bids, covering 62% of the available licenses. In addition to being high bidders, CAI, Pacific Telesis Group ("PacTel"), Heartland Wireless Communications, Inc. ("Heartland"), and People's Choice TV Corp. ("PCTV") Gold won many of the licenses for the major population centers. For example, as can be seen in Appendix D, Table 2, these operators won the ten largest BTAs, as ranked by population. Publicly held operators also won 36 of the top 40 markets. Heartland and American Telecasting, Inc. won the most licenses, 93 and 56 respectively, by concentrating primarily on licenses in small population BTAs. 53. Subscribership. Between the end of 1994 and the end of 1995, the total number of subscribers to wireless cable systems increased by 41%, from 600,000 to 847,000 subscribers. While this increase exceeded expectations, growth in 1996 has been slower than expected and predictions for the next few years vary greatly. At the beginning of this year, at least one analyst predicted subscriber growth would increase at a rate of more than 50% per year through 1996 and 1997, reaching 3 million subscribers by 1999. WCAI projects that by the year 2000, the wireless cable industry's subscribership will grow to over 4 million. Even if these projections bear out, this level of subscribership still represents only a fraction of the wired cable industry's 62.1 million subscribers served at the end of 1995. 54. Actual subscriber growth for the first half of 1996, however, has been less than 20%. In part, this is because operators planning to deploy digital wireless cable systems chose to delay heavy marketing efforts until the increased channel offerings made possible by digital technology were available. Between the end of 1994 and the end of 1995, the number of homes capable of receiving a wireless cable operator's signal (commonly referred to as homes seen) rose from 27.3 million to 29.2 million, a 7.% increase. The growth of subscribership, relative to homes seen, increased the industry's penetration rate from 2.2% at the end of 1994 to 2.7% at the end of 1995. 55. Financial Performance. The wireless cable industry's total revenues for 1995 were $302 million, a 49% increase from 1994. During 1995 the industry's negative cash flow decreased from $14.2 million in 1994 to $3.9 million in 1995. One analyst projects that the wireless cable industry will have positive cash flow in 1996. 56. Status of LEC Investment. In the 1995 Report, the Commission reported that Bell Atlantic, NYNEX and PacBell had all invested in wireless cable operations. In 1996, one new LEC, BellSouth, entered the wireless cable industry. However, late in 1996, Bell Atlantic and NYNEX announced a suspension of their investment in wireless. Also late in 1996, a proposed acquisition by PacTel of a wireless system in northern California collapsed, although PacTel states it is continuing with plans for a southern California digital wireless system. 57. On May 29, 1996, BellSouth won, in a court-run auction, the MMDS licenses for New Orleans, Louisiana. BellSouth announced its intentions to offer more than 100 digital channels of wireless cable programming in New Orleans by mid-1997. In that auction (in which BellSouth was the sole bidder), BellSouth agreed to pay $12 million for the rights to 30 analog wireless cable channels. BellSouth has also commenced negotiations with National Wireless Holdings, Inc. to acquire all of its wireless cable assets in the Miami, Florida area. On October 28, 1996, BellSouth announced that it had signed a letter of intent agreeing in principle to acquire Wireless Cable of Atlanta, Inc. ("WC of Atlanta") for stock valued at $43.5 million. On November 5, 1996, BellSouth announced that it had spent $13.3 million to purchase licenses in areas surrounding Atlanta from CS Wireless Systems, Inc. ("CS Wireless") and CAI. The licenses being purchased from WC of Atlanta, CS Wireless, and CAI are expected to allow BellSouth to reach 1.2 million line-of-sight homes in the Atlanta area. 58. On December 13, 1996, Bell Atlantic, NYNEX and CAI announced a one-year suspension of their 1995 joint business agreement and CAI's option to repurchase Bell Atlantic's and NYNEX' $100 million investment in CAI securities. The companies also announced the suspension of their plans to jointly launch wireless systems in Hampton Roads, Virginia, and Boston, Massachusetts. 59. Consolidation. The trend toward consolidation experienced by the non-LEC wireless cable industry in 1995 has continued into 1996. For example, on February 23, 1996, Heartland announced that it had closed five transactions, acquiring wireless cable systems with 7.6 million combined line-of-sight homes and 59,900 subscribers. To complete these acquisitions, Heartland issued $180 million in new common stock and assumed $20 million in pre-existing debt. 60. Simultaneous to the closing of these acquisitions, Heartland and CAI announced the creation of CS Wireless with systems serving 5.7 million line-of-sight homes and 58,400 subscribers as of March 31, 1996. For Heartland, the combined effect of the activity described in the preceding paragraphs resulted in a net increase of one million line-of-sight homes and 38,900 subscribers. 61. In addition, on July 29, 1996, Wireless One, Inc. acquired TruVision Wireless, Inc., increasing Wireless One's line-of-sight homes by approximately 2 million and subscribers by 15,435 as of April 30, 1996. After this acquisition, Wireless One was operating in 21 markets which had, as of April 30, 1996, 34,100 subscribers out of a total of over 2 million line-of-sight homes (plus licenses to serve 6.37 million additional line-of-sight homes). 62. Digital Developments. On July 10, 1996, the Commission issued a declaratory ruling which enables wireless cable operators, MMDS and ITFS licensees to increase their channel capacity and service offerings through the use of two digital modulation techniques, Quadrature Amplitude Modulation and Vestigial Sideband. The Commission ruled that these digital modulation techniques could be implemented without causing harmful electromagnetic interference to nearby analog or digital stations. The wireless cable industry hailed this regulatory development as a significant improvement in the competitive posture of the industry. 63. In order for wireless cable operators to provide digital services, subscribers must use specialized digital set-top converters. In May 1996, PCTV and American Telecasting announced the issuance of a joint request for proposals ("RFP") for a purchase of up to 500,000 digital set-top converters. Eight manufacturing companies responded to the RFP. In addition, PacTel has announced plans to launch in 1997 a digital wireless cable service in the Los Angeles and Orange County area, which encompasses four million homes. While PacTel has not disclosed any definite programming plans, it has stated that it will offer approximately 120 channels, including 14 broadcast stations, and 40 channels of near-video-on-demand. 64. In addition, since the 1995 Report, several wireless cable operators have begun to test technology which will allow them to use their systems to provide high-speed Internet access and other data services similar to those offered by other MVPDs. In May 1996, CAI began testing Internet access technology in Washington, DC, using technology capable of sending information to users at the rate of ten megabits per second with a normal telephone line used as the return path. In June 1996, CAI demonstrated the transmission of a signal which integrated both digital video (including local broadcasting stations and national cable television programming) and 10 megabit per second Internet access (with a telephony return path). In September 1996, CAI began testing technology which would allow 27 megabits per second Internet access using General Instrument SURFboard modems and a telephony return path. In addition to CAI's efforts, PCTV and American Telecasting have been conducting Internet access trials on American Telecasting's Lakeland, Florida system with the help of Zenith Electronics Corporation, Conifer Corporation, and Comwave. Recently, the Commission issued developmental authorizations to test two-way Internet access to American Telecasting for Henderson, Nevada, and to PCTV for Phoenix and Tuscon, Arizona. In addition, Atlantic Microsystems, Inc., a wholly-owned subsidiary of CAI, received a developmental authorization to develop and test a two-way digital system on two MDS channels in Hartford, Connecticut. 