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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. 98-102 Competition in Markets for the ) Delivery of Video Programming ) FIFTH ANNUAL REPORT Adopted: December 17, 1998 Released: December 23, 1998 By the Commission: Chairman Kennard and Commissioners Ness, Powell and Tristani issuing separate statements; Commissioner Furchtgott-Roth dissenting and issuing a statement. Table of Contents Paragraph I. Introduction . . . . . . . . . . . . . . . . . . .1 A. Scope of this Report . . . . . . . . . . . . . .. . .2 B. Summary of Findings . . . . . . . . . . . . . .5 II. Competitors in Markets for the Delivery of Video Programming. . .. . .. . .. . .14 A. Cable Industry . . . . . . . . . . . . . . 14 B. Direct Broadcast Satellite Service . . . . . . . .. . .61 C. Home Satellite Dishes. . . . . . . . . . . . . .80 D. Wireless Cable Systems . . . . . . . . . . . . .81 1. Multichannel Multipoint Distribution Service . .. . .81 2. Local Multipoint Distribution Service . . . . .. . .87 E. Satellite Master Antenna Television Systems. . . . .. . .88 F. Broadcast Television Service. . . . . . . . . . .95 G. Other Entrants . . . . . . . . . . . . . . 102 1. Internet Video . . . . . . . . . . . . 102 2. Home Video Sales and Rentals. . . . . . . . .106 H. Local Exchange Carriers . . . . . . . . . . . .110 I. Electric and Gas Utilities. . . . . . . . . . . .. . .120 III. Market Structure and Conditions Affecting Competition. . .. . .. . .122 A. Horizontal Issues in Markets for the Delivery of Video Programming . .. . .122 1. Market Definition . . . . . . . . . . . . .123 2. Concentration in Local Markets . . . . . . . .. . .126 3. Competitors Serving Multiple Dwelling Units. . .. . .129 4. Regional Concentration of Cable Systems . . . .. . .144 5. Concentration in the National Market. . . . . .. . .152 B. Vertical Integration and Other Programming Issues . .. . .158 1. Status of Vertical Integration . . . . . . . .. . .158 2. Other Programming Issues . . . . . . . . . .170 C. Technical Advances. . . . . . . . . . . . . . .195 1. Deployment of Digital Technology . . . . . . .. . .196 2. Navigation Devices. . . . . . . . . . . . .199 IV. Competitive Responses. . . . . . . . . . . . . . . .207 A. New Case Studies. . . . . . . . . . . . . . . .208 B. Preliminary Findings . . . . . . . . . . . . . .. . .232 V. Administrative Matters . . . . . . . . . . . . . . .236 Appendices A. List of Commenters B. Cable Industry Tables C. Horizontal Issues Tables D. Vertical Integration Tables E. Program Access Matters Resolved F. Inquiry Conerning Cable Television Programming Costs -- Report of the Cable Services Bureau I. INTRODUCTION 1. This is the Commission's fifth annual report ("1998 Report") to Congress submitted pursuant to Section 628(g) of the Communications Act of 1934, as amended ("Communications Act"). Section 628(g) requires the Commission to report annually to Congress on the status of competition in markets 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 a means of obtaining information on the competitive status of markets for the delivery of video programming. A. Scope of this Report 2. In this 1998 Report, we update the information in our previous reports and provide data and information that summarizes the status of competition in markets for the delivery of video programming. The information and analysis provided in this report is 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. To the extent that information included in previous reports is still relevant, we do not repeat that information in this report other than in an abbreviated fashion, and provide references to the discussions in prior reports. 3. In Section II we examine the cable television industry, existing multichannel video programming distributors ("MVPDs") and other program distribution technologies, and potential competitors to cable television. Among the MVPD systems or techniques 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"), satellite master antenna television ("SMATV") systems and broadcast television service. We also consider several other existing and potential distribution technologies for video programming, including the Internet, home video sales and rentals, local exchange telephone carriers ("LECs"), and electric and gas utilities. We include these services and providers of service because they offer, or are expected to offer, video programming in conjunction with non-video service. 4. In Section III of this report, we examine market structure and competition. We evaluate horizontal concentration of the multichannel video marketplace and vertical integration between cable television systems and programming services. We also discuss competitors serving multiple dwelling unit ("MDU") buildings. We further discuss programming issues and technological advances. In Section IV, we examine a limited number of cases where consumers have a choice between an incumbent cable operator and another MVPD provider in a particular market and report on the effects of this entry. B. Summary of Findings 5. In the 1998 Report, we address the status of competition in markets for the delivery of video programming, discuss how the regulatory changes enacted in the 1996 Act have affected the competitive environment, and describe barriers to competition that continue to exist. The information gathered in this report provides the last comprehensive picture of the state of cable competition prior to March 31, 1999, the date on which the Commission's authority under Section 623(c)(3) to review complaints submitted by local franchising authorities concerning increases in rates for cable programming service ("CPS") tiers sunsets. 6. The Report finds that competitive alternatives and consumer choices are still developing. We find that cable television continues to be the primary delivery technology for the distribution of multichannel video programming and continues to occupy a dominant position in the MVPD marketplace. As of June 1998, 85% of all MVPD subscribers received video programming service from local franchised cable operators compared to 87% a year earlier. 7. There has been an increase in the total number of subscribers to noncable MVPDs. Much of this increase is attributable to the continued growth of DBS, which is attracting former cable subscribers and consumers not previously subscribing to an MVPD. Between June 1997 and June 1998, the DBS grew from approximately 5 million subscribers to 7.2 million subscribers. DBS subscribers now represent 9.40% of all MVPD subscribers compared to 6.85% a year earlier. In addition, new open video systems ("OVS") have launched in a few areas. However, there have been declines in the number of subscribers and market shares of HSD, MMDS, and SMATV over the last year and the one existing LMDS system recently terminated service. There also has been a limited number of additional cable overbuilds in the last year. In communities where the incumbent cable operators face such competition, they respond in a variety of ways, including lowering prices, adding channels at the same monthly rate, improving customer service, or adding new services such as interactive programming. 8. A total of 76.6 million households subscribed to multichannel video programming services as of June 1998, up 4.1% over the 73.6 million households subscribing to MVPDs in June 1997. This subscriber growth accompanied a 2.3 percentage point increase in multichannel video programming distributors' penetration of television households to 78.2% in June 1998. During this period, the number of cable subscribers continued to grow, reaching 65.4 million as of June 1998 up about 2% over the 64.2 million cable subscribers in June 1997. The total number of noncable MVPD subscribers grew from 9.5 million as of June 1997 to 11.2 million as of June 1998, an increase of over 18% since the 1997 Report. 9. During the period under review, cable rates rose more than four times the rate of inflation. According to the Bureau of Labor Statistics, between June 1997 and June 1998, cable prices rose 7.3% compared to a 1.7% increase in the Consumer Price Index ("CPI"), which is used to measure general price changes. A portion of these rate increases is attributable to capital expenditures for the upgrading of cable facilities (up 21% over 1996), an increase number of video and nonvideo services offered, and increased programming costs (license fees increased by 18.4% and programming expenses increased by 20.9%). In addition, we note that there is evidence indicating that where direct competition exists it affects cable operators' pricing decisions. 10. As a general matter, significant competition from telephone companies has not developed even though the Telecommunications Act of 1996 ("1996 Act") removed the barriers to LEC entry into the video marketplace. The 1996 Act repealed a statutory prohibition against an entity holding attributable interests in a cable system and a LEC with overlapping service areas. At the time of the 1996 Act's passage, it was expected that local exchange telephone carriers would begin to compete in video delivery markets, and cable television operators would begin providing local telephone exchange service. With the exception of Ameritech, which has acquired 87 cable franchises and reports that it serves 200,000 subscribers, telephone entry into video markets has been slow to develop. The Bell Atlantic video distribution system in Dover Township, New Jersey, which seemed likely at one time to be the prototype for telephone entry into the video business, will be terminated by the end of 1998 or very early in 1999. Pursuant to its joint marketing agreement with DirecTV, however, Bell Atlantic will give its Dover subscribers the opportunity to switch to DirecTV. In addition, Congress developed the OVS framework as another means to encourage telephone company entry into the video marketplace. Thus far, however, few telephone companies have sought certification to provide video through OVS. Further, the technological convergence that would permit use of the telephone facilities for provision of video service has not yet occurred. 11. Noncable MVPDs that provide competitive pressure on incumbent cable operators and provide consumers with real choice still find regulatory and other barriers to entry in to markets for the delivery of video programming. MVPDs with the potential to compete with incumbent cable operators continue to experience some difficulties in obtaining programming, both from vertically integrated satellite cable programmers and from unaffiliated program vendors who continue to make exclusive agreements with cable operators. In multiple dwelling unit ("MDU") markets, while landlords may have a choice of more than one distributor, potential entry may be discouraged or limited by incumbent video programming distributors that have negotiated long-term exclusive contracts. In addition, consumers report that the inability to provide local broadcast signals, pursuant to current copyright law, is a major drawback of DBS service, which affects their decisions to subscribe to this alternative MVPD. 12. Our findings as to particular distribution mechanisms operating in markets for the delivery of video programming include the following: þ Cable Systems: The cable industry has continued to grow in terms of subscriber penetration, channel capacity, the number of programming services available, revenues, audience ratings, and expenditures on programming. The cable industry remains healthy financially, which has enabled it to invest in improved facilities, either through upgrades or rebuilding. As a result, there have been increases in channel capacity, the deployment of digital transmissions that provide better picture quality than can be offered through analog service, and the initiation of nonvideo services, such as Internet access. Cable operators also are beginning to offer telephony, although the use of integrated facilities remains primarily experimental with limited exceptions. Since the 1997 Report, the cable television industry has continued to grow in terms of subscribership (up to 65.4 million subscribers as of June 1998, a 2% increase from June 1997), channel capacity (some systems, such as Comcast's Orange County, California system, now offer over 120 video channels), number of national satellite-delivered video programming services (up to 245 services by June 1998 from 172 in June 1997, a 41% increase, most of which can be attributed to new digital programming packages such as HBO, HBO 2, HBO 3, HBO Family), revenues (an approximate 8% increase between June 1997 and June 1998), audience ratings (non-premium cable viewership rose from a 38 share at the end of June 1997 to a 41 share at the end of June 1998), and expenditures on programming (an approximate 20% increase in program license fees paid by cable system operators). þ Direct-to-Home ("DTH") Satellite Service (DBS and HSD): Video service is available from high power DBS satellites that transmit signals to small DBS dish antennas installed at subscribers' premises, and from medium and low power satellites requiring larger satellite dish antennas. It is estimated that there are 7.2 million DBS (DirecTV/USSB and Echostar) and medium power (Primestar) subscribers, an increase of almost 43% since the 1997 Report. Industry reports state that 2.2 million of the 3.6 million net new MVPD subscribers in 1998, or almost two thirds, are choosing DBS. Between 3.8 and 4.0 million households are HSD users, although only about 2.0 million HSD subscribers actually purchase programming packages, a 7% decrease in the last year that is likely due to subscribers switching to DBS. DirecTV and Primestar (which is significantly owned by cable operators) have the largest number of DBS subscribers and are again among the 10 largest providers of multichannel video programming service. DBS represented a 9.4% share of the national MVPD market in June 1998 and HSD represented another 2.7% of that market. þ Wireless Cable Systems: Currently, the wireless cable industry ("MMDS") provides competition to the cable industry in only limited areas. MMDS subscribership fell from 1.1 million subscribers to 1.0 million subscribers between June 1997 and June 1998, a decrease of 9%. This drop in subscribership may be the result of a reduction of marketing of analog MMDS service in anticipation of deployment of digital services. The advent of digital MMDS and the recent authorization of two-way MMDS service that will make high-speed Internet and telephony possible have the potential to foster renewed MMDS growth. Wireless cable represented a 1.3% share of the national MVPD market in June 1998. þ SMATV Systems: SMATV systems use some of the same technology as cable systems, but do not use public rights-of-way, and focus principally on serving subscribers living in multiple dwelling units ("MDUs"). SMATV subscribership has declined 19.1% since the last report, with the industry representing a 1.2% share of the national MVPD subscribership as of June 1998. Certain technological advents, such as upgraded facilities, implementation of digital transmission and microwave headend technologies, and expanded service offerings to include DBS programming, Internet access, telephone service, and security services, have the potential to foster SMATV growth. þ Broadcast TV: Broadcast networks and stations are competitors to MVPDs in the advertising and program acquisition