FTC Staff Comment to the Hon. Frank Sawyer Concerning Ohio H.B. 622 to Define When Municipalities May Grant Additional Cable Franchises

UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
CLEVELAND REGIONAL OFFICE
520-A Atrium Office Plaza
668 Euclid Avenue
Cleveland, Ohio 44114-3006
(216) 522-4210
Facsimile: 522-7239
V900018
COMMISSION AUTHORIZED
Mark D. Kindt
Regional Director
The Honorable Frank S. Sawyer
Ohio House of Representatives
State Capitol
Columbus, Ohio 	43215
Dear Mr. Sawyer:
July 5, 1990
The staff of the Federal Trade Commission is pleased to respond to your
invitation to comment on House Bill 622. 1 This bill defines conditions under
which municipalities may grant additional cable franchises in areas with an
existing cable system. 	The FTC staff believes that enactment of HB 622 might
result in the insulation of incumbent cable systems from beneficial competition.
Previous experience with similar forms of entry regulation suggests that
consumers' interests are rarely served when prospective entrants are required to
demonstrate, in a regulatory setting, the competitive benefits" of entry.
Franchising authorities have a legitimate interest in regulating access to
public rights-of-way. 	However, experience suggests that even regulations designed
to address legitimate policy objectives may have adverse, if unintended,
competitive consequences. 	The Assembly may wish to take these possible
consequences into account when evaluating the merits of HB 622.
These comments are the views of the staff of the Cleveland Regional Office
and the Bureau of Economics of the Federal Trade Commission. 	They are 	not
necessarily the views of the Commission or any individual Commissioner.

I. 	EXPERIENCE OF THE STAFF OF THE FfC
The FTC is an independent regulatory agency res~onsible for maintaining
competition and safeguarding the interests of consumers. 	In response to requests
by federal, state, and local government bodies, the staff of the FTC often analyzes
regulatory or legislative proposals that may affect competition or the efficiency of
the economy. 	In the course of this work, as well as in antitrust and consumer
protection researc~ non public investigations, and litigation, the staff applies
established economic principles to competition and consumer protection issues,
including efficiency rationales for rate and entry regulation? 	In particular, the
FTC staff has commented on rules relating to whether cable television systems
"must carry" television broadcast signals,4 and has submitted a comment in
response to the Federal Communications Commission's (FCC) recent Notice of
Inquiry on competition, rate deregulation, and policies relating to the provision of
cable television service.5
II. 	COMPETITION AMONG CABLE SYSTEMS
The Cable Communications Act of 1984, 47 U.S.c. 521 et. seq., began a process
of deregulating basic cable rates and more clearly delineating the regulatory
power of federal, state and local governments. 	To that end, the Cable Act
provided for a phase-out of rate regulations on basic cable service whenever the
incumbent cable system was subject to "effective competition." 	In implementing
this portion of the Cable Act, the FCC was required to establish criteria for
identifying the existence of effective competition. 	The FCC ultimately adopted
what has corne to be known as the "three signal rule," whereby a cable system is
considered to be subject to effective competition if the entire community it serves
can receive three or more unduplicated broadcast television signals. 	The FCC
2 15 U.S.c. §§ 41 - 59.
3 	See, e.g., Mathios and Rogers, The Impact of State Price and Entry Regulation on
Intrastate Long Distance Telephone Rales, Bureau of Economics Staff Report to the
Federal Trade Commission, November 1988.
4 	MM Docket No. 85-349.
5 	See Comment of the Staff of the Bureau of Economics and the San
Francisco Regional Office Before the Federal Communications Commission In the
Matter of Competition, Rate Deregulation and the Commission's Policies Relating
to the Provision of Cable Television Service, MM Docket No. 89-600, April 20, 1990
("FTC staff Cable Comment"). 	A copy of this comment has been appended to this
su bmission.
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recently issued a Notice of Proposed Rulemaking (NPRM) to consider revisions to
the three signal rule. 6
As we noted in our recent comment to the FCC, it seems unlikely that
over-the-air (OT A) broadcasts (as currently available in most markets) impose a
fully effective competitive constraint on cable systems.' 	Rather, we believe that
such competition can only come from video distribution technologies that can
offer an array of programming similar to that offered by a cable system. 	One
possible source of effective competition for an incumbent cable system obviously
would be the existence of a second cable system, a situation commonly referred to
as "overbuilding."