2. Local Multipoint Distribution Service 65. LMDS frequencies are microwave channels in the 28 GHz band that may be used to deliver two-way multichannel video programming as well as voice and data service. As with distribution using MMDS frequencies, LMDS requires that subscribers have a special antenna. The propagation characteristics of the 28 GHz band are such that an LMDS system must operate in multiple "cells" with radii of three to six miles in order to provide service to a metropolitan area that could be covered by a single wireless cable transmitter. With the exception of CellularVision of New York, L.P.'s ("CellularVision") 6,500-subscriber LMDS system in Brooklyn and Queens, New York, LMDS frequencies are not currently used to distribute video programming in the United States. The first fully commercial operation of 28 GHz technology, however, was launched in Caracas, Venezuela, in 1994. Canada recently issued licenses for 66 major and 127 lesser markets for what are known there as "local multipoint communications systems." 66. On July 17, 1996, the Commission adopted a frequency band plan that allocated 1000 MHz of spectrum to LMDS and permitted LMDS systems, geostationary and non-geostationary Fixed Satellite Service (FSS) systems, and feeder links for non-geostationary Mobile Satellite Service (NGSO/MSS or Big LEO) systems to operate in the 28 GHz Band. In the same order, the Commission proposed to allocate an additional 300 MHz of spectrum to LMDS at 31.0 - 31.3 GHz in order to provide greater technological flexibility for this nascent industry. The Commission also sought comment on whether incumbent LECs and cable operators should be eligible to bid at auction for a LMDS license in their geographic service area. Service and auction rules relating to LMDS will be established in the near future. E. Local Exchange Carriers 1. Introduction 67. The legal and regulatory changes that occurred in the past year as a result of passage of the 1996 Act are likely to have a significant effect on LEC entry into markets for the delivery of video programming. Given the short period of time since the passage of the 1996 Act, however, LEC entry into markets for the delivery of video programming has not changed dramatically. LECs represent a major competitive presence in only a few markets for the delivery of video programming. LECs continue to weigh their options for entry into markets for the delivery of video programming and continue to move toward that entry, by means of the technology (MMDS, wireline) and method (cable franchise, MMDS license, open video system) believed to be most appropriate for each company and local market. 2. Statutory Changes and Commission Action 68. As noted above, the 1996 Act fundamentally changed the statutory framework for LEC entry into markets for the delivery of video programming by repealing the telephone-cable cross-ownership restriction that had generally prohibited a common carrier from providing video programming directly to subscribers in its local telephone service area. Pursuant to Section 302 of the 1996 Act, LECs have four regulatory options for entering video programming delivery markets within their own regions: (1) Title III radio-based systems, such as MMDS; (2) Title II common carriage systems; (3) Title VI cable systems; or (4) new Title VI open video systems ("OVS"). While opening up new avenues for entry, this provision also prohibits: (1) a LEC from acquiring more than a 10% financial or management interest in an existing cable operator providing cable service within the LEC's local telephone service area; (2) a cable operator from acquiring more than a 10% financial or management interest in a LEC providing local telephone service in the cable operator's franchise area; and (3) joint ventures between cable operators and LECs in the same market to provide either video programming or telecommunications services in that market, subject to certain exceptions. 69. Section 302 of the 1996 Act and the regulations adopted to establish OVS provide that if a LEC certifies compliance with certain non-discrimination and other requirements established by the Commission, the open video system will be entitled to reduced regulation under Title VI. An open video system's carriage rates are entitled to a presumption that they are just and reasonable where one or more unaffiliated video programming providers occupy channel capacity on the system at least equal to that of the open video system operator and its affiliates. Open video systems are subject to the Commission's rules governing must carry, retransmission consent, program access, sports exclusivity, network nonduplication, syndicated exclusivity, and public, educational and governmental ("PEG") access channels. In addition, while open video systems are exempt from local cable franchise requirements, localities are permitted to assess a fee on an open video system's gross revenues at a rate not exceeding the franchise fee imposed by that locality on the local cable operator. 4. Current and Planned LEC Entry a. Video Delivery i. Status of VDT Systems 70. Last year, we reported that 16 applications for permanent, commercial VDT service had been approved by the Commission and two applications were pending before the Commission. None of the permanent, commercial systems were operational at that time. Bell Atlantic's Dover, New Jersey system was constructed and scheduled to begin service shortly after the release of the 1995 Report. The remaining systems were either in planning or in early construction stages. We also reported on the status of eight approved VDT trials. 71. VDT systems authorized prior to enactment of the 1996 Act had until November 6, 1996, to effect a transition to one of the four statutorily-recognized options for provision of video programming services. No action was required where trials had ended or were scheduled to end before the deadline, or where the permanent, commercial VDT systems had not begun operation. On October 17, 1996, the Commission approved Bell Atlantic's request for certification to operate its VDT system in Dover Township, New Jersey, as an OVS system. U S West has elected to pursue cable franchises for its former Omaha, Nebraska, VDT trial. BellSouth has obtained a cable franchise in Chamblee, Georgia, for the area served by its former VDT trial and has filed an election to utilize the cable regulatory option. Sprint has applied for cable franchises in Wake Forest and Wake County, North Carolina, and has notified the Commission that it will pursue this option for its VDT trials. ii. MMDS 72. In the 1995 Report the Commission noted that Bell Atlantic, NYNEX and PacBell had made significant investments in wireless cable. As noted above, BellSouth entered this domain this year with its acquisitions of licenses for a wireless cable system in New Orleans. However, as also noted above, Bell Atlantic and NYNEX have suspended their wireless cable ventures with CAI. Currently, the only operational MMDS system directly owned by a LEC is the 42,000 subscriber system in Riverside, California owned by PacBell. iii. Cable Franchises a. In-Region Cable Franchises 73. In the 1995 Report, we reported that a number of LECs had pursued cable franchises in their service areas as a means of providing video services to their customers. The most aggressive of the LECs in this area was and continues to be Ameritech. Ameritech has acquired 27 cable franchises in Illinois, Michigan, Ohio, and Wisconsin, to serve communities with a total population of more than 1.2 million. Seventeen of these cable franchises are currently operational. 