markets. Additionally, broadcast networks and stations are suppliers of content for distribution by MVPDs. Since the 1997 Report, the broadcast industry has continued to grow in the number of operating stations (from 1561 in 1997 to 1583 in 1998) and in advertising revenues ($32.5 billion in 1997, a 4% increase over 1996). While audience levels have declined in the last year, the four major television broadcast networks still account for a 55% share of prime time television viewing for all television households. In the last year, the Commission took several actions on digital television and the first DTV television stations started offering service in November 1998. þ LEC Entry: The 1996 Act expands opportunities for LECs to enter markets for the delivery of multichannel video programming. As noted in previous reports, LECs do not yet represent a national presence in the MVPD market. The competitive presence of LECs in specific video markets, however, is growing. In certain areas, especially in the midwest, LECs are already or are becoming significant regional competitors. Particularly notable are the efforts of Ameritech as a cable overbuilder and BellSouth as an overbuilder and MMDS operator. Ameritech has acquired 87 cable franchises, potentially passing more than 1.5 million homes. Seventy-two of these cable franchises are operational, in whole or in part, and it is reported that they serve at least 200,000 subscribers. Bell South has acquired cable franchises in 18 areas, with the potential to pass 1.2 million homes, and is launching digital MMDS service in a number of areas. The growth of the LEC competitive presence in the MVPD market will probably continue in the same manner as it has until now: deliberately, and by a number of different delivery mechanisms. Whether LECs will become nation-wide competitors to the cable industry is less clear. þ Open Video Systems: In the 1996 Act, Congress established a new framework for the delivery of video programming -- the open video system ("OVS"). Under these rules, a LEC or other entrant may provide video programming to subscribers, although the OVS operator must provide non-discriminatory access to unaffiliated programmers on a portion of its channel capacity. The Commission has certified 11 OVS operators to serve 17 areas. Most of the firms receiving OVS certification are not LECs. Bell Atlantic in Dover Township, New Jersey, and RCN in New York City and Boston are the only operating open video systems, no change over the last year. Bell Atlantic, however, is transitioning away from its Dover system and plans to ask customers to switch to its joint venture with DirecTV. Starpower, a joint venture of RCN and Potomac Electric Power Company ("PEPCO") in Washington, D.C. is currently serving 20,000 subscribers with Internet access, local telephone or long distance telephone service, or all three. It expects to begin video service by the end of the year. Between June 1997 and June 1998, the number of OVS subscribers grew from 3,000 to 66,000. þ Internet Video: At the end of 1997, 44% of all households owned a personal computer and 60 million adults and 20 million children were Internet users. Previously, we reported on the availability of software technologies that make real-time and downloadable audio and video from the Internet accessible through a personal computer. We also noted that there are technologies available for the provision of Internet video over a television using set-top box Internet access and through the WebTV and Worldgate service packages. As of June 1998, investment and development of Internet video services was continuing, though video pictures offered by Internet video still remain of less than broadcast quality. Media companies, however, continue to offer increasing amounts of video over their websites in the expectation that the pictures will be acceptable for the intended use or eventually improve to broadcasting or VCR quality. However, the medium is not a direct competitor to providers of traditional video services at this time. þ Home Video Sales and Rentals: Video cassettes and laser discs provide feature films similar to those distributed by cable operators on premium channels and others involved in the distribution of video programming. The most significant development in the home video market in the last year was the increased availability of Digital Versatile Discs ("DVDs") that were first introduced in 1997. DVD technology provides picture and audio quality that is superior to that of video cassettes. As of September 1998, 700,000 DVD players had been purchased, with over 1000 movies, documentaries and concerts available for sale or rental in the DVD format. þ Electric Utilities: Utilities have the potential to become major competitors in the telecommunications industry generally, and in the video marketplace in particular, since they already possess fiber-optic networks throughout the public rights-of-way in the areas they serve. In the last year, several utilities have announced, commenced, or moved forward with ventures involving multichannel video programming distribution. In particular, Tacoma City Light began offering cable service in Tacoma, Washington. PEPCO has formed a joint venture with RCN, named Starpower, that is beginning to offer video, telephone, and Internet services in the Washington, D.C. area. PEPCO is mainly providing its fiber optic backbone to this joint venture. Other utilities, including Black Hills Corporation serving the Rapid City, North Dakota, area and the municipal utility in Coldwater, Michigan, have announced plans to offer video services. 13. We also find: þ Nationally, concentration among the top MVPDs has declined since last year. DBS operators DirecTV and Primestar rank among the ten largest MVPDs in terms of nationwide subscribership along with eight cable multiple system operators ("MSOs"). As a result of acquisitions and trades, cable 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 is currently 117, down from the 139 reported last year. Although the number of clusters declined, the trend for clusters to increase in subscribership or size appears to be continuing, and these clustered systems now account for service to approximately 52% of the nation's cable subscribers. By clustering their systems, cable operators may be able to achieve efficiencies that facilitate the provision of cable and other services, such as telephony. þ The number of satellite-delivered programming networks has increased from 172 in 1997 to 245 in 1998. Vertical integration of national programming services between cable operators and programmers, measured in terms of the total number services in operation, declined from last year's total of 44% to just 39% this year, the continuation of a four year trend. However, in 1998, cable MSOs, either individually or collectively, owned 50% or more of 78 national programming services. A year earlier, cable MSOs owned 50% or more of 50 national networks. Sports programming warrants special attention because of its widespread appeal and strategic significance for MVPDs. The Report identifies 29 regional sports networks, many owned at least in part by MSOs. The number of regional and local news networks continue to grow, with 25 news services currently competing with local broadcast stations and national cable networks (e.g., CNN). þ The program access rules adopted pursuant to the provisions of the 1992 Cable Act were designed to ensure that alternative MVPDs can acquire, on non-discriminatory terms, vertically-integrated satellite delivered programming. We recently strengthened our enforcement procedures for these rules. We observe that some former vertically integrated satellite-delivered programming service is now being distributed terrestrially. We recognize that the issue of terrestrial distribution of programming, including in particular regional sports programming, could eventually have a substantial impact on the ability of alternative MVPDs to compete in the video marketplace. We will continue to monitor this issue and the impact on the competitive marketplace. 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). In particular, cable operators and other MVPDs continue to develop and deploy advanced technologies, especially digital compression, in order to deliver additional video options and other services (e.g., data access, telephony) to their customers. To access these wide ranging services, consumers use "navigation devices." In the last year, the Commission adopted rules and policies to implement Section 629 of the Communications Act, which is intended to ensure commercial availability of these navigation devices. The cable industry, through CableLabs, is developing standards for the interoperability of digital set-top boxes and cable modems. II. COMPETITORS IN MARKETS FOR THE DELIVERY OF VIDEO PROGRAMMING A. Cable Industry 14. This section addresses the performance of franchised cable system operators in five major areas: (1) general performance -- both the quantitative and qualitative measures of basic services provided, subscriber levels, and viewership; (2) financial performance -- revenue, cash flow status, and stock valuations; (3) capital acquisition and disposition -- the amount of funds raised and used to improve existing physical plant and acquire new systems; (4) other performance indicators -- system transactions, cable overbuilds, and rates charged by cable operators; and (5) provision of advanced broadband services -- the growth of cable data access, digital broadband services, and broadband telephony. 1. General Performance 15. Since our last report, the cable industry has continued to grow in basic cable subscribership, homes passed, basic cable penetration, premium service subscriptions, basic cable viewership, and channel capacity. In addition, during 1997 and the first half of 1998, the industry began to implement some of its previously announced plans to offer expanded broadband services including digital video, Internet access through cable, interactive cable, and broadband telephony. 16. Cable's Capacity to Serve Television Households The number of U.S. homes with at least one television ("TV households") was reported as 97 million at the end of 1996 and 98 million at the end of 1997 and June 1998. According to one source, the number of homes passed by cable was 93.7 million at the end of 1996 and 94.6 million at the end of 1997, an increase of 1%. The same source indicates that by the end of June 1998, the number of homes passed by cable was 95.1 million. As such, the number of homes passed as a proportion of the number of TV households decreased one tenth of one percent from 96.6% in January 1997, to 96.5% in December 1997, and in the first half of 1998, increased one half of one percent to 97% of TV households. 17. Subscribership. Basic cable television subscribership grew from 63.5 million subscribers at the end of 1996 to 64.9 million subscribers at the end of 1997, an increase of 2.2%, and increased to an estimated 65.4 million subscribers by June 30, 1998, a six month increase of about 0.8%. Basic cable penetration also grew, increasing from 67.8% at the end of 1996 to 68.6% at the end of 1997 to 68.8% at the end of the first half of 1998. The percentage of TV households subscribing to cable continues to increase, rising to 66.2% of all TV households by the end of 1997, and to 66.7% by the end of June 1998. The number of basic cable subscribers as a percentage of the number of homes passed increased from 67.8% in 1996 to 68.6% in 1997 and to 68.8% by June 1998. The number of homes subscribing to premium cable services increased by 1.6% in 1997 to 31.5 million homes from 31 million homes at the end of 1996, and the number of premium services to which homes are subscribing (known as "premium units") increased 2.6%, with 56 million premium units subscribed to by the end of 1997, and an estimated 56.4 million units subscribed to by the end of the first half of 1998, a 0.7% increase. 18. Channel Capacity. Over the past year, cable operators have made significant capital expenditures to upgrade and rebuild cable infrastructure in order to increase channel capacity and provide additional services. Additionally, some operators have chosen to increase channel capacity through the deployment of digital platforms. Through upgrades and rebuilds, which are discussed later in this section, operators can increase the bandwidth of their networks, thus enabling them to offer additional channels of video service, as well as other services (i.e. Internet access, telephony). Through digital compression techniques, also discussed later, operators can have the option of offering their customers more video channels or a higher quality of resolution and reception. Changes to capital infrastructure and types of auxiliary services available are also discussed later in this report. 19. Some operators believe that a system will soon need to offer 150 or more channels to remain competitive. Many have made commitments for upgrades that will enable them to make this possible for their customers. For example, where available, Comcast's digital service offers customers over 175 digital and analog channels including 75 to 85 analog channels, 24 premium digital, 30 to 40 digital pay-per-view channels, and 40 audio music channels. MediaOne's digital service offers approximately 189 channels including up to 77 analog, 72 digital video channels, and 40 digital music channels. Cablevision Systems Corporation offers over 100 channels in some of its service areas, and other operators are preparing to make similar offerings to their subscribers. As such offerings by cable operators continue to be made, average channel capacity for cable systems continues to increase. In August 1997, analysts estimated that the year- end average cable system analog channel capacity would reach 78 channels by year-end 1997, and 90 channels by the end of 1998. 20. According to one source, cable systems with a capacity of 30 or more channels accounted for 83% of cable systems in October 1997. This represents 8,260 systems nationwide. The percentage of systems with channel capacities of 54 channels or more accounted for 19% of cable systems in October 1997, or 1,886 systems. In October 1998, cable systems with a capacity of 30 or more channels accounted for 84.6% of cable systems, or 8,328 systems. Cable systems with channel capacities of 54 channels or more accounted for 20.7% of cable systems in October 1998, or 2,040 systems. 21. In October 1997, 98.2% of all subscribers were served by systems with capacities of 30 channels or more. Moreover, 58.4% of all subscribers were served by systems with capacities of 54 or more channels in October 1997. In October 1998, 98.8% of all subscribers were served by systems with capacities of 30 channels or more and 61.51% of all subscribers were served by systems with capacities of 54 or more channels in October 1998. 22. Viewership. As noted in last year's report, viewership of non-premium cable networks has grown significantly over the past decade, while viewership of broadcast television stations has steadily declined. This trend continues. Twenty-four hour a day, seven day a week, non-premium cable viewership rose from a 38 share at the end of June 1997 to a 41 share at the end of June 1998. Twenty-four hour a day, seven day a week broadcast television viewership decreased from a 64 share at the end of June 1997 to a 61 share at the end of June 1998. 