Overbuilding currently is rare. 	Of the more than 9,000 cable franchises
currently in existence, less than one-half of one percent face any direct
competition for subscribers from other cable companies. 	There are some
indications that the number of "overbuilds" has recently increased,S but
overbuilding nonetheless remains relatively uncommon.
The paucity of cable overbuilds should not be surprising if, as is widely
believed, cable distribution is a natural monopoly.9 	Even if cable television is a
6 	See FCC Notice of Proposed Rulemaking in the Matter of Reexamination
of the Effective Competition Standard for the Regulation of Cable Television
Basic Service Rates, MM Docket No. 90-4, January 22, 1990 ("Effective Competition
NPRM"). 	As of December 29, 1986, basic cable television rates in most
communities were deregulated.
7 	See FTC staff Cable Comment, pp. 15-24. 	As we explain in greater detail in
our comment to the FCC, we are also doubtful that cable systems' market power
can be constrained by regulation as long as the regulatory power is limited to the
regulation of basic service. 	This is because cable systems would be free to shift
many of their programs from the regulated basic service tier to unregulated
higher service tiers if basic rates were re-regulated. 	See FTC staff Cable
Comment, pp. 21-24.
8 	The October 31, 1989 issue of Cable TV Franchising lists 78 pending overbuilds,
and 21 actual overbuilds. 	Cable TV Franchising estimates that there are 41 percent
more overbuilds now than one year ago.
9 	Virtually all discussions of the properties of cable technology assume that
the cost of serving a given geographic area is lowest when it is served by a single
firm. 	The reason is that single firm production avoids duplicative investments in
receiving equipment (e.g., the "headend") and in the cable itself. 	Although this is a
reasonable argument, there exist only a few econometric studies of cable television
costs (see, e.g., Owen and Greenhalgh, "Competitive Considerations in Cable
(continued_)
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natural monopoly, however, it does not necessarily follow that competition from
overbuilding could not, under some circumstances, be both profitable and
beneficial to consumers. 10 The infrequency of overbuilds may also be partly
attributable to statutory and regulatory policies that have insulated incumbent
cable operators from competition. 	Although local ~overnments have a recognized
interest in regulating access to public rights-of-way, 1 there is a possibility
(discussed further below) that these regulatory mechanisms have been used to
impede beneficial entry by a second cable system, thereby reducing benefits to the
consumer.
Accordingly, the Assembly may wish to exercise caution in crafting
legislation that might shield incumbent cable systems from entry. 	While
eliminating regulatory entry barriers will not necessarily ensure competitive
behavior in every cable market, it seems unlikely that significant competitive risks
would be posed by the removal of these barriers.
IlL 	HB 622 Could Discourage Competition
A. 	The Benefits of Free Entry
House Bill 622 establishes conditions that franchising authorities must
satisfy before granting additional cable franchises in areas already receiving cable
service. 	Section 4931.52 would prohibit municipalities from approving "overbuilds"
without a public hearing. 	At this hearing the municipality would be required to
consider the implications of entry with regard to a number of different issues.
9(_con tinued)
Television Franchising," Contemporary Policy Issues 4 (1986), 69-79). 	These studies
appear to confirm, however, the hypothesized natural monopoly properties of
cable television. 	The economics of cable television would seem to have similarities
to the economics of electricity and gas distribution, which also are natural
monopolies. 	One possible difference, however, is the fact that two different cable
systems could potentially provide differentiated products (e.g., two competing cable
systems might offer differing sets of channels), while gas and electric companies
could not.
10 As we discuss in greater detail in our comment to the FCC (see pp. 4-14),
economic theory suggests that under some circumstances long-run competition
between two cable systems can occur even when total production costs would be
minimized by single-firm production. 	See A. Smiley, "Direct Competition Among
Cable Television Systems," U.S. Department of Justice Economic Analysis Group
Working Paper No. EAG 86-9, June 5, 1986. for a more detailed discussion.
11 See, e.g., Video Interneuional Production, Inc. v. Warner-Amex Cable Communications,
Inc., 858 F2d 1075, 1081 (5th Cir. 1988), cert. denied, 109 S.Ct. 1955 (1989).