74. In addition, in the last year, BellSouth has acquired cable franchises in seven areas in the southern United States. GTE has received five cable franchises, which will pass over 400,000 homes. PacBell has obtained cable franchises for San Jose and the surrounding Santa Clara County in California. SNET has received a state-wide cable franchise in Connecticut, where previously it had applied to provide VDT service. Finally, SBC has received authorization to perform an 18-month cable trial in Richardson, Texas, a suburb of Dallas. b. Out-of-Region Cable Systems 75. We previously reported on out-of-region cable systems owned by LECs. The major development in this area is the acquisition of Continental Cablevision, Inc., the third largest cable MSO with nearly 4.2 million subscribers, by U S West. Approximately 280,000 subscribers involved in the transaction were in-region, and the Commission granted a temporary waiver on October 18, 1996, to U S West so that it could complete the acquisition and subsequently sell these in-region systems. These systems are in addition to those, described above, of LECs electing to convert their VDT authorizations to cable franchises. iv. OVS 76. The Commission has certified three OVS operators. As noted above, on October 17, 1996, Bell Atlantic received approval for its certification to convert its Dover, New Jersey, VDT system to OVS. Bell Atlantic subsequently purchased the division of Futurevision which had been the only operating program package provider on the Dover system, and has begun offering programming on this system using those resources. MFS was granted certifications on December 9, 1996, for the operation of OVS systems in Boston and New York, both of which are being used to provide programming. On October 10, 1996, Digital Broadcasting Open Video Systems received approval to offer OVS service in southern California. v. Switched Digital Video 77. This year, Bell Atlantic announced plans to upgrade its infrastructure to a switched broadband network in Philadelphia and southeastern Pennsylvania, with eventual service to over 12 million homes and small businesses across the mid-Atlantic region over the next three years. NYNEX also recently announced plans for large-scale deployment of switched fiber networks in the Boston and New York areas, with plans to be able eventually to provide video to up to five million subscribers. b. Video Programming and Packaging 78. In the 1995 Report, we reported on two LEC joint ventures for video programming and packaging: Tele-TV, comprised of Bell Atlantic, NYNEX, and PacTel; and Americast, comprised of Ameritech, BellSouth, SBC, GTE, and Disney Corporation. Throughout most of the year, it was reported that both companies had made some progress toward providing video programming and packaging services. For instance, Tele-TV had begun to offer an analog-to-digital conversion service, and Americast announced that it would offer a basic national package to program packagers sometime in 1996. Despite this progress, trade press reports began warning in the summer of 1996 that the viability of both ventures was precarious, in part due to the proposed merger of SBC and PacTel. Recently, in fact, there have been reports indicating that Tele-TV's business plan is undergoing fundamental changes. Some reports indicate that the venture is being scaled back, and possibly, terminated and the LEC investors are shifting devotion of their resources to entry into markets for long distance services. The LEC investors, however, reportedly deny this scenerio and PacTel stated that funding will remain unchanged at $300 million a year for the next three years. 5. Conclusion 79. As with the 1995 Report, both the degree and the method of LEC planned entry into video programming services markets remains unclear, but now, as a result of the 1996 Act, LECs have four possible modes of entry. A large, nation-wide competitive presence has not been realized, and no single technology has been chosen for entry into the markets for the delivery of video programming. LECs continue to test various technologies and construct various types of systems for video delivery, and it appears that LECs will use different technologies as each situation warrants. Bell Atlantic was the only LEC to build and begin operating a VDT system before passage of the 1996 Act, and Bell Atlantic and MFS remain the only LECs with operational OVS systems in the nation. The other modes of current LEC entry are via wireless cable and cable franchises. Overall, while LECs may offer MVPD competition in some local markets in 1997, to date, LECs have yet to become a significant competitive presence. F. Satellite Master Antenna Television Systems 80. SMATV systems are private cable systems that do not use public rights-of-way, which allows them to operate without being subject to franchise requirements. SMATV systems are defined in the Communications Act as an exception to the definition of a cable system. Historically, SMATV systems generally served commonly-owned multiple dwelling units ("MDUs") such as apartments or condominiums, commercial establishments such as hotels, institutions (i.e., hospitals), or groups of buildings in close proximity such as universities or resort facilities. More recently, some SMATV systems have been using microwave transmissions linked to system headend(s) to serve multiple buildings that are not commonly-owned without using public rights-of-way. The 1996 Act amended that exception by easing the statutory restrictions on SMATV operators, permitting them to use wires to connect separately-owned buildings, provided they do not use public rights-of-way. This may permit significant SMATV system growth in areas where many different residential buildings can be interconnected without crossing public streets. 81. Industry estimates place the total number of SMATV residential subscribers as of September 1996 at approximately 1.05 million, an increase of 10.5% over the 950,000 subscribers reported in the 1995 Report. The estimated number of SMATV operators serving MDUs had risen to 5200 operators by December 1995, an increase of 41% since December 1994 when there were 3700 operators. Industry analysts attribute this growth to technical improvements which now make it profitable for operators to install SMATV systems in smaller MDUs. The result has been an increase in the overall number of systems, although many of these SMATV systems may serve only single MDUs. Industry reports suggest that SMATV growth is strongest in the South and Southwest, but is also growing in other regions such as New York City, Boston and Washington. At the same time, the SMATV industry has continued to experience system consolidations. Much of the growth in the larger SMATV operators has come by acquiring smaller operators. In fact, for the first eight months of 1996, the value of mergers and acquisitions has totaled approximately $65 million as compared with $75 million for all of 1995. 82. Many SMATV operators are installing more technologically advanced plant and equipment, and are moving aggressively with marketing and product innovations. Increasingly, SMATV systems are using 18 GHz microwave facilities to link headends to rooftop antennas and to link buildings, which increases efficiencies. While industry analysts have historically noted that many SMATV systems have been competitively hampered by limited channel capacity, a recent industry survey found that on average, SMATV operators had added six more channels since last year, raising total average channel capacity to 39.6 channels. In addition, some SMATV operators are experimenting with digitalization, and other SMATV operators are installing fiber optics to create the type of hybrid fiber coaxial ("HFC") architecture found in the most technically advanced cable systems. Still other SMATV operators are combining technologies to create "hybrid systems," such as DBS/SMATV or MMDS/SMATV systems as part of a "niche market" strategy. For example, Satellite Connection, a national C-Band programming company, has contracted with DIRECTV to provide programming for its 10 channel, all-digital DBS/SMATV system serving a 120 unit RV Park in Hon-Dah, Arizona. As described above, RCN has a venture with DIRECTV to provide programming to subscribers in its MDUs in metropolitan New York. In Melbourne, Florida, Coastal Wireless Cable Television has developed an MMDS/SMATV system to serve the large residential MDU and hotel/motel markets. 