23. Cable Networks. In 1997, the number of basic cable networks increased by five, from 126 to 131 total basic cable networks, a 4% increase. During the first half of 1998, the number of basic cable networks increased by two to 133, a 1.5% half-year increase. The number of premium networks decreased by four networks, from 18 to 14, a 22.2% decrease between the end of 1996 and the end of 1997, but increased by six channels during the first half of 1998, to reach 20 total premium networks, a 42.9% half year increase. The number of pay-per-view networks decreased, from seven to six networks in 1997, a one network, 14.2% decline. The number of PPV networks, however, increased by three networks during the first half of 1998 to reach nine total PPV networks, a half-year increase of 50%. The number of networks classified as combined decreased by approximately 31% or by four networks in the first half of 1998 from 13 to nine. 24. Programming Costs. License fees paid by cable system operators to basic cable network programmers increased by 18.4%, from approximately $3.1 billion in 1996 to $3.7 billion in 1997. Analysts estimate that in 1998 fees will increase by an additional 20.5% to reach $4.4 billion. At the same time, programming expenses for the cable networks themselves have reportedly increased 20.9% in 1997 to $4.1 billion and an estimated 16.7% in 1998 to an estimated $4.8 billion. These increased programming costs for cable operators can be, and often are, passed along to cable subscribers as allowed for under the Commission's rules. 25. In June 1998, a voluntary questionnaire seeking information on the source of programming cost increases was distributed by the Commission to six multiple system operators ("MSOs"). The Cable Services Bureau analyzed the responses and prepared a Report. The responses of four of those questioned revealed that sports programming accounted for 26.7% of total expenditures for regulated programming in 1997 (or $127.6 million). Those four MSOs attributed 19.4% of rate increases to sports programming costs. Some cable operators note that distribution rights for NFL and NBA events have increased by 100% to 150%, while the NHL has increased its distribution rights fees 260%. Cox estimates that 27% of its total programming costs were attributable to sports programming in 1997. MediaOne indicates that its sports programming costs grew to 19.75% of all programming costs in 1997. Comcast notes that within the past few years, almost all regional sports networks have migrated from premium tiers (at $8 -$14 per month) to the basic cable package. Comcast further states that while this migration has likely contributed to the increase in the price of the basic cable package for subscribers, these tier migrations have generally met with customer approval. It also asserts that the shift of sports programming back to the basic cable tiers should address Congress' 1992 concerns regarding customers' lack of access to local sports programming when it is offered on premium channels. 26. The responses to the 1998 voluntary questionnaire also revealed that, according to the same four MSOs, news programming costs accounted for 11.2% (or $53.3 million) of total programming cost, children's programming accounted for 11.5% (or $55.2 million), and the general entertainment category labeled "all other," accounted for 50.6% (or $242.1 million) of the total programming. The MSOs attributed 11.9% of their rate increases to news programming, 4.5% to children's programming, and 64.2% to the "all other category." A&E Networks notes that the audience demand for higher quality programming content has been expanding, and thus programming networks must pay more for the same pool of talent, which consequently increases the price of that talent. This increase in the price for talent often results in an increase in fees charged to cable networks, which are often passed through to cable operators. The networks' strategy to increase original programming and investment in promotion for that original programming also contributes to the rising price of programming. 27. Other expenses incurred by cable operators are copyright fees for broadcast signal carriage. Fees collected for the first half of 1998, however, showed a noticeable decline over past half-years mostly due to the reclassification of WTBS from a distant broadcast superstation to a cable network. As of December 10, 1998, copyright fees paid by cable system operators for broadcast signal carriage under Section 111 of the Copyright Act for the period July 1 to December 31, 1996, were $88.98 million, and for the period January 1 to June 30, 1997 fees collected were $78.23 million. For the period July 1 to December 31, 1997, fees collected as of December 10, 1998 were $77.34 million, and for the period January 1 to June 31, 1998 fees collected were $51.87 million. 2. Financial Performance 28. Data concerning cable industry revenue and cash flow indicate that the cable industry remained financially strong in 1997 and the first half of 1998. Stock prices according to the Kagan MSO Index also show growth in the cable multichannel service operator sector. 29. Cable Industry Revenue. Annual cable industry total revenue grew 10.1% in 1997 to reach $30.784 billion. Analysts estimate 1998 year-end total revenue will reach $32.627 billion, an estimated 6% increase. By the end of 1997, revenue per subscriber grew 7.7% to $479.40 per subscriber per year, or $39.95 per subscriber per month. Analysts estimate that by 1998 year-end revenue per subscriber per year, will reach approximately $500, or $42 per subscriber per month. 30. When cable system revenue is indexed by source, the category with the greatest amount of growth in 1997 was the advanced video services (analog and digital) sector, increasing almost 130%, to reach $208 million, as subscribers began to take advantage of operators' new offerings. Analysts estimate that advanced services revenues will double by the end of 1998 to reach an estimated $424 million. In the more traditional revenue-generating sectors of cable, the greatest revenue generating segment was the pay- per-view sector, which had revenue increases of 27.2% from $647 million annual revenue in 1996 to $823 million annual revenue in 1997. Industry analysts predict total pay-per-view revenue will decrease 5.1% in 1998 to an estimated $781 million. Advertising revenues retained by MSOs increased almost 16% in 1997 from $1.7 billion in annual revenue in 1996 to $1.9 billion in 1997. Industry analysts predict this revenue sector will increase to an estimated $2.2 billion by year-end 1998. Premium tier revenues and home shopping revenues grew the least in 1997. Annual revenue from pay tiers decreased approximately 1% from $4.955 billion in 1996 to $4.952 billion in 1997, and are expected to decline to $4.913 billion by the end of 1998. Revenue from home shopping services grew from $145 million in 1996 to $152 million in 1997, a 4.8% increase, and is expected to increase to $160 million by year-end 1998. 31. Cable Industry Cash Flow. Cash flow may be used to value the financial position of cable firms. Analysts often report industry-wide cash flow in terms of operating cash flow. In the case of individual firms it may be expressed in terms of a proxy known as "EBITDA" (earnings before interest, taxes, depreciation, and amortization). Financial analysts report that industry-wide cash flow increased by 11.6% between the end of 1996 and the end of 1997, from $11.972 billion to $13.369 billion. Analysts estimate that by year-end 1998, cash flow will increase 8% to reach $14.440 billion. For 1997, the cable industry generated approximately $208.23 in annual cash flow per subscriber, about $18 higher than the $190.54 per subscriber generated in 1996. Analysts estimate that cash flow per subscriber per year will increase by approximately $13 to reach $220.80 in 1998. The ratio of cash flow to revenue ("cash flow margin") increased from 42.3% in 1996 to 43.4% in 1997, and is expected to increase to 44.2% in 1998. 32. Stock Prices. Between January 1997 and June 1998, stock market values of cable MSOs, as represented by the Kagan MSO Index, grew steadily, with growth accelerating between the fourth quarter of 1997 and the second quarter of 1998. By comparison, during the same period, both the Standard and Poor's Index of 500 widely-held stocks ("S&P 500") and the Dow Jones Industrial Average ("Dow Jones") grew more modestly. Indexed to a scale of January 1997 equalling 100, all three indices grew during the first quarter of 1998 and most of the second quarter of 1998, but by the end of the second quarter 1998, the Kagan MSO Index grew 59 percentage points more than the Dow Jones and 54 percentage points more than the S&P 500 indices. 33. A number of specific events contributed to the increase in MSO stock market values (i.e. "MSO valuations") in 1997 and the first half of 1998. As we reported in the 1997 Report, the collapse of the News Corporation's planned $1 billion acquisition of Echostar, and Microsoft's $1 billion investment in Comcast, contributed to the increase observed in MSO valuations in 1997. Also contributing to increased market valuations in 1997 were speculations of an AT&T-TCI merger, and Southwestern Bell's decision to exit the MVPD marketplace. AT&T's purchase of Teleport from a consortium of MSOs and purchases made by Microsoft co-founder Paul Allen contributed to increases in MSO valuations in late 1997 and the first half of 1998. The actual announcement of AT&T's proposed purchase of TCI led to increases in MSO market valuations after the second quarter of 1998. 34. Analysts indicate that specific cable operators are finding very high market acceptance to initial launches of cable-telephony service (up to 20% penetration in some areas), which is having a favorable impact on industry-wide stock values. Revenue gains of 6%-11%, and cash flow growth of 8%- 12%, with cash flow margins stable or increasing, also seems to be key to strong industry-wide market valuations. However, some analysts assert that several factors will limit revenue growth in 1998, including public pressure to restrict price increases. 3. Capital Acquisition and Disposition 35. Cable Industry Financing. The cable industry has typically relied on combinations of private and public financing, with the exact distribution of these combinations varying greatly from year to year. These year to year fluctuations in financing sources appear to be based on the availability of acceptable financing rates through private investors or capital lending institutions. Between July 1 and December 31, 1997, the cable industry acquired $865 million in private debt financing (i.e., financing received by MSOs from banks, insurance companies, and other institutional investors). In the second half of 1997, $2.775 billion of net new public debt was issued. The remaining industry financing was obtained through a mixture of private equity (i.e., equity received by MSOs from individuals, private corporations, venture capital firms, and investment banks) and public equity offerings (i.e., stock markets). Private markets yielded $88 million in the second half of 1997, and public markets yielded $180 million. 36. From January through June 1998, the cable industry acquired more private debt than during the same period in 1997. Between January and June 1998, the industry acquired $1.6 billion of private debt compared with $735 million for the same period in 1997. Less public debt was issued between January and June 1998 than during the same period in 1997. Approximately $5.8 billion of net new public debt was issued for the first half of 1998 while approximately $7 billion was issued during the same time period in 1997. Between January and June 1998, $1.7 billion of public equity activity was generated while $1.1 billion was generated for the same period in 1997. Private equity generated from January to June 1998 was $50 million whereas only $12 million was generated between January and June the year before. 37. Capital Expenditures/Capital Investment. In 1997, the cable industry invested a total of about $6.8 billion on the construction of plant and equipment, a 21% increase over the $5.6 billion spent in 1996. Total capital expenditures are expected to grow again in 1998 to reach an estimated $7.7 billion by year's end, an increase of 13%. Expenditures in 1997 included approximately $960 million for maintenance, $700 million for new builds, $1.65 billion for rebuilds, $2 billion for upgrades, and $1.46 billion for converters/ inventory. Most of the expenditures in 1997, projected expenditures for year- end 1998, and expenditures made in the past few years have been for upgrades or rebuilds (i.e. the improvement of existing plant). Since 1995, expenditures for the improvement of existing plant has increased approximately 20% each year. In 1995, operators spent $2.5 billion on upgrades and rebuilds combined, while in 1996, $3 billion was spent, and in 1997, operators spent $3.7 billion. Analysts estimate that in 1998 money spent on upgrades and rebuilds alone will reach $4.3 billion. 38. The trend to improve existing plant reflects the fact that while many systems currently have sufficient bandwidth to provide advanced services they cannot do so without sacrificing channel capacity for existing video services. Additionally, many systems have enough bandwidth to provide two-way services, but not without the risk of ambient interference. Higher amounts of bandwidth allow operators to increase channel capacity for video and other downstream services, as well as the capacity to maintain reliable two-way activated systems. In order to offer customers the advanced, two-way services, such as telephony and cable-only Internet access, cable operators must make their systems two-way activated. Thus, as was discussed earlier, MSOs are expected to improve their systems through increased channel capacity. Indeed, many cable operators are spending millions to upgrade and rebuild their systems. In addition, a substantial portion of total expenditures continues to be spent on new builds, as U.S. housing starts have grown since January 1997. 39. In 1997, many of the large MSOs spent as much as half a billion dollars each on capital expenditures. For example, Cox states that by the end of 1998, it will have spent $3.3 billion over the past five years to upgrade its infrastructure to deploy new services to subscribers. Capital expenditures in 1997 alone for Cox were $708 million. MediaOne spent approximately $1.6 billion in 1997 on rebuilds and upgrades. In 1996 and 1997, Comcast spent $800 million to upgrade most of its cable systems nationwide. In 1998, it expects to spend an additional $700 million. As a result of these investments, Comcast expects to meet its Social Contract commitments with the Commission, such that by March 31, 1999, 80% of its cable subscribers will be served by systems of 550 MHz or greater, with 60% of its cable subscribers served by systems of 750 MHz. Comcast says that 70% of its subscribers are presently served by systems at 550 MHz or higher. Additionally, Comcast has invested in infrastructure that will increase channel capacity and bring high-speed Internet access to several specific systems around the country. 