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These issues include, inter alia, "the likelihood and inu'act of short-range and long-
range competition in the provision of cable service," 	and "the capacity of the
public rights-of-way and the utility infrastructure to accommodate the proposed
cable system.',13
The procedure that would be established by Section 493152 appears similar
in some important respects to the Certificate of Need (CON) proceedings formerly
conducted by various federal regulatory agencies (e.g., the Interstate Commerce
Commission and the Civil Aeronautics Board), and still conducted by numerous
state regulatory commissions. 	In such proceedings, parties wishing to enter a
market typically face the burden of proving that their entry would be "necessary"
and not harmful to the public. 	Often, the applicant is required to meet and rebut
allegations - no matter how unfounded - that the applied-for service is unnecessary
and inappropriate. 	These proceedings raise the cost of entry, and have often
effectively deterred entry and deprived consumers of the benefits of price and
service competition. 	When these barriers have been lifted, as when Congress
deregulated the interstate motor carrier market,14 the result has been increased
competition, better service, and lower prices. 15 In industries where CON programs
continue to be used to regulate entry, experiences have often been unfavorable. 16
A recent study of competition in cable television markets provides case
study evidence illustrating the potential benefits from overbuilding. 	See Hazlett,
"Duopolistic Competition in Cable Television: 	Implications for Public Policy;' 7
12 § 493152( A).
13 § 4931.52(B).
14 Motor Carrier Act of 1978, 49 U.s.c. § 10923 et seq.
15 See Owen, Deregulation in the Trucking Industry, Bureau of Economics Issues
Paper, May 1988; Statement of Reese H. Taylor, Jr., Chairman of Interstate
Commerce Commission, Before the Senate Committee on Commerce, Science, and
Transportation (Sept. 21, 1983); Staff Report, Interstate Commerce Commission,
Highlights of Activity in the Property Motor Carrier Industry (March 1986); and United
States General Accounting Office, Trucking Regulation: 	Price Competition and Market
Structure in the Trucking -Industry, 8-10 (Feb. 1987).
16 For example, many states still use CON laws to restrict entry into hospital
markets. 	A substantial body of empirical research has demonstrated, however,
that the effect of these programs has been to raise, not lower, hospital costs and
prices. 	See Statement of the Federal Trade Commission by Keith B. Anderson,
Before the Subcommittee on Health, Committee on Ways and Means, U.S. House
of Representatives, on Certificate of Need Regulation of Health Care Facilities as
Related to H.R. 712 (The Medicaid Inpatient Hospital Capital Expenditures
Amendments of 1989), March 13, 1989, and the references cited therein.
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Yale Journal on Regulation 65-119 (1990). 	For example, in Orange County, Florida
(which contains the city of Orlando), Hazlett reports that in 1987 entry induced
the incumbent operators to reduce the price of basic service from $12.95 to $6.50
per month. 	Pay service prices were reduced by a similar magnitude. 	In Riviera
Beach, Florida, prior to entry the incumbent operator had been serving the
market with a 12-channel system with basic service priced at $8.40 per month. 	A
second firm entered with a 2fKhannei system, offering basic service at price of
$5.75 per month. 	Hazlett reports that the incumbent responded to this entry by
lowering its price and upgrading its service quality.
In light of these considerations, the Assembly may wish to consider the
impact of a policy that might require entrants to demonstrate, in a regulatory
setting, the likely competitive benefits of entry into cable markets. 	Earlier
experiences strongly suggest that consumers' interests would be better served by a
policy that permits free entry, to the extent that such a policy is compatible with
other legitimate state and local interests.
B. 	The Risks From Other Entry Requirements
In addition to requiring the franchising authority to consider the impact of
entry on competition, Section 4931.52 of the Bill also requires the franchising
authority to assess (and. presumably, the applicant to make affirmative
establishments regarding): 	(1) the capacity of the public rights-of-way and the
utility infrastructure to accommodate the proposed cable system; (2) the impact on
present and future uses of the public rights-of-way and utility infrastructure
proposed to be used by the proposed cable system; (3) the potential disruption to
existing users of those public rights-of-way and to the residents of the area from
construction and operation of the proposed cable system; (4) the aesthetic impact
of the proposed cable system; and (5) the financial and technical qualifications of
the franchise applicant to provide the additional cable service and his
demonstrated compliance with cable service and other laws of the franchising
authority and other authorities.
Local authorities have a valid interest in regulating access to public rights-
of-way, and Section 4931.52 appears to address such considerations. 	Nevertheless,
even when a regulatory institution is created to serve an entirely legitimate
function, situations may arise where the institution can be used to facilitate
anticompetitive behavior. 	There is, therefore, a risk that the regulatory procedure
that would be established by HB 622 could, like any procedure that regulates entry
into a market, be used to impede beneficial entry, and thereby harm consumers.
Part of the danger from entry regulation arises from the ability of the
incumbent to use (or misuse) the regulatory system to obtain protection from
competition. 	For example, the Federal