83. Increasingly, SMATV operators are also customizing their products and services to suit niche markets and MDU subscribers' needs. For example, many SMATV systems offer programming not available from their community's local franchise cable system, such as sports packages, concerts and other special programming. Some SMATV systems have added more advanced electronic features such as "picture-in-picture," "pick-and-pay" (or pay-per-view programming), interactive games and video-on-demand ("VOD") programming as part of their "custom-designed" programming packages for subscribers. Many of these SMATV systems also offer alarm line monitoring and closed circuit security cameras, a feature particularly important to many MDU residents. In addition, some of the larger SMATV operators, like OpTel and MTS, are also competing with the incumbent LECs to provide local and long distance telephony and Internet access to their SMATV subscribers in MDUs. 84. SMATV Operator Concerns. Several SMATV operators expressed concern that some of the provisions of the 1996 Act may affect the competitiveness of SMATV systems. OpTel raises concerns over potential interpretations of the 1996 Act's revised "effective competition" standard OpTel, RCN and Bartholdi raise concerns over the 1996 Act's provision exempting from the uniform rate structure provision cable systems subject to effective competition. Both of these provisions are the subject of pending proceedings, thus we decline to address them further in the context of this report. 85. RCN, Bartholdi and WCAI raise concerns over the demarcation point for inside wiring and the effect of the Commission's inside wiring rules on SMATV operators' competitiveness. The Commission is addressing the issues raised regarding access to inside wiring by competing MVPDs in a separate proceeding. G. Broadcast Television Service 86. Broadcast television service is both a source of video programming and a transmission medium for video programming. The number of commercial and noncommercial television stations increased to 1550 from 1542 over the last year. Although the overall audience for broadcast television programming has declined in the last year, it is still viewed by a large majority of the television audience. During the 1995-1996 television season, the four major networks (i.e., ABC, CBS, Fox, and NBC) accounted for a combined 62% share of prime time viewing among all television households; UPN and WB, the two newest networks, achieved a combined 9% share of prime time viewing. The amount of prime time programming provided by UPN and WB was six hours and five hours, respectively. The most recent data available for households subscribing to cable service indicates that, even in cable homes, programming originating on local broadcast television stations accounted for a combined 61% share of all day viewing in the 1994-95 television season, while non-premium cable networks and pay cable services achieved a combined 50% share of all day viewing. 87. Broadcast total advertising revenues reached $27.9 billion in 1995. Advertising revenues for the four major networks alone reached $12.4 billion in 1995, an increase of 4% over 1994. In addition, for the new season which began on September 15, 1996, ABC, CBS, Fox, and NBC received a record $5.8 billion in pre-season advertiser commitments, despite losing 8% of their prime time viewers last year. In comparison, cable programming networks received $3.7 billion in advertising revenue in 1995, an increase of 14% over 1994. 88. The role of broadcast television service as a directly-received transmission medium has continued to change in recent years, with fewer homes receiving broadcast signals directly over the air. Over-the-air broadcast television service continues to serve as the sole transmission medium for approximately one-quarter of all television households. It is also one means by which subscribers to satellite services (e.g., DBS) receive local signals because satellite services generally do not retransmit broadcast television signals or are limited in those areas that may be served with broadcast signals. 89. The ability of the broadcast spectrum to compete as a transmission medium with cable is effectively limited by the amount of broadcast spectrum and channels that are assigned to television markets. The scarcity of video programming outlets available via "over-the-air" broadcasting can have a significant impact on competition. In nearly all markets, the number of channels available solely through the broadcast transmission medium is considerably fewer than those available on most cable systems. WB attributes its difficulties in obtaining increased broadcast television coverage to the scarcity of unaffiliated broadcast stations in many markets. Essentially, WB asserts that a sixth broadcast network cannot attain national coverage solely by using local broadcast stations as affiliates and that it must rely on cable carriage. 90. Recently, the Commission has sought to increase the video distribution capacity of the current analog broadcast spectrum. In seeking comment on revisions to our local broadcast ownership rules, we noted that in many markets, several television broadcast station allotments remain vacant. Currently, local broadcasters in the market are forbidden from applying for licenses for these vacant allotments. The Commission invited comment on whether we should entertain a waiver request to the local television ownership rule to enable a current local broadcast television licensee to apply for a channel allotment that has remained vacant or unused for a long period, such as five years. 91. In making this proposal, we noted that "it may not be in the public interest to have allotted broadcast channels lie fallow -- particularly in markets where it might be possible to allow additional NTSC stations to come on the air without adversely impacting the proposed DTV allotment table and the transition to digital television." We stated that evidence that the allotment has remained vacant for a period of years "may suggest that the operation of another television station on a stand-alone basis in the community in question is not economically viable" and that the public interest may be advanced by permitting an existing licensee in the market to acquire a license for the currently-vacant allotment rather than allow the channel to remain unused. 92. To the extent that the capacity of the analog broadcast spectrum is expanded by these proposals, such expansion may eventually increase the analog broadcast spectrum's ability to compete with cable as a transmission medium. However, the amount of analog capacity available will still be limited until the transition to digital technology. 93. The Commission's effort to implement a swift transition to digital transmission technology also has the potential to significantly increase the capacity of the broadcast spectrum, and such a development might advance the ability of broadcast transmission to compete with cable. Most importantly, digital encoding and transmission technology will permit a station to broadcast multiple streams of Standard Definition Television ("SDTV") programming, a single High Definition Television ("HDTV") signal, a combination of the two, or a combination of video with other digital ancillary services. The increase in broadcast spectrum capacity that digital technology allows may in the future result in a broadcast transmission service that is better able to compete with cable systems. 94. In previous reports, we noted that low power television ("LPTV") stations can offer multichannel video programming services on a subscription basis and that such service exists in a rural area of Minnesota. Construction permits have been issued to a multichannel LPTV applicant in Pinconing, Michigan, and there is an eight-channel LPTV system operating in Anchorage, Alaska. However, such service remains extremely limited and does not appear to have a significant impact on competition in the video market. In addition, the potential for even more multichannel LPTV systems to become operational may be constrained by the current freeze on licensing LPTV stations within 100 miles of the 36 largest markets in order to preserve spectrum availability for the transition to digital television service. H. Other Entrants 1. Electric and Gas Utilities 95. Section 103 of the 1996 Act removed a significant regulatory barrier which had deterred registered public utility holding companies' entry into telecommunications, information services, and video markets. Specifically, prior to enactment of the 1996 Act, the Public Utility Holding Company Act of 1935 ("PUCHA") imposed strict "line of business" restrictions on registered public utility holding companies which sought to diversify into telecommunications or information services markets. Section 103 of the 1996 Act, which added a new Section 34 to PUHCA, now permits registered public utility holding companies to enter telecommunications industries without prior SEC permission through the acquisition or maintenance of an interest in an "exempt telecommunications company" or "ETC." Congress essentially eliminated disparate regulatory treatment among different types of utility companies by this action. 