40. In 1997, TCI's cable group spent $538 million, as compared to $1,834 million and $1,591 million during 1996 and 1995, respectively. It is estimated that almost $394 million of its expenditures were for maintenance and extension capital, while $69.2 was for the provision of data services, $56.6 million were for rebuilds and upgrades, and the remaining $20 million for miscellaneous expenditures. Though not specific about where most future upgrades might occur, TCI indicates, prior to its decision to potentially merge with AT&T, that it plans to spend $1.8 billion between 1998 and 2000 to complete its upgrade program. It states that these funds will be used to increase channel capacity, provide high-speed data, and pay-per-view video, but does not include plans for voice telephony. Both AT&T and TCI suppose that $400 to $500 million of the estimated $1.8 billion upgrade will be expended by TCI prior to the anticipated merger, so that one-third of TCI's existing cable plant will be upgraded by the consummation of the proposed merger. 41. As a result of these expenditures, some cable system subscribers now have access to improved cable plant. By the end of the third quarter of 1998, Comcast had upgraded 60% of its homes passed by two-way cable infrastructure of 750 MHz or higher. As of June 1998, Cox had upgraded 56% of its systems to 750 MHZ or higher with 50% two-way activated. Cablevision has just less than half of its systems, or 43%, at 750 MHz or higher, but it has almost three quarters, or 70%, of its systems two-way activated. Media One has 45% of its systems at 750 MHz or higher with 49% two-way activated. Adelphia has 30% of its systems at 750 MHz or higher with 21% two-way activated. And TCI has 20% of its systems at 750 MHz or higher with 26% two-way activated. 4. Other Performance Indicators 42. Cable System Transactions. The number of mergers, acquisitions, and exchanges between MSOs has fluctuated over the past few years. The number of systems sold increased between 1996 and 1997 from 99 to 112 systems. From January 1998 through June 1998, 45 transactions were recorded. The total number of subscribers served and the average system size of systems changing hands continue to vary greatly from year to year. The average system size increased 26.5% from an average 79,322 subscribers per system in 1996 to an average 100,353 subscribers per system in 1997. Between January and June 1998, the average number of subscribers per system transaction was 405,366, a half-year increase of over 300%. The total number of subscribers affected by system transactions in 1997 increased 43.4% from approximately 8 million subscribers in 1996 to approximately 11 million subscribers in 1997. Thus far in 1998, the total number of subscribers affected has been approximately 18 million subscribers. The total dollar value of transactions increased 41.5% between 1996 and 1997, following a 20.3% decrease between 1995 and 1996. The average dollar value per subscriber of transactions was approximately $1,164 between January and June 1998. 43. Overbuilding. From 1995, when overbuild activity began to increase, to June 1998, competing franchises have been awarded covering 149 communities in 21 states with the potential to pass 7.2 million homes. However, not all of the franchises awarded are currently in operation serving customers. Once a franchise is awarded, it takes a significant amount of time for the franchisee to build or gain access to a network over which to provide video service. For example, as of December 1998, Ameritech held 87 franchise awards, but of the communities included in those franchise areas, service is currently being offered in only 72 communities (i.e. parts or whole of the 87 franchise areas). Ameritech's 87 franchise awards gives it the potential to pass 1.5 million homes, and Ameritech thus far has passed 1 million of those homes with its infrastructure. As of December 1998, Ameritech had a total of 200,000 customers. Given these figures, it appears that Ameritech has achieved penetration rates of approximately 10% within its total of 87 franchise areas. This compares with a current national cable penetration rate of 68%. Because Ameritech has not completed construction in all 88 areas, however, its penetration rate in areas of direct competition is significantly higher. Other local exchange carriers ("LECs") also have yet to build out their entire awarded franchise areas. Bell South offers service in parts or whole of nine of its 18 franchise areas. GTE offers service in three of its 11 franchise areas, and SNET offers service in 12 cities within its Connecticut statewide franchise area. More discussion about Ameritech video service provision and other LEC video efforts are discussed later in this Report. 44. Among other smaller firms awarded competing franchises are RCN-BETG, McLeodUSA, Knology Holdings, Inc., Private Cable Ltd., Fiber Vision. New overbuilds since our 1997 Report include McLeodUSA's overbuild in Cedar Rapids, Iowa which competes with incumbent TCI. The competitor offers cable video and audio channels and Internet access, while the incumbent offers cable video and audio channels, with plans to offer Internet access by the end of November 1998. McLeodUSA is also expanding its fiber optic network in the area, over which it currently delivers local phone and long distance service in the city. The company plans to target Des Moines, Iowa next. In May, 1998, Knology Holdings, Inc. was awarded a franchise for 132,000 homes passed in Charleston, South Carolina, where it has started to compete with Comcast and Time Warner. Knology already passes 68,000 homes in Columbus, Ohio; 82,000 homes in Montgomery Alabama; and 97,000 homes in Huntsville, Alabama where it competes with TCI, Charter, Comcast, Media Communications, and Wireless One. Knology, similar to overbuilders RCN and McLeodUSA, offers its customers numerous services including video, telephony and high-speed Internet access services. 45. Among municipal overbuilds since the 1997 Report is Click!, a Tacoma, Washington, municipal overbuild that competes with TCI. Areas where overbuilding is being considered currently include the town of Lebanon, Ohio, and 11 communities in Northern Kentucky. Other communities, such as Breckenridge and Moorhead, Minnesota, have rejected municipal overbuilds. In Virginia, state legislators enacted legislation barring local municipal overbuilds capable of offering telecommunications services. Municipal overbuilding is especially active in Iowa, where 10 communities have decided to overbuild and 12 communities are considering overbuilding. 46. One indication that an overbuilt system may be in operation is the filing for determination of effective competition status, by the incumbent provider, with the Commission. Incumbent providers file such petitions when they believe that an overbuilder presents sufficient competition to meet one of the tests for effective competition in the rules. Since 1995, 57 petitions for determination of effective competition status have been granted by the Commission specifically on the basis of overbuild competition. Each petition represents a franchise which may encompass numerous systems in several communities. For example, within these 57 petitions are 60 individual community units, identified by a Commission-assigned Community Unit Identification number ("CUID"). 47. As discussed later in this Report, a study of selected areas where incumbent cable operators face head-to-head effective competition are discussed later in this Report, shows that such competition often result lower prices, additional channels at the same monthly rate, improved services, or additional nonvideo services. However, in general cable rates have risen more than four times the rate of inflation. According to the Bureau of Labor Statistics, between June 1997 and June 1998, cable prices increased by 7.3% compared to a 1.7% increase in the Consumer Price Index ("CPI"), which is used to measure general price changes. A portion of these rate increases is attributable to capital expenditures for the upgrading of cable facilities, an increase number of video and nonvideo services offered, and increased programming costs. In addition, we note that there is evidence indicating that where direct competition exists it affects cable operators' pricing decisions. 5. Provision of Advanced Broadband Services 48. Cable operators are continuing with the deployment of advanced technologies including digital video, Internet access, and telephony services over their cable systems. As indicated earlier, upgrades to their system infrastructure are being made so that operators can provide quality and reliable new services. Operators also may be choosing to make upgrades to increase system capacity prior to commencing digital transmission or two way services. Additionally, cable systems previously providing only one-way ("downstream") analog service to the customer may require upgrading to eliminate poor electronic connections and other sources of interference prior to providing two-way ("upstream" and "downstream") data services. Two-way infrastructure is necessary for services such as two-way cable modems where data is transmitted entirely over cable and the provision of telephone services over cable wiring. 49. Digital Video Services. As we reported last year, digital signal transmission, as compared to the analog signal transmission historically used in cable systems, can provide superior video picture quality and increased channel capacity through compression techniques. Subscriber reception of digital video signals requires a set-top device to decompress and decode incoming signals and to translate the digital signals into the analog signals used by current television sets. 50. TCI states that digital video is a widely appealing product that will achieve high penetration among its customers and it has made virtually all of its headends capable of delivering digitally compressed tiers. At the end of July 1998, TCI had approximately 600,000 digital customers. Cox is marketing its digital product in six major markets with plans to offer digital service in all nine of its major cluster markets by the end of 1998. Cox's most penetrated digital market is Orange County, California, where it has achieved 10% penetration on a 252,000 subscriber system. As of August, 1998, Comcast was offering digital service in Orange County and Sacramento, California; Greater Philadelphia, Pennsylvania; Baltimore, Maryland; parts of Middlesex, Union, and Essex Counties, New Jersey; Indianapolis, Indiana; and Southeast Michigan. It was expected that Comcast will have 50,000-60,000 digital subscribers by the end of the year. 51. As of June 1998, Time Warner and MediaOne had committed to smaller orders of digital set-top converter boxes, offering service in only a few selected markets. In May, 1998, Time Warner began testing digital cable in its Austin, Texas, system. Time Warner had expected to launch digital service in several major markets by December 1998. As of December 1998, MediaOne was offering digital service to 152,000 homes passed in the suburban Detroit cities of Canton, Plymouth, Northville, and Southfield, Michigan. There are 60,00 subscribers to MediaOne's digital services in the upgraded, 750 MHz system. Analysts predict that digital penetration for six of the nation's largest MSOs will reach between 25%-50% within the next three years. 52. Internet and High-Speed Data Services. Last year we reported thatInternet and other data can be transmitted faster over cable infrastructure than over most telephone systems. Cable systems and cable modems are reported to be offering speeds up to 27 megabits-per-second ("Mbps") as compared with telephone company xDSL technologies that allow consumers to surf the Internet at speeds between 1.5 Mbps and 52 Mbps, though most users experience between only 3 to 10 Mbps for cable and between 1.5 and 7.1 for ADSL, the most widely used form of xDSL. Telephone companies, however, are able to offer customers the ability to access the Internet, while simultaneously talking on the same telephone line. Additionally, telephone companies, in association with xDSL technologies, utilize the "dedicated lines" that run from the telephone company customer's home to the central office, thus can nearly guarantee certain speeds of data transmission. Cable networks use shared network infrastructure to the central office, thus the rate of speed can depend on the number of subscribers using the shared bandwidth at any given point in time. Consumers also can purchase traditional "low-speed" data access for the personal computer, which uses a traditional telephone modem and traditional telephone lines to transmit data, and which yields significantly slower data exchange rates. 53. The current most important differences in cable and high-speed telephone company products are availability and pricing. A number of telephone companies are offering dedicated ADSL. For example, in Washington, DC, Philadelphia and Pittsburgh, Pennsylvania, and Hudson River communities in New Jersey, Bell Atlantic offers 7.1 Mbps downstream (to the customer) and 680 kilobits-per-second ("K") upstream (to the provider) for $109.95 or $189.95 a month depending on whether or not the customer also subscribes to Bell Atlantic's Internet service provider ("ISP") service. There is a one-time $99 connection fee for all service levels. Most cable providers charge between $39.95 and $59.95 per month for service that may provide up to 10 Mbps. Installation for cable modems ranges from no charge up to $499 in rare cases. Typical installation for cable Internet access is around $100. Additionally, cable operators have been marketing their high-speed product longer than the telephone companies. 54. In the last year, access to the Internet over cable generally has become easier. Most cable operators do not require video subscription as a condition of subscription to the Internet. Among the least costly options for Internet access, considering both cable operator and telephone company offerings, are WebTV and Worldgate, which provide Internet access and "hyperlinking" technology. WebTV, which provides television content, as well as Web-surfing and hyperlinking capabilities, uses a special set- top box and keyboard, along with a television and a cable and a telephone connection to get "on-line." WebTV Plus offers programming content not available to regular viewers, and requires additional equipment such as a personal computer ("PC") with a television tuner add-on card and Windows98. WebTV still is working on a technology that would download video overnight for storage in the WebTV set-top box for "video-on-demand-style" service. Worldgate offers Internet access through the standard digital or analog set-top box, already used by consumers, and has its computer processing centralized at the cable headend, thus the data transfer is entirely over cable infrastructure. As such, Worldgate does not require its customers to purchase special equipment to get on-line. 55. The most popular way to get online through cable infrastructure is the use of a cable modem for the personal computer. The connection by cable modem is often less expensive if the customer is also a video subscriber, and the service received may or may not provide original content as well as a connection to the Internet. Virtually all of the major MSOs offer Internet access in some areas and they are expanding service areas to meet demand. Currently, however, service is limited to select markets, such as Orange County, California, and various locales in Connecticut, Florida and New York. Internet access through cable modems will continue to become more widely available as system infrastructure is upgraded, as discussed earlier in this section. Additionally, the commercial availability of cable modems may enhance MSOs' ability to market their Internet access services. Some MSOs, such as Cablevision, have chosen to provide Internet access only in areas where they can provide the access wholly over cable infrastructure instead of providing access with the downstream transfer of data over cable and the upstream path over telephone company wireline ("telco-return"). As of August 31, 1998, more than 15 million homes were passed by Internet access service through cable modem technology and there were approximately 300,000 subscribers. 56. Last year, we reported that cable modem subscribers also may benefit from two services specially designed to increase data transfer speeds through local and regional networks, the @Home network and Road Runner. These services are technologically different from other traditional dial-up on-line services. As we reported last year, @Home service provides its own local network. It has its own routing and caching (storage) servers, which allow the most frequently accessed material from its own content centers and from the Internet to be transferred from the source to these storage areas. As of June, @Home had 147,000 subscribers across North America. Service was available, or was in agreement to be available, for MSOs Bresnan, Cablevision Systems, Century, Comcast, Cox, InterMedia Partners, Jones, Marcus, and TCI customers, as well as Canadian MSOs Rogers and Shaw. As of September 30, 1998, @Home had 210,000 cable modem subscribers, an increase of 43% from just three months prior. As also reported last year, Road Runner Internet service did not build its own national network backbone and customer service infrastructure, rather it formed a partnership with MCI to provide dedicated national and regional backbone service connections to local cable system headends and a network operations center to monitor performance of local cable system data networks. In addition, Road Runner is testing a second version with additional interactive features. Road Runner, formed by Time Warner, reached an agreement in December 1997 to merge with MediaOne's Internet service MediaOne Express. By June 1998, Microsoft and Compaq had invested a combined $425 million in that venture. Road Runner provides service for Time Warner Cable and several MSO affiliates including MediaOne, Cablevision Systems Corp., Century Communications, and Fanch Communications for a combined Road Runner/MediaOne Express subscribership of 70,000. 57. Since our last report, a formal path of certification has been established for cable modem suppliers to obtain an "interoperability seal" for their high-speed data delivery devices under the cable modem standard, DOCSIS (Data Over Cable Service Interface Specification). Originally only one among many proposed standards, DOCSIS started to emerge as the leading option for a cable modem standard in late 1997. Between July 1997 and May 1998 vendors tested prototypes of the equipment. In March 1998, the International Telecommunications Union approved DOCSIS. In June, 1998, CableLabs hosted a series of "Interoperability and Certification Wave" vendor conclaves to initiate the final, "certification and commercialization" phase of a cable modem standard. The formal seal of DOCSIS compliance will be granted by a Certification Board made up of five MSO representatives and a liaison from CableLabs. The goal of all involved parties is to have a standard approved by the end of 1998, and for interoperable modems to become commercially available shortly thereafter. Currently, cable modems are commercially available in some areas, but these modems may not be technically compliant with DOCSIS standards, and may not be interoperable with modems that will appear after DOCSIS certification. Equipment issues are discussed more fully in the technical advances section below. 58. Telephone Services Offered by MSOs. As we reported last year, cable telephony requires sizeable and expensive upgrades and presents a number of technical obstacles. This year, some cable operators have publicly expressed interest in Internet Protocol Telephony ("IP telephony") as a potential alternative to cable telephony. An IP telephony voice call starts out similar to a cable telephony voice call in that both begin with special equipment that connects a household's twisted pair infrastructure and cable infrastructure to one another. The difference between the technologies is that cable telephony eventually turns the call over to traditional "circuit switched" processing, while IP telephony eventually turns the call over to the network of the Internet for Internet Protocol processing. IP telephony treats voice telephone calls like data are treated on the Internet; that is, digitized pieces of data are divided into discrete packets and are transported over the Internet following the path of least resistance. As a result calls made using IP telephony technology may encounter choppiness and delays ("latency"). Today, many features, such as call waiting, are not part of the package of IP Telephony, but will be available to residential customers within the next one to two years. The Internet itself is not designed to provide circuit switched connections, such as those now used by switched telephone networks. Although there are significant technological difficulties that need to be worked out with IP telephony, many MSOs are considering this approach to replace current cable telephony technology. TCI, in conjunction with AT&T, is currently the leading proponent of IP telephony. The cable industry's approach to eliminate latency in IP telephony is to eventually build a backbone network that is separate from the general public Internet backbone. IP telephony is currently being commercially offered on a small scale by providers such as AT&T, Sprint, Qwest Communications, NetWorks Telephony Corporation, Vocal Tec, and numerous small IP Telephony Service Providers ("IPTPs"), but for the most part remains in the development and trial stage, with larger scale deployments expected next year. 59. Last year, we reported that numerous MSOs were offering commercial cable telephony, and we indicated the specific locations where service was being offered. The number of locales where MSOs offer cable telephony has increased in the last year, and it is available to a large number of customers in many markets. For example, Cox is offering "Cox Digital Telephone" in parts of five major markets. MediaOne offers "MediaOne Digital Telephone" in parts of the Los Angeles and Atlanta metropolitan areas. Additional market launches are planned since the number of homes taking the service compared to the number of homes passed by the service ("penetration") has been ranging 10%-19%, and profit margins for cable telephony are in the range of 40%. Cablevision Systems Corporation has commercial telephone operations on Long Island, New York and in several Connecticut markets. It has more limited residential versions on Long Island, but has plans for widespread launches to 200,000 homes on Long Island and locales in Connecticut by the end of the year. Jones Intercable has had continued success with its rollout in the Washington, D.C., metropolitan area and plans to expand service within the region. Jones has attained 27% penetration among the 28,000 homes it passes with telephone service in the Washington, D.C., metropolitan area. TCI continues to provide cable telephony in Arlington Heights, Illinois and Hartford, Connecticut, but is not planning future launches. Time Warner terminated its commercial telephony launch in Rochester, New York, with no plans to launch elsewhere. As of July 1998, Time Warner does not offer local phone service to any of its customers. 60. Multi-Service Offerings. As discussed above, numerous MSOs are offering customers, in many of their service areas, more than standard video services. Multi-service offerings and bundling services for sale seem to enhance subscription to alternative services offered by cable companies. Digital audio and digital, high-resolution video, as well as telephony and Internet access through cable modems are becoming high demand services that cable has the bandwidth capability to offer, depending on the capacity of the particular system. Indications are that customers value receiving these services through "one-stop- shopping." For example, many large MSOs have found that bundling increases penetration of video and of new services. MSOs, such as Cox, MediaOne, Jones, and Cablevision, indicate that bundling their services increases consumer awareness, interest, and ultimately penetration of services while saving on administrative and marketing costs. Many of the small overbuilders such as McLeodUSA, RCN, and Knology started by offering video programming as part of bundled services. Many of these firms depend on their ability to offer multiple bundled services in discounted packages as a way to attract customers. B. Direct Broadcast Satellite Services 61. Direct broadcast satellite ("DBS") operators use satellites to transmit video programming to subscribers, who must buy or rent a small parabolic "dish" antenna and pay a subscription fee to receive the service. Each DBS operator transmits its programming services to subscribers from satellites located at specific orbital locations. DirecTV, United States Satellite Broadcasting ("USSB"), and EchoStar (marketed as the DISH Network) currently offer DBS video programming. In addition, there are several companies, licensed to operate a DBS system who have yet to begin service. Primestar is offered by means of a medium powered fixed satellite service ("FSS") that shares many of the attributes of DBS operators, but requires a larger antenna and has lower channel capacity. All of the above services offer various packages of programming for various monthly fees. DirecTV offers more than 200 channels. USSB, usually ordered in concert with DirecTV's service, offers 20 premium movie channels and access to pay-per- view events. EchoStar offers 240 channels of programming. Primestar offers 160 channels of programming. 62. Subscribership. DBS continues to represent the single largest competitor to cable operators and DBS subscribership continues to show strong growth. The four DBS providers furnished programming to more than 7.2 million subscribers as of June 1998. This is an increase of more than 2.2 million subscribers since June 1997, or nearly 43%. In addition, industry reports state that 2.2 million of the 3.6 million net new MVPD subscribers in 1998, or almost two thirds, are choosing DBS. The Strategis Group projects that DBS subscribership will grow to 20 million by 2003, with its share of the multichannel video market growing to 25%. SkyReport, a trade publication that tracks DBS subscriber growth, estimates that DBS will have 15.2 million subscribers by 2002. 63. DBS versus Cable. Both DBS and cable offer video programming to subscribers for a monthly fee along with premium and pay-per-view services. DBS subscribers continue to report higher levels of customer satisfaction, 30% higher than the cable industry average, according to one recent survey. DBS subscribers have reported that the main advantages of DBS are superior channel capacity (including the capacity for "Near Video On Demand" movies on pay-per-view), digital quality picture, CD- quality sound, and specialized programming such as National Football League or National Basketball Association packages. Some of these advantages, however, may diminish as cable operators roll out digital services that allow cable operators to match DBS operators in number of channels and signal quality. Consumers continue to report that the biggest drawbacks of DBS service are the difficulties associated with the provision of local broadcast signals, and the upfront cost of equipment and installation. As with DBS' advantages, however, these disadvantages vis-a-vis cable have been mitigated somewhat over the past year: equipment and installation prices are dropping, and DBS providers are working toward solutions by which they can supply local channels. It appears that, over time, the differences between cable and DBS will continue to diminish. Currently, it also appears that DBS represents a substitute for some consumers, especially those with access to local broadcast stations. As DBS equipment prices continue to drop and especially if DBS operators are able to offer local broadcast stations, DBS may become a closer substitute to cable for an increasing number of consumers. 64. In the Notice, we sought information for each type of MVPD that described the service provided (e.g., 50 channels of video programming, Internet access) and the average monthly cost to the customer of each service (e.g., video, data) provided by the MVPD. We asked commenters to provide separate cost figures for each type of service offered by the MVPD. We sought information that would reflect: (a) the up-front costs for equipment and installation for each service; (b) the costs of adding each service to more than one television set; (c) prices for the various program options and packages offered by each service; (d) the costs of receiving local broadcast stations along with each service; and (e) any other information relevant to consumer considerations when selecting among services. Further, we sought comment on the appropriate method for comparing the services and costs of different MVPDs. For example, for services that require the purchase, rather than the rental, of equipment, should the costs of equipment be amortized over a period of time? What is the appropriate time period? Are there other factors that we should consider in making such comparisons? Commenters did not provide information that would allow comparisons of the costs to consumers of subscriber to various MVPDs. We recognize that such comparisons are difficult to the the wide range of prices for equipment and the variability of programming packages offered and their prices. We also observe that some providers are now offering free equipment along with long term commitments to purchase programming, making such comparisons particularly difficult. 65. Availability of Local Broadcast Stations. In 1988, Congress passed the Satellite Home Viewer Act ("SHVA"). In the Satellite Home Viewer Act, Congress granted a limited exception to the exclusive programming copyrights enjoyed by television networks and their affiliates because it recognized that some households are unable to receive network station signals over the air. The exception is a narrow compulsory copyright license that direct-to-home (DTH) satellite video providers may use for retransmitting signals of a defined class of television network stations "to persons who reside in unserved households." The SHVA also contains a "superstation" compulsory copyright license with no geographic restrictions. The term "unserved household," with respect to a particular television network station is defined by SHVA to mean a household that -- (A) cannot receive, through the use of a conventional outdoor rooftop receiving antenna, an over-the-air signal of grade B intensity (as defined by the Federal Communications Commission) of a primary network station affiliated with that network, and (B) has not, within 90 days before the date on which that household subscribes, either initially or on renewal, to receive secondary transmissions by a satellite carrier of a network station affiliated with that network, subscribed to a cable system that provides the signal of a primary network station affiliated with that network. 