96. On September 12, 1996, the Commission adopted final rules to implement Section 103. Following Congress's mandate, the rules provide a straight-forward procedure for determining ETC status, thus expediting the entry of public utility holding companies into the telecommunications industry. Since enactment of the 1996 Act, the Commission has granted all 18 of the applications for a determination of ETC status filed thus far. Most of these ETCs have been affiliates of public utility holding companies such as Central and South West Corporation, Entergy Corporation, Northeast Utilities, American Electric Power, Allegheny Power, and the Southern Company. 97. Most registered public utility holding companies are entering telecommunications markets by providing service in voice and data markets. There also is some evidence, however, that registered public utility holding companies are beginning to contribute to the performance of MVPD markets. The Southern Company recently entered into a partnership with a real estate developer to develop a 303 unit apartment community in Duluth, Georgia. According to Southern, this complex will provide a one-stop utilities package for its residents, including energy management control, alarm monitoring, long distance telephone service, and wireless cable. The wireless cable package will reportedly be provided by Wireless Cable of Atlanta, and will provide basic and premium service, including HBO, Showtime and The Movie Channel. 98. The 1996 Act has spurred some entry by other utilities. Boston Edison and RCN announced an agreement to form a joint venture to provide local and long distance telephone service, video, high-speed Internet access and, eventually, energy management and property monitoring services. Similarly, KN Energy ("KN") is offering a "one-stop shopping" service in Scottsbluff, Nebraska, where KN will offer consumers satellite television service by the DISH network, as well as long distance service, wireless internet service, and energy management systems. A further example is the project wherein Metricom is working with PEPCO in Washington, DC, to build a network to provide wireless access to the Internet. 2. Internet Video 99. Last year we reported that software that would deliver real-time audio and video over the Internet was becoming available and that while the Internet had the potential to affect the video marketplace, it was too early to assess its impact. We still believe it is premature to assess the impact of the Internet on the video marketplace. However, at least one industry analyst reports that in the last year the number of Internet users increased by 50% and the demographic profile of users has shifted to reflect overall population averages. In addition, in the past year there have been developments in the ability of computer hardware and software to deliver video. 100. For example, this year Toshiba is offering a personal computer that offers built-in television and radio tuners in addition to audio-CD access and embedded speakers. Rather than offering television via the Internet, this personal computer reportedly incorporates existing television technology into a platform shared by a computer. Such a melding of television and computer hardware is presently the exception in video delivery by computer. 101. In addition, considerable commercial activity has been directed in the past year at software that renders video deliverable to any existing computer via an Internet connection. Currently there are two primary means to accomplish such video delivery: (1) downloading a video file for later playback; and (2) streaming. 102. Downloading a video file and the necessary software application to "play" the video file once it is opened is presently the most common way to receive video via a personal computer. While compression techniques used in this process significantly reduce the size of the video file, a typical consumer will expend considerably more time downloading the file than it will take to "play" it. The time to download a file depends on a number of factors, including: (1) the speed of the Internet connection; (2) how busy the server sending the video file is; and (3) the size of the video file. 103. A one-minute video could take 20-30 minutes or more to download to a personal computer if the consumer were using a 9600 baud modem connection to the Internet. Faster modems, different compression coding techniques, the user's hardware and software, and the speed of the actual Internet connection all factor into the time necessary to download a file. Ideal combinations of these factors can eliminate the need to download files before viewing them. A 10- megabyte file can be downloaded, on average, in the following times for different modem speeds, other factors remaining constant. Modem Speed/Type Transfer Time 9.6 Kbps modem 2.3 hours 14.4 Kbps modem 1.5 hours 28.8 Kbps modem 46 minutes 128 Kbps IDSN 10 minutes 1.54 Mbps T-1 connection 52 seconds 4 Mbps cable modem 20 seconds 10 Mbps cable modem 8 seconds 1.5 to 6.4 Mbps ADSL technology 12 to 53 seconds 104. "Streaming" is a means of receiving video from the Internet that eliminates both the wait time associated with downloading a video file and the storage of that file on the consumer's hard disk. Video using a streaming format can be viewed in real time by a consumer using a 28.8 Kbps telephone modem (or faster) connection. At least four Internet video consumer products have attracted attention and comment. 105. StreamWorks from Xing Technology of Arroyo Grande, California, permits both real time and on demand viewing of video by allowing users to access "streams" of encoded video packets from either a live feed or an encoded file. A viewer connected to a StreamWorks Internet server would view a video through a personal computer as though watching a TV obtaining its programming from a VCR. CU-SeeMee from White Pine offers a streaming tool used primarily for live videoconferencing, but which also permits viewing of recorded programming on a fixed schedule for all viewers. VDOnet Corporation of Palo Alto, California, offers VDOLive, a product incorporating adaptive streaming technology. 106. A third mechanism for video delivery is being developed for Java-enabled browsers. OnlineTV reports that in July it began offering real-time live video through its Internet site to anyone with a Java enabled browser. Online TV states that its video offerings do not require downloads, plug-ins, or installations. The company states that its goal is to become the first digital television network to bring regularly scheduled video content to the Internet. 107. Despite the technological advances embedded in these commercial services, it appears that consumer reaction to them continues to be tempered by issues related to the capacity and reliability of the Internet backbone and the speed at which an individual can receive data. The ability of the Internet to significantly impact the market for the delivery of video programming will likely remain tangential at least until higher data transfer speed becomes widely available. 