66. In August 1997, the Copyright Office issued a report which, among other things, recommended that Congress amend the Satellite Home Viewer Act to eliminate the Grade B signal standard and the 90 day waiting period. In 1998, two bills were introduced in Congress to make changes in the SHVA. No Congressional action, however, was taken on this issue, and the two bills expired at the end of the Congressional term. 67. DirecTV and Primestar currently offer retransmission of distant broadcast signals to unserved households through third party satellite program packagers -- PrimeTime 24 and Netlink, respectively. USSB does not offer a package of distant signals to its subscribers. Most USSB subscribers, however, receive DirecTV and can request its package of network signals. EchoStar does not contract with an outside provider but, instead, offers its subscribers its own "DISH" branded packages of east coast and west coast signals. In addition, EchoStar states that it now offers local-into-local service to unserved households in 13 markets: Pittsburgh, Miami, Denver, Salt Lake City, Phoenix, San Francisco, Boston, New York City, Washington, D.C., Atlanta, Chicago, Dallas, and Los Angeles. These subscribers receive their local ABC, CBS, NBC, and Fox affiliates, and the national feed of PBS. EchoStar plans to add markets, eventually serving 20 local markets. EchoStar subscribers who want either form of broadcast signals must purchase a second dish, but do not need any other additional equipment. 68. Recently, this practice of retransmitting network broadcast stations by DBS has become the subject of civil litigation. Network broadcasters filed suit against PrimeTime 24 in Florida, North Carolina, and Texas, alleging that PrimeTime 24 was supplying network broadcast signals to DBS subscribers who were not "unserved" in violation of the SHVA. Thus far, rulings have been issued in the United States District Court for the Southern District of Florida, involving the local CBS and Fox affiliates and in a Raleigh, North Carolina federal district court, involving the local ABC affiliate. In both cases, the courts found that PrimeTime 24 had violated the SHVA. In the Florida case, the court, finding evidence that violations of the SHVA had taken place, issued a preliminary, nationwide injunction ordering PrimeTime 24 not to deliver CBS or Fox television network programming to any customer that does not live in an unserved household. The court initially provided PrimeTime 24 with 90 days to comply with the preliminary injunction, which applies only to subscribers who signed up with PrimeTime 24 after March 11, 1997 (the day the plaintiffs filed their lawsuit). The parties subsequently and jointly agreed to an extension of the compliance date to February 28, 1999, and the court approved the parties' agreement on October 6, 1998. If enforced, the preliminary injunction could result in the termination of network signals to an estimated 700,000 to one million subscribers. A permanent injunction could end satellite network service to as many as 2.2 million subscribers. 69. In the Raleigh case, the federal district court also ruled against PrimeTime 24. A permanent injunction followed on August 19, 1998. Similar to the Miami ruling, the court found that the SHVA defines unserved household and Grade B using strictly objective standards. PrimeTime 24 has provided network services to as many as 35,000 households in the ABC affiliate's Raleigh/Durham market. At the time of the court's decision, PrimeTime 24 continued to serve more than 9,000 subscribers within the affiliate's Grade B contour. 70. Subsequently, the NRTC, an investor in DirecTV and an MVPD serving home satellite dish ("HSD") customers, filed an emergency petition with the Commission urging that it adopt a new standard of "Grade B intensity" to be used to define unserved households in the SHVA. The effect of the NRTC proposal would be that many viewers who are now deemed able to receive a local network signal would be redefined as unserved households eligible to receive distant network signals from their satellite service providers. EchoStar, in a separate petition, asks the Commission to establish a more accurate way to predict and measure whether a household receives a signal of Grade B intensity as currently defined. The Commission issued an NPRM on November 17, 1998 in response to these petitions. EchoStar also has filed suit in Colorado Federal court against the four major networks and their affiliates, seeking a declaration that EchoStar's transmission of distant network signals is legal under the SHVA. Finally, in November, ABC, CBS, Fox, and NBC filed suit against EchoStar in the Miami District Court, claiming that EchoStar's DISH NETS offerings are an effort to circumvent the previous Miami ruling against PrimeTime 24. 71. The litigation, petitions, and legislative proposals do not, however, address the reception of local signals by satellite subscribers in their own local stations markets. According to the Copyright Office, the retransmission of local signals by satellite carriers is not specifically addressed in the SHVA "because the technology did not exist to make such local retransmission possible [but] if satellite carriers could retransmit the signals of local network stations to subscribers, the concern that led to the unserved household provision would theoretically become resolved." Technological issues, however, may make nationwide local-into-local service infeasible. The SHVA NPRM seeks comment on this issue. While cable systems are terrestrially-based and designed to deliver both local and national programming to discrete local markets, DBS systems deliver their programming on a national basis from orbital locations that cover the entire United States. In addition, there are over 1500 television broadcast stations in the U.S. and DBS providers may not have the channel capacity to accommodate the nationwide retransmission of local broadcast stations along with their currently offered national programming. We note that Northpoint Technology, L.P. has filed a petition with the Commission seeking permission to use DBS spectrum to transmit local broadcast signals (and other services). We further note that Capitol Broadcasting Company, Inc. has announced plans to provide local-into-local service to DBS operators for the entire country. 72. An additional retransmission issue involves the fees paid by DBS carriers for carriage of broadcast signals. In August 1997, the Copyright Office of the Library of Congress decided that the compulsory license fee for superstations (previously either 14 cents or 17.5 cents, depending on whether or not they carried nationally-cleared programming) and broadcast stations (previously six cents) should increase to 27 cents to reflect "fair market value." This determination became effective January 1, 1998, but is stayed pending review by the U.S. Court of Appeals for the D.C. Circuit. In 1976, Congress determined that the retransmission of copyrighted works by smaller cable systems whose gross receipts from subscribers were below a certain dollar amount deserved special consideration because of their mostly rural locations. Therefore, in effect, the cable compulsory license subsidizes smaller systems and allows them to follow a different, lower-cost royalty computation. Large systems, on the other hand, pay in accordance with a highly complicated and technical formula. The change in the royalty fee and confusion over the manner in which fees are assessed has led to even greater controversy as to whether an industry is being disadvantaged. SBCA stated that "average cable systems" pay an average fee of between 2.45 and 9.8 cents, and that the decision to raise royalty fees for satellite carriers to 27 cents creates a competitive disadvantage for DBS. The Leagues, however, assert that this comparison is invalid because, among other reasons, DBS operators do not compare evenly with the SBCA's "average cable system," and because cable systems pay a range of royalties as opposed to the flat fee paid by DBS operators. MPAA, representing copyright holders, performed its own analysis of comparative fees. Its approach shows that cable systems generally pay more than the 27 cent rate when carrying four or more distant signals. 73. Equipment Prices and Installation. In the 1996 Report and the 1997 Report, we noted that DBS equipment prices, and other "upfront costs," such as installation, were declining. We also noted that DBS operators were aggressively pursuing marketing plans and discount packages to increase demand for their products. Both trends have continued. Strategis Group found that ". . .equipment costs have spiraled downward." For example, EchoStar recently offered installation for $49, as opposed to the normal price of $199. EchoStar also launched separate promotions in which: (1) it will give new subscribers the second dish required for local signals, and (2) it will give away the DBS dish to new subscribers who sign up for a year of certain programming. In terms of specials, DirecTV has offered $200 of free programming with installation and orders for certain programming. In addition, some of the joint marketing agreements with telecommunications companies, discussed below, lower upfront costs. Customers still cite, however, the cost for connecting multiple television sets so that they can watch different programming on different sets, as compared to the lower cost for this capability with cable, as an area where cable has an advantage over DBS. 74. New Marketing Efforts. In the 1996 Report, we indicated a trend toward marketing satellite video programming with telecommunications and information services. In the 1997 Report, we noted that AT&T ended its effort to market DirecTV's and USSB's satellite programming and DBS equipment, but that an agreement with Cincinnati Bell had been very successful. Over the past year, DirecTV and USSB began joint marketing agreements with GTE, Bell Atlantic, and SBC. GTE markets the DBS service in Los Angeles and Dallas with inserts in its telephone bills, and sells the service through retail locations in those cities. Bell Atlantic and SBC have marketing programs they consider to be complete "cable replacements," and are buying the DSS equipment themselves and leasing it to subscribers, thus lowering upfront costs, and installing an antenna for local signals. In a new strategy, DirecTV signed an agreement under which it replaced a cable operator as the provider for an entire homeowners association. DirecTV also is involved in joint marketing, sales, and distribution agreements with three small cable operators: Austin, Texas-based Classic Cable, Chicago-based Anderson-Eliason Cable Group, and Sikeston, Missouri- based Galaxy Telecom. These agreements will result in joint analog-cable/digital-DBS basic programming packages. DirecTV has also signed similar agreements with SMATV operators, and with CS Wireless, an MMDS operator. EchoStar recently pledged that it will not raise its rates for certain types of programming until after March 1, 2000. 75. Data and Interactive Services. DirecTV offers a satellite-delivered high-speed Internet access service ("DirecPC"), with a telephone return path. This service allows up to a 400 kbps downstream connection, which is slower than cable modems, but is more than seven times faster than analog telephone modems. This service is available independent of DBS service or, with DirecDUO, a dual-functioning DBS antenna, consumers can receive both video programming and DirecPC services. EchoStar formed a deal with OpenTV, Inc. (a company which produces interactive television technology) in order to offer interactive services, to its subscribers early next year, such as e-mail and on-line banking, and to incorporate OpenTV technology in its next generation of receivers. Finally, both Motorola and Thompson announced that they were going to produce equipment, including DSS systems, which would include Internet access capability. 76. High Definition Television. DirecTV has aggressively promoted the advent of High Definition Television ("HDTV"). In late July, Thomson Multimedia entered an agreement with DirecTV under which Thomson would build televisions and set-top boxes which combine DSS reception with digital terrestrial signal reception. DirecTV also announced that it will begin its own transmission of 24-hour HDTV signals at the end of 1998, probably beginning with pay-per-view events. USSB has announced plans to carry HBO's HDTV signals as soon as they are available, perhaps at no additional cost to subscribers. EchoStar has said that it will carry some of HBO's HDTV programming, but has not specified how much. 77. Ownership. Beginning in September 1997, Primestar Inc., a medium power satellite company owned by the five largest cable companies in the U.S., sought to acquire the high power orbital location awarded to MCI (now MCI-WorldCom) by the Commission along with two high-power DBS satellites currently under construction for $1.1 billion in nonvoting convertible securities. Primestar also proposed to reorganize its ownership structure and sought to transfer control of the DBS channels licensed to Tempo from its subsidiary TSAT to Primestar. Acquisition of these high power DBS assets would have given Primestar the capacity to become a high-power DBS operator, allowing its customers to use smaller antennas and increasing its channel capacity. In May 1998, the U.S. Department of Justice ("DOJ") sued to block this transaction over concern that the cable ownership of Primestar, combined with the assignment of MCI's DBS channels would "substantially lessen competition and tend to create a monopoly in markets for the delivery of multichannel programming services." Subsequently, Primestar announced that it would withdraw its petition to acquire ASkyB's orbital slot and would focus on its medium power business and seek financing to support that business. It admitted at that time that it faced challenges in this area due to a lowered credit rating. Other reports indicated that Primestar was attempting to sell its subscribers and slots to either DirecTV or EchoStar. Primestar has subsequently announced that it would not need to sell its assets due to new support from its major shareholders, that it would continue to build its medium-power business, and that it would launch a new high-power DBS service using licenses and a satellite it is in the process of acquiring from TCI Satellite Entertainment. As noted above, EchoStar has reached an agreement to acquire ASkyB's satellite assets, but the agreement has not been finalized. Finally, also noted above, DirecTV's parent corporation, Hughes, has reached an agreement to acquire USSB, but the agreement has not closed. 