108. Bundling of Video Services with Cable Modem and Other Services. As discussed in several places above, many MVPDs are beginning to combine their video service offerings with other services (e.g., local or long distance telephony, Internet access, cellular service, paging, music, etc.) in packages designed to win customers. Cable system operators and other MVPDs have shown considerable interest in deploying modems that permit subscribers to receive high-speed access to the Internet and, perhaps, other data transmission services. For example, a number of cable system operators recently announced large orders for cable modems, and the near-term deployment of Internet access services was one of the most discussed topics at a recent industry trade show. 109. The commercial viability of bundled services is unknown, but will depend on a number of factors, including consumer demand, service quality and the technical requirements of the bundled components. For example, some analysts maintain that the success of services offering access to the Internet through broadband cable wires may be threatened by technological issues. To the extent that bundling does emerge as technologically feasible and economically desirable for MVPDs, it has the potential to substantially affect competition in markets for the delivery of multichannel video programming. For example, according to one recent research report, nearly 80% of American households would like to receive these telecommunications services from a single provider, if the overall cost remained the same. 3. Interactive Video and Data Services 110. The interactive video and data service ("IVDS") is a point-to-multipoint, multipoint- to-point, short distance communications service in which licensees may provide information, or services to individual subscribers at locations within a service area, and subscribers may provide responses. This radio-based interactive service is available for a variety of uses that may be delivered by, and coordinated with, broadcast television, cable television, MMDS, DBS, or any other future television delivery technology. By itself, however, the service is not capable of delivering voice or full-motion video. Among the types of services that IVDS licensees may offer, in conjunction with video or data delivery systems, are polls, educational classes, home banking, and home shopping. 111. The Commission awarded 18 IVDS licenses by a lottery in 1993 and auctioned an additional 594 licenses in 1994. Each license permits service within a specified service area, which is equivalent to a cellular radio service area. 112. During 1996, the Commission made two significant revisions to its rules concerning IVDS. First, it revised the IVDS "build-out" requirement to eliminate the one-year requirement (requiring service to 10% of the population or area within the license service area), while retaining the three-year and five-year requirements (30% and 50%, respectively). Second, the Commission revised the rules to permit full mobile use of IVDS Response Transmitter Units ("RTUs"), which are the customer units. This latter change, especially, is expected to assist licensees in becoming competitive in the general telecommunications market. 113. At this time, however, it appears that IVDS services are not available to sufficient numbers of consumers to affect the video marketplace. The Commission intends to hold a second IVDS auction in early 1997 (current estimate), which will award an additional 856 licenses. This will permit additional licensees to fill-out the geographic areas in the country that currently have no licensees or service. IV. MARKET STRUCTURE CONDITIONS AFFECTING COMPETITION A. Horizontal Issues in Markets for the Delivery of Video Programming 114. In this section of the 1996 Report, we examine several issues concerning horizontal structure and rivalry in markets for the delivery of video programming. First, we discuss the market definition we used in the 1995 Report, and have used again here. Next, we examine changes since the 1995 Report in concentration and the extent of competition in local markets. Finally, we examine changes in concentration at the national and regional levels, including the effects of some recent cable mergers and acquisitions. 1. Market Definition 115. We begin our examination of horizontal issues by recalling our definition of the relevant market, which consists of two elements, a relevant product market ("relevant product") and a relevant geographic market ("relevant geographic area"). In the 1995 Report, we reaffirmed our use of the 1992 Cable Act's definition of "multichannel video programming service" as a starting point for the definition of the relevant product. We also repeated our belief that the relevant geographic area is local, rather than regional or national, because buyers' alternative sources of delivered video programming are limited to those sources available in the immediate area where buyers live. We also noted that commenters generally agreed on the cable franchise area as the relevant geographic area. 116. In the Notice, we invited comment on changes in the structure of markets for the delivery of video programming, including changes in the definition of the relevant product. Although no commenters explicitly addressed the definition of the relevant product in their filings, they relied (as in previous years) on the 1992 Cable Act's definition of "multichannel video programming service." As a result, we will continue to use this definition as the basis for the relevant product in the 1996 Report. We also sought comment in the Notice on the relevant geographic area and whether it has changed since the 1995 Report. As in past Reports, most commenters have generally relied on the cable franchise area as the relevant geographic area. 117. Because cable system operators, the largest distributors of multichannel video programming, remain subject to the franchise process, it is clearly necessary to take into account the cable franchise area in developing a definition of the relevant geographic area. However, we also need to consider other geographic areas because the service areas of rival MVPDs may be larger or smaller than cable franchise areas. Broadcast television and MMDS deliver multiple channels of video programming to entire metropolitan areas -- areas generally much larger than a cable franchise region. A SMATV may offer service to only one apartment building -- an area much smaller than a cable franchise. Satellite providers such as DIRECTV and Echostar offer service to the entire nation. These supply-side geographic areas, which are based on the "footprint" of the relevant supplier, are relevant because they influence the range of choices available to consumers (the demand side of the market). Because most customers cannot reasonably be expected to move to another community simply to receive better video programming, perhaps the most relevant starting point for the definition of the relevant geographic market is an assessment of the range of choices a typical consumer has among MVPD offerings to his or her home. 118. Based on these considerations, we find that the relevant geographic area for assessing MVPD competition is local and that its extent can be defined by the overlap of the "footprints" of the various service providers. This area of overlap determines the number of MVPD choices available to a typical household. Of equal importance is the relative attractiveness of the MVPD choices to the household. A rough approximation of their attractiveness is provided by the subscriber shares of the MVPDs in the local area. In order to obtain a summary measure of horizontal concentration in the typical local area, we will focus, in the next section, on aggregate national subscribership data, which generally reflect the amount, significance, price and quality of choices available to a typical American household. 2. Concentration in Local Markets 119. In both the 1994 and 1995 Reports, we concluded that local markets for the delivery of video programming were highly concentrated and characterized by substantial barriers to entry by potential distributors. We noted that, in general, sellers in highly concentrated markets may be able to coordinate their conduct, lessen competition, and increase their rates of return. As a result, a high degree of concentration accompanied by substantial barriers to entry may result in prices above competitive levels and sub-optimal product quality, innovation, and service. 