78. DBS Public Interest Obligation. On November 19, 1998, the Commission adopted rules implementing Section 25 of the 1992 Cable Act, which imposed certain public interest obligations on DBS providers. The statute requires DBS service providers to set aside a percentage of channel capacity for non-commercial programming of an educational or informational nature. In implementing the statutory requirement, the Commission ruled that DBS providers must set-aside four percent of their channel capacity exclusively for non-commercial programming of an educational or informational nature. In carrying out Congress's mandate, the Commission balanced two important goals -- providing DBS subscribers access to a greater diversity of non-commercial, educational programming, and providing flexible rules for an industry that promises to provide significant competition to cable television. The Commission anticipates that a variety of programming could soon become available on DBS systems, including, for example, distance learning programs produced for all ages, major university research projects shared nationwide, and health applications developed for rural America. As specifically required by statute, DBS licensees must also now comply with the political broadcasting rules of Section 312(a)(7) of the Communications Act, granting candidates for federal office reasonable access to broadcasting stations, and 315 of the Act, granting equal opportunities to candidates at the lowest unit charge. 79. Barriers to Competition. DirecTV, NRTC, and SBCA also favored a broad extension of the Commission's rules on placement of over-the-air reception devices to MDUs and renters to allow further competition for households in these situations. The Commission recently modified the rules to permit viewers who rent property to install and use antennas where they have exclusive use, such as balconies or patios, in order to remove this barrier to competition to the extent permitted by Section 207 of the Telecommunications Act of 1996. DirecTV and NRTC also urge that the Commission's program access rules must be strengthened to include terrestrially-delivered programming, to impose damages for evading program access rules, and to expedite the resolution of program access complaints. For instance, DirecTV states in its comments that, "...if meaningful competition to the television industry is ever to emerge, the law's provisions should be strengthened, not diluted." DirecTV states that, in regard to the Commission's Inside Wiring rules, exclusive contracts for providing service to MDUs should be forbidden, and that incumbents in MDUs should be required to share inside wiring where technically feasible. DirecTV also supports proposals in Congress to require cable operators to provide a lifeline tier. C. Home Satellite Dishes 80. As we have previously reported, the difference between DBS service and HSD service is mainly the use of a much larger dish. While some HSD owners receive only non-subscription programming, the number of subscribers most relevant to an assessment of the MVPD market is the figure for authorized subscribers who receive much of the same programming generally provided to cable and other MVPD subscribers. HSD package programming subscribership has declined from 2,184,472 in June 1997 to 2,028,225 in June 1998, or by 7.2%. Much of the decline in HSD subscribership results from owners switching to DBS services. DBS firms like DirecTV have launched aggressive advertising and promotional campaigns encouraging consumers to switch from HSD to DBS service. D. Wireless Cable Systems 1. Multichannel Multipoint Distribution Service 81. MMDS systems, often referred to as "wireless cable," transmit programming to subscribers through 2 GHz microwave frequencies, using Multipoint Distribution Service ("MDS") and leased excess capacity on Instructional Television Fixed Service ("ITFS") channels. An MMDS system must have a line-of-sight ("LOS") path between the transmitter or signal booster and the receiving antenna. When using analog signals, MMDS operators have a maximum of 33 microwave channels available in each market, including 13 MDS channels and 20 ITFS channels. Digital MMDS significantly increases this signal capacity, and also improves picture and audio quality, along with making two-way services, such as high- speed Internet access and telephony, possible. 82. At present, the MMDS industry provides competition to the cable industry only in limited areas. The capacity of analog MMDS systems, 33 channels, is generally not competitive with most cable systems, and subscribership drops for MMDS reflect this fact. These subscribership drops, coupled with capital spending aimed at the development of digital MMDS, has put MMDS operators under severe financial strain. According to one report, WCA believes, however, that the advent of digital MMDS and high-speed Internet access will improve the industry's financial status. 83. MMDS Capacity to Serve Television Households and Subscribership. The number of homes with a serviceable line of sight to an MMDS operator's transmission facilities grew from 60,300,000 at the end of 1996 to 61,800,000 at the end of 1997, an increase of 2.5%. The number of homes capable of receiving an MMDS operator's signal (commonly referred to as "homes seen") grew from 31,500,000 at the end of 1996 to 34,000,000 at the end of 1997, an increase of 8%. MMDS subscribership fell from 1,180,000 at the end of 1996 to 1,050,000 at the end of 1997, a decrease of 11%. As stated in the 1997 Report, this drop in subscribership may have resulted from a reduction of marketing of analog MMDS service in some markets in anticipation of deployment of digital service. 84. Financial Performance. The wireless cable industry's total revenues for 1997 were $440 million, a 4.8% increase from the $420 million in 1996. Numerous questions about the industry's viability were raised in the last year, however. First, in April, Standard & Poor's lowered the debt rating on all wireless cable companies to CCC+, and Heartland Wireless, a large wireless operator, to D, stating that analog wireless cable is not a viable competitor to cable. Three months later, CAI Wireless, one of the largest wireless cable operators, declared Chapter 11 bankruptcy. More recently, Heartland Wireless also declared bankruptcy. As stated above, according to one report, WCA believes that the advent of digital MMDS and high-speed Internet access will improve the industry's financial status. 85. Internet and High-Speed Data Services. On September 17, 1998, the Commission adopted an order authorizing two-way digital ITFS and MDS communications. This action will permit these licensees to provide two-way high-speed Internet access, video conferencing, distance learning, continuing education, or any other two-way service using MMDS and ITFS spectrum. While three wireless cable operators have already received limited approval to offer wireless two-way services, the Two-Way Order provides licensees and operators greater flexibility to provide broadband two-way wireless services, and establishes a framework for expedited licensing of two-way facilities. In addition, Commission staff has granted developmental authority for wireless two-way services in several markets. 86. Barriers to Competition. WCA requests that Congress amend the program access statute to apply to all programming, regardless of method of delivery or affiliation, in order to assure wireless cable operators access to all programming and thus improve their ability to compete in the MVPD market. Antilles, a small wireless operator, in its comments states, "Smaller wireless operators like Antilles Wireless suffer from a serious lack of accessibility to programming. While the Cable Television Consumer Protection and Competition Act of 1992 theoretically outlawed discrimination by programmers in the offering of programming to wired and wireless video operators, the real world has yet to see the benefits of the law." Several other commenters, however, disagree with WCA's position on program access, stating that expanding program access rules could damage the programming industry. WCA also states that: (a) the Commission's cable-MDS cross-ownership rule, cable-MDS cross-leasing rule, and cable-ITFS cross-leasing rule unduly restrict investment in the wireless cable industry by the cable industry; (b) Congress should clarify the Commission's jurisdiction over home run wiring, thus improving cable competitors' ability to provide service to MDUs; and (c) Congress should clarify that competitive bidding is not required to resolve new, mutually exclusive ITFS applications to assure the continuation of ITFS as a local and non-commercial service. An additional competitive issue was whether the Commission's OTARD rules would be extended to MDUs and renters. As noted earlier, the Commission recently modified the rules to permit viewers who rent property to install and use antennas where they have exclusive use, such as on balconies or patios. 2. Local Multipoint Distribution Service 87. Previously, the Commission reported that LMDS was a potential competitor in the MVPD market. It now appears the LMDS licensees will not be competitors in the video market, at least in the short term. Analysts and bidders in the LMDS auctions stated that plans for LMDS were for commercial voice and high-speed data, and that LMDS is not currently suited for video delivery or for residential service. At the end of November 1998, the only existing provider of video over LMDS, CellularVision in New York City, sold more than half its spectrum to WinStar, a competitive local exchange carrier. Winstar intends to use this spectrum to build an Internet access business. CellularVision has announced that it will quit the video business and use its remaining spectrum to offer high-speed Internet access. E. Satellite Master Antenna Television Systems 88. As we indicated in last year's Report, SMATV systems are satellite systems used to distribute television signals to households located in one or more adjacent buildings, primarily serving urban and suburban MDUs. SMATV systems do not use public rights-of-way and, thus, fall outside of the Communications Act's definition of a cable system. As such, SMATV operators are subject to less regulatory oversight than traditional cable systems. Some SMATV systems also are using microwave transmissions and wires to serve multiple buildings that are not commonly owned. Under the 1996 Act, SMATV operators may use wires to connect separately owned buildings, as long as the wires do not traverse public rights-of-way. It was thought that the statutory change that allowed SMATV systems to connect separately owned buildings would encourage growth in the private cable industry. 89. On January 10, 1998, Entertainment Connections, Inc. ("ECI") filed a motion for declaratory ruling with the Commission seeking a determination that it was not a cable operator, and therefore, not required to obtain a franchise under section 621 of the Communications Act of 1934. ECI uses Supertrunking Video Transport Service, provided by Ameritech, to transport video programming across public rights-of-way to subscribers located in multiple dwelling units ("MDUs") in two Michigan cities. ECI's facilities are located solely on private property, not crossing any public rights-of-way, and Ameritech's facilities that deliver signals from ECI's headend facilities to the MDUs served by ECI are not owned, managed, or controlled by ECI. On June 4, 1998, the Commission adopted a Memorandum Opinion and Order, granting ECI's Motion for a Declaratory Ruling. The Commission concluded that ECI is not a cable operator as defined by the Communications Act and is not obligated to comply with the requirements of Title VI of the Communications Act, including the franchising obligations of Section 621. In granting ECI's motion, the Commission decided that ECI's facilities and Ameritech's facilities do not constitute a single integrated cable system, and that it is Ameritech, not ECI, that "uses" the rights-of-way as the Commission and courts have interpreted the term. 90. Growth. As we have reported in the past, the SMATV industry is composed of hundreds of private and public, small and medium size firms throughout the nation. As of 1990, there were almost 31.5 million "households" (or, individual "dwelling units") in MDUs in the United States, compromising approximately 28% of the total housing units nationwide. As such, SMATV operators continue to have the potential to serve over one quarter of housing units nationwide. Last year, we reported that there were approximately 1,162,500 residential SMATV subscribers, as of June 30, 1997. This year, there are several varying estimates of SMATV subscribership. One source estimates that there were 940,000 residential SMATV subscribers, as of June 1998, a decrease of 19.1% from the previous year. This estimate would place SMATV's share of the MVPD market at 1.21%. Another source estimates that as of June 1998, there were approximately 800,000 residential SMATV subscribers, and anticipates that the number of SMATV subscriptions will continue to decline. A SMATV industry source estimates that as of June 1998 there were approximately 1.5 to 1.6 million subscribers. It states that this figure is an estimate based on a growth rate in excess of 10% per year, consistent with growth rates in prior years. 91. Although subscribership over the past year appears to have declined, certain technological advents have the potential to foster SMATV growth. As we reported last year, many SMATV operators are upgrading their systems to 750 MHz hybrid fiber coaxial broadband architecture capable of transmitting hundreds of channels using digital compression. This year, common carrier supertrunking and the continued use of technologies that integrate DBS antennas and standard SMATV technology, as described below, have the potential to foster SMATV industry growth as well. These technological advances and the regulatory changes that have allowed SMATV operators to use them, enable operators to serve separately- owned buildings and increased numbers of potential subscribers. Future growth, however, not only depends on the ability of SMATV operators to provide channel lineups and basic services comparable to those offered by franchised cable operators, but also demands that SMATV providers offer combination services as well as video, at attractive prices. 92. Technology. As we reported last year, some SMATV operators offer local and long distance residential telephone service as well as closed-circuit security monitoring, interactive and Internet access, voice mail, paging, and other business services tailored to the needs of residential tenants. This year, the demand for these services has increased. As a result, some SMATV operators have begun to upgrade their networks for providing local residential phone service. Many have started to use a variety of new networking arrangements, turning away from private branch exchange ("PBX") technology to a standard central-switch operation enabling SMATV operators to offer service levels on their telephone service equal to that of the independent local exchange carriers, including caller ID, call return, call rejection, distinctive ringing, and other such specialized features. OpTel, one of the largest SMATV operators, is currently licensed as a CLEC in each state in which it competes. Additionally, new technologies are being introduced into the SMATV industry that are not found with other MVPD technologies. For example, one entrepreneur has developed an electronic, touch-screen monitor kiosk to be placed on-site at the MDU that provides information about the services offered in the MDU including channel lineup, rates, a credit-card swipe to order services such as PPV, Internet, and telephone service. 93. SMATV/DBS Combination Services. According to some industry observers, the decision of SMATV providers to take advantage of DBS technology to provide video programming service to residents of multiple dwelling units has been beneficial for both SMATV and DBS providers. As we reported last year, satellite providers such as DirecTV/USSB, Primestar, and Echostar offer SMATV operators a low-cost, technically-advanced, digital programming service that significantly increases channel capacity and adds special programming that is otherwise unavailable from cable systems or MMDS operators. DirecTV, for example, has formed a number of alliances with SMATV operators such as WirelessOne, OnePoint Communications, and Heartland Wireless. NCTA states that, in the case of Wireless One, the company keeps approximately 20% of the revenue generated, with the rest going to DirecTV, which supplies equipment and programming. 94. Real Estate Owners and Property Managers. As we reported last year, Real Estate Investment Trusts ("REITS") and other national property management companies and ownership groups, with numerous interstate property holdings, are negotiating with programming and other MVPD services on a national basis. According to industry observers, private property owners are becoming more adept in negotiating contracts with SMATV operators, allowing for revenue sharing and demanding increased services for subscribers. An industry source indicates that an increasing number of small and large MDU owners and real estate investment trusts are negotiating with SMATV operators to provide service in their buildings regionally and nationally because SMATV can offer a viable alternative to other MVPDs in terms of number of channels, installations and maintenance, and the provision of service at rates comparable or lower than incumbent providers. SMATV operators in Cincinnati and Chicago, in particular, are finding REITS and apartment building owners are forming consortiums and seeking SMATV bids for thousands of apartment buildings. F. Broadcast Television Service 95. Broadcast networks and stations are competitors to other MVPDs in the advertising and program acquisition markets. Additionally, broadcast networks and stations are suppliers of content for distribution by MVPDs. Since the 1997 Report, the broadcast industry has seen continued growth in the number of operating stations and in advertising revenues. The number of commercial and noncommercial television stations increased to 1583 as of August 31, 1998, from 1561 as of July 31, 1997. Broadcast total advertising revenues reached $32.5 billion in 1997, a 4% increase over 1996. Advertising revenues for the six broadcast networks alone reached $15.2 billion in 1997. Network advertising rates, however, are estimated to have dropped by 3% between the 1998-99 and 1997-98 seasons (in comparison to an average increase of 6.5% since 1980), mainly because of competition from cable networks. Broadcasters sold slightly more advance commercial time for the 1998-99 season (between $6.4 and $6.5 billion) than was sold for the 1997-98 season (between $6.25 billion and $6.3 billion). In comparison, cable programming networks received $5.7 billion in advertising revenue in 1997, an increase of 16% over 1996. 96. During the 1997-98 television season, the four major networks (i.e., ABC, CBS, Fox, and NBC) accounted for a combined 55% share of prime time viewing among all television households (compared to 59% in the previous year); UPN and WB, the two newest networks, achieved a combined 9% share of prime time viewing, the same as last year. The most recent data available for households subscribing to cable service indicate that programming originating on local broadcast television stations accounted for a combined 58% share of all day viewing in the 1996-97 television season, while non-premium cable networks and pay cable services achieved a combined 54% share of all day viewing, up from 51% the previous season. On August 31, 1998, PaxTV, a new national broadcast network began operation. PaxTV generally offers family-oriented programming, and uses cable carriage or C-Band carriage to reach some households in areas where it does not have a broadcast affiliate. 97. The Commission took several actions on digital television ("DTV") during the past year. First, the Commission reallocated television channels 60-69 for public safety use and to free some of the spectrum for auction. Four of the freed channels were allocated for public safety, and the rest will be auctioned. Second, the Commission reaffirmed its service rules for the conversion by all U.S. broadcast television stations to DTV, including build-out construction schedules, analog and DTV channel simulcasting, and the return of analog channels to the government by 2006. Finally, the Commission adopted the final DTV allotment table, reaffirming DTV channel assignments and other technical rules and procedures with minor modifications. 98. As stated in the 1997 Report, affiliates of the top four networks in the top ten markets are required to be on the air with digital signals by May 1, 1999. Certain volunteer stations in the top ten markets agreed to be on the air by November 1, 1998, and 41 stations planned to begin DTV service on or near that date. As reported in the 1997 Report, as of December 31, 1997, seven DTV construction permits had been granted. This year, as of December 2, 1998, 118 DTV construction permits had been granted, with an additional 71 pending. Chicago and San Francisco appear to be the only top ten market in which none of the broadcast stations met the November 1, 1998 deadline, due to tower problems. 99. While the first DTV sets went on sale in August, these televisions are not compatible with the cable industry's preferred method of delivering DTV signals. While cable operators are today capable of simply "passing through" an 8VSB-modulated DTV signal which can be received by current DTV receivers, the cable industry's preferred method of delivering DTV signals involves using the IEEE 1394 standard to connect cable set-top boxes and DTV receivers. Unfortunately, no currently-available DTV receiver contains IEEE 1394 inputs. Accordingly, the ability of these first-generation DTV sets to receive DTV programming over cable will depend on whether individual cable operators implement alternative compatibility solutions, such as 8VSB pass-through or component video conversion, and it is possible that some customers will initially not be able to receive DTV signals through their cable systems. The Consumer Electronics Manufacturers Association ("CEMA") and NCTA released an interoperability specification based on the IEEE 1394 standard on November 2, 1998, which, they indicate, should allow for commercial deployment by November 1999. 100. In addition, the issue of copy protection is not fully resolved. Copy protection is an important issue for the transition to DTV because, unlike copies of analog video content, digital copies do not deteriorate when copied repeatedly and can be widely distributed over today's digital networks, such as the Internet. Until a copy protection solution is defined, content owners may limit the availability of high- value content for display on DTV receivers, which may in turn slow consumer adoption of DTV equipment. In response to requests for proposals by the Copy Protection Technical Working Group ("CPTWG") -- a study group that includes representatives from the major production studios -- several copy protection solutions for video content have been proposed. One leading proposal is the Digital Transmission Content Protection ("DTCP) method, which has been developed by the so-called "5C" group of companies consisting of Intel, Toshiba, Sony, Hitachi, and Matsushita. Recently, Zenith and Thomson proposed a different copy protection standard, known as the Extended Conditional Access or "XCA" method, which they claim offers a better overall solution than the 5C method. A number of other proposals also have been offered. Until resolved, the copy protection issue could slow the deployment of next-generation DTV consumer products (e.g., DTV receivers that incorporate the 1394 digital interface) because manufacturers may choose to await the eventual completion of a satisfactory copy protection solution prior to completing the design of new products. Additional potential problems include the fact that current indoor antenna designs may not always provide satisfactory over-the air reception. Also, with respect to DBS, at least one manufacturer is now selling DTV sets with a built-in satellite receiver, but current DBS subscribers will need a digital-to- analog converter to display DTV signals on their existing analog television receivers. 101. DTV has the potential to allow the broadcasters to become more effective competitors with cable operators in the MVPD market. Under the Commission's rules for DTV, digital encoding and transmission technology will permit stations to broadcast one or perhaps two High Definition Television ("HDTV") signals, multiple streams of Standard Definition Television ("SDTV") signals, or some combination. Some broadcasters have proposed that they combine the digital spectrum of all stations in a local television market to create a 40 to 50 channel service that could compete with MVPDs. At this time, however, it is unclear the proportion of HDTV to multicast SDTV that broadcasters will offer, or what broadcasters would show on multiple channels, and no deals on combining digital spectrum have been announced. Thus, at least for the near term, it appears unlikely that broadcast television will offer consumers a multichannel video programming service in competition with cable. G. Other Entrants 1. Internet Video 102. At the end of 1997, 44% of all households owned a personal computer and 60 million adults and 20 million children were Internet users. Previously, we reported on the availability of software technologies that make real-time and downloadable audio and video from the Internet accessible through a personal computer. We also noted that there are technologies available for the provision of Internet video over a television using set-top box Internet access and through the WebTV and Worldgate service packages. As of June 1998, investment and development of Internet video services was continuing, although long form video programming offered by Internet video still remains less than broadcast quality. Media companies continue to offer increasing amounts of video over their websites in the expectation that the pictures will reach broadcasting, cable or VCR quality of play. 103. In the 1997 Report, we indicated that several firms were providing software for placing video content on the Internet, but that the availability of video content was limited. Since then, some providers of Internet video software have grown such that they now offer access to more traditional video content. A few Internet streaming providers formed alliances with content producers such as major record labels and broadcasters. As a result they now provide direct access to video programming content through their products. In July 1998, RealNetworks formed an alliance with Atlantic Records and Sony music, introducing a music service with archives of full-length music videos available for access through streaming. In August 1998, NBC announced plans to invest in Intertainer Inc., a start-up online service, to provide movies, television programs and music on demand through personal computers. Under this agreement, viewers would be able to see NBC-owned programming (e.g., Dateline) at their convenience, although there is some concern about the reaction of local affiliated stations to this plan. The website broadcast.com offers broadcasts of 21 television stations and cable networks. 104. Some cable networks also are creating Internet video content, stored on their websites, available for playback over RealNetworks' RealPlayer G2 or other similar software packages. In June 1998, the American Health Network ("AHN") began offering a weekly operating room series, Behind the Mask, and other "special events" such as a live birth and a heart surgery. AHN uses RealNetworks' RealVideo streaming technology to video-stream its programming choices. Cable News Networks has archived, on its main website, episodes of Larry King Live and Crossfire for viewing through two different streaming video software packages. The Independent Film Channel ("IFC") and Bravo have created "broadband sites" that offer originally produced full-motion Internet video that supplements their standard cable video networks. Users, however, can only gain access to these sites through cable operators offering this service who provide it to customers with cable modem access. 105. Despite the increase in interest in Internet video, the medium is not seen as a direct competitor to traditional video services at this time. Currently, Internet video is used primarily for news, sports clips, and other brief video excerpts because of the inferior quality of the picture and the need for viewers to have the proper software and hardware. Webcasters hope that streaming will eventually improve so that they can offer movies, sports, and television shows, but industry observers believe video streaming is unlikely to be compete with traditional video media in the foreseeable future. Despite financial investments by firms such as Intel, Sony, US West, Comcast, Sun Microsystems, Oracle, Microsoft, and others, limitations in video streaming remain. 2. Home Video Sales and Rentals 106. Previously, we stated that we consider the sale and distribution of feature film entertainment through video tape sales and rental outlets as part of the video programming market since they provide video services similar to the premium and pay-per-view services offered by MVPDs. We also observed that premium and pay-per-view cable services are not regulated because they are competitive and that the video rental industry is highly competitive. It is estimated that 88% of all U.S. television households own at least one VCR. There were approximately 27,000 video specialty stores in the U.S. selling or renting video tapes, with a large video store carrying as many as 10,000 titles. This revenue stream is now the largest single source of revenue to movie studios, representing approximately $4.5 billion, or 45%, of the $9.9 billion of estimated domestic studio revenue in 1996. Recently, Blockbuster and Hollywood Video, the two largest video retailers, began revenue sharing arrangements with the movie studios that lowered their costs in return for sharing rental revenues with the studios. For example, Blockbuster previously purchased video tapes through a distributor at $65 each. Now it buys tapes for one tenth that price directly from the movie studios and then gives about 40% of its rental revenue to the studios. 107. Laser discs also provide a means for consumers to view video programming, especially movies. Introduced into the home video market in the early 1980s, laser discs, require their own laser disc players, deliver better quality pictures than video tapes and digital/compact disc ("CD") quality sound. Laser discs often have features not included on video tapes, such as original movie trailers and behind-the-scenes information. There are a large number of movies available on laser discs, with major movies released simultaneously on laser disc and video tape. 108. In the future, laser discs are likely to be replaced