120. In order to obtain a summary measure of concentration in local markets for the delivery of video programming, we calculated a Herfindahl-Hirschman Index ("HHI") for an average local market using national subscribership numbers as a surrogate for market share in the HHI. As we noted in the 1995 Report, the HHI is a measure of horizontal concentration that is calculated by summing the squared market shares of the sellers in a market. The United States Department of Justice ("DOJ") and Federal Trade Commission ("FTC") regularly use the HHI to evaluate the effects of proposed mergers on competition. The DOJ and FTC consider markets with an HHI below 1000 as "unconcentrated;" markets with an HHI between 1000 and 1800 are "moderately concentrated;" and markets with an HHI above 1800 are "highly concentrated." 121. This concentration measure suggests that, on average, local markets for the delivery of video programming remain highly concentrated. Using the nationwide total number of subscribers to cable and non-cable MVPDs found in Appendix F, Table 1, as a surrogate for measuring the availability and attractiveness of various options available to the average local market, we calculate an HHI of 7905, a decrease from the HHI of 8395 in September of 1995. While the HHI has decreased, an HHI of 7905 remains several times greater than the 1800 threshold at which a market may be considered "highly concentrated." The HHI decrease can be attributed to the measurable increase in the non-cable MVPD share of subscribers, which rose from less than 5% in 1992, to 9% at the end of September 1995, and 11% at the end of September 1996. 122. As noted in the 1995 Report, an alternative approach to measuring concentration in the average local market is to assign equal market shares to all MVPDs that have similar capabilities to serve subscribers in such a market. Under this approach, a market with five or fewer firms that have similar abilities to serve customers would be highly concentrated for purposes of a merger analysis. In most markets for the delivery of video programming, there are currently one cable operator and up to four rival DBS service providers. Thus, under this approach, a local market served by five video distributors with roughly comparable levels of deployed capacity would have an HHI of 2000, which is still in the highly concentrated range. In some programming delivery markets, there may also be, in addition to the cable operator and DBS providers, one or more of the following: (1) an overbuilder, (2) an MMDS provider, (3) some SMATV operators, and/or (4) some additional HSD providers. If these additional competing MVPDs have similar levels of capacity deployed in a market, then, the HHI in these markets would lie below the 1800 threshold for a highly concentrated market. It should be noted that this approach to assessing competition rests on the assumption that the available non-cable MVPDs offer services that are viewed as closely substitutable for cable services by subscribers. The actual degree of substitutability between cable and non-cable multichannel services is discussed above in the sections on the individual distribution technologies and below in the section on product differentiation. 3. Extent and Nature of Competition in Local Markets 123. Whether cable operators can exercise market power under the local conditions described above depends on other factors that affect the extent of competition. Two important factors that affect both the extent and nature of competition in video programming delivery markets are the ability of the existing alternative distributors to offer differentiated programming services and the conditions of entry. 124. Product Differentiation. The ability of MVPDs to create varieties of service offerings is an important factor that affects the extent of competition in video programming delivery markets. Such product differentiation affects the nature of competition and the benefits to consumers. On the one hand, consumers benefit from product differentiation by video programming distributors because more consumers will be satisfied by varied programming than would be satisfied if all distributors offered the same programming. On the other hand product differentiation allows a firm to raise prices without losing as many of its customers. To the extent there are few firms offering similar products and entry is difficult, individual firms may be able to differentiate their products to the point that there are few, if any, close substitutes. This allows them to exercise market power and reap economic profits and returns on investment that are greater than can be obtained in competitive markets. Where there are other products that consumers would switch to in response to relatively slight price changes or where entry is relatively easy, however, other firms will seek to obtain some of those profits, resulting in a product market where consumers have greater choices and pay prices that equal the average costs of production (which includes a normal return on investment). 125. Different MVPDs appear to be pursuing different strategies with regard to product differentiation relative to cable service. For example, DBS providers, which generally are unable to carry local broadcast programming at present, are emphasizing both the technical superiority of their digital service and their unique program offerings (e.g., their comprehensive sports packages) to differentiate their services from those of cable. By contrast, MMDS and SMATV systems generally provide programming and other services similar to those of the incumbent cable operator, and compete with the operator on price. Some SMATV operators, however, are attempting to differentiate their product by providing unique services such as security monitoring. LECs appear to be competing with incumbent cable operators on the basis of both price and product differentiation in those limited areas where LECs have begun to offer video distribution service. Cable overbuilders appear to compete principally on price. 126. Entry. The conditions of entry include any impediments that would-be sellers face in order to enter a market. To the extent that MVPDs face substantial impediments to entry into a video programming delivery market, consumers will have fewer potential new supply sources. Thus, the existence of impediments to entry, combined with the high concentration noted above, could enable incumbent cable operators to exercise market power by charging higher prices, being less responsive to customer desires, and/or being less efficient and innovative than a successful seller in a competitive market might be. 127. Potential entrants into video programming delivery markets face several substantial impediments. In order to distribute multichannel video programming, an entrant may (1) incur significant sunk costs, (2) have to obtain a license or certification from federal authorities or a franchise from local authorities, (3) face resistance at the local level from governmental agencies or bodies, and (4) face incumbent-generated regulatory or litigation challenges. Such impediments may be why new (non-DBS) entrants have not yet made major inroads into incumbent cable operators' share of subscribers. The 1996 Act attempts to promote entry into markets for the delivery of video programming. It remains to be seen, however, whether the 1996 Act and other developments will enable potential entrants to overcome these impediments. Examples of entry during the past year are discussed above in the sections on distribution technologies. 128. In all but a few local markets for the delivery of video programming, the vast majority of consumers still subscribe to the service of a single incumbent cable operator. The resulting high level of concentration, together with impediments to entry and product differentiation, mean that the structural conditions of markets for the delivery of video programming are conducive to the exercise of market power by cable operators. The continuing expansion of DBS, MMDS, and overbuilding is beginning to create an alternative to cable. It is difficult to precisely ascertain the impact DBS may be having on cable prices, program offerings and services in a particular local market. While at least one major cable MSO has announced that it is upgrading its systems to offer increased channel capacity and new programming in response to the nationwide presence of DBS, we note that on the other hand the US Bureau of Labor Statistics reports that the cable services segment of the Consumer Price Index has increased at a 8.5% compound annual rate for the eleven months from January 1996 to November 1996. At the same time, cable subscribership continues to increase, albeit at a reduced pace from last year. We do, however, see a definite competitive response benefitting consumers in the few local markets where, in addition to an incumbent cable operator and DBS, there is direct facilities based competition from MMDS or a cable overbuilder. In these markets, cable operators are adopting several strategies in response to new entry and increased competition, including lower prices, expanded program packages, and improved services. As non-cable video programming distributors expand further in the future, consumers may be able to rely more on competition for the benefits of lower prices and improved programming choices and less on regulation. However, as we noted in the 1995 Report, it is difficult to predict whether non- cable MVPDs ultimately will provide vigorous rivalry for cable operators or will remain competitors with small market shares or services that are highly differentiated from those of cable systems. 4. Concentration of Cable Systems at the National Level 129. In the 1995 Report, we noted that the 1992 Cable Act was concerned with, and placed limits on, the concentration of cable systems at the national level. These concerns and limits reflect the possibility that concentration in the distribution of video programming may have anticompetitive effects on the supply of programming networks to MVPDs. For example, if a few cable operators own a large fraction of multichannel distribution capacity and subscribers, they may be able to exercise "monopsony" buying power that would distort the market for the provision of programming networks to all MVPDs. 130. In assessing the potential for monopsony buying power in the MVPD programming network market, we have in prior Reports examined the percentage of cable subscribers of cable MSOs on a national basis. Between 1995 and 1996, concentration of cable systems at the national level increased, whether measured by the subscriber share of the four largest MSOs or by the HHI. In the 1995 Report, we found that the four largest cable MSOs served 55% of all cable subscribers nationwide, with TCI (with a subscriber share of 26%), Time Warner (16%), Continental (7%), and Comcast (6%) being the four largest. In the past year, the percentage of cable subscribers served by the four largest MSOs has risen to 61.40%, with TCI (27.94%), Time Warner (18.94%), Continental/U S West (7.69%), and Comcast (6.83%) remaining the four largest. Examination of changes in the national HHI for cable MSOs reveals a similar increase in concentration. These shares indicate a nationwide cable industry HHI of 1098 in 1995, a figure that increased significantly this year to 1326. 131. However, in assessing the true impact national concentration may have in the MVPD programming network market, we believe that it is now appropriate to consider the presence of allMVPDs and MVPD subscribers in national concentration figures, and not just cable MSOs and cable subscribers. As their subscribership increases, the significance of DBS, MMDS and SMATV operators in the MVPD programming network market also increases. As a result, in this and future Reports, we will examine national concentration measures for all MVPDs. While our focus has shifted, Appendix F, Table 2, demonstrates that cable MSOs continue to be the main distributors of multichannel video programming, with 89% of total MVPD subscribers. Significantly, Table 2 demonstrates the rapid growth of DBS systems such as DIRECTV/USSB and PRIMESTAR -- indeed, both DIRECTV/USSB and PRIMESTAR count among the top ten MVPDs nationwide. However, despite the significant inroads non-cable MVPDs have made in subscriber penetration, the largest cable MSOs remain the largest MVPDs. 132. Table 2 demonstrates that the share of the top four MVPDs (the four largest cable MSOs) of the nationwide MVPD subscribership market has increased in the past year. In 1995, the four largest cable MSOs (TCI, Time Warner, Continental, and Comcast), with almost 55% of all cable subscribers, served just under 50% of all MVPD subscribers. Table 2 demonstrates that these same four firms now serve 53.3% of all MVPD subscribers nationwide. 133. Increased national concentration among the four largest MVPDs is largely the result of merger and acquisition activity. Since the 1995 Report, each of the four top MVPDs has increased subscriber reach through acquisitions. TCI closed its purchase of Viacom's cable systems in July 1996, and Time Warner closed its purchase of Cablevision Industries Corporation ("CVI") in December 1995. In addition, U S West purchased Continental, the third largest MSO, with more than 4.2 million subscribers. When added to U S West's existing cable holdings, this acquisition makes US West the third largest MSO, with more than 4.7 million subscribers. Finally, Comcast acquired the cable television operations of the E.W. Scripps Company. 134. To assess the potential for monopsony power resulting from concentration in the MVPD programming network market, the shares in Table 2 can appropriately be translated into HHI figures because MVPD programming networks are often purchased on a "per-subscriber" basis. Table 2 shows the nationwide purchaser MVPD or HHI to be 1013 -- "moderately concentrated" under the Merger Guidelines approach. 135. The still relatively small nationwide share of subscribers to non-cable MVPD service -- 11% -- implies that MVPD programming networks generally cannot rely exclusively on these distributors as an outlet for their programming. The available evidence suggests that a successful launch of a new mass market national programming network -- that is, the initial subscriber requirement for long-term success -- requires that the new channel be available to at least ten to twenty million households. Non-cable MVPDs currently serve fewer than eight million subscribers nationwide, a figure that appears to be too small an audience in most circumstances to provide programmers a distribution mechanism that can substitute for cable. However, the presence and continued growth of these non-cable distribution channels may mitigate the dependence of programming networks on cable MSOs. 136. Our reexamination of national MVPD concentration reveals a moderate and increasing level of concentration at the national level. Continued non-cable MVPD growth -- especially from smaller firms such as Echostar and MMDS suppliers -- may tend to decrease national concentration levels. On the other hand, continued growth from larger non-cable MVPDs such as DIRECTV and PRIMESTAR could increase national MVPD concentration. However, in the event that non-cable MVPD subscribers increase, it may be possible that new MVPD programming networks will be able to substitute non-cable MVPDs for cable as a successful initial distribution outlet. 5. Regional Concentration of Cable Systems 137. In the 1995 Report, we noted that the desire of cable MSOs to develop "clusters" of contiguous cable systems appeared to be a major factor underlying many cable mergers, acquisitions, and exchanges ("swaps"). Cable MSOs continue their trend towards creating large regional system clusters. The number of clusters of systems serving at least 100,000 subscribers increased from 97 at year-end 1994 to 137 by year-end 1995. The latter number of clusters accounted for 50% of all cable subscribers. Among the largest MSOs, Time Warner had 32 clusters, TCI 32, Cox 9, and Comcast 6. Small MSOs continued to expand their clusters, too. In the past year, clusters have been created through both the sales of systems and also system-for-system swaps between MSOs. The three largest system-for-system swaps since the 1995 Report occurred when Continental swapped its systems in Illinois and Missouri for TCI's systems in eastern Massachusetts, and its systems in Virginia and Rhode Island for Cox's system in Weymouth and western Massachusetts, and TCI swapped its Springfield, Missouri, system for the Washington Post system in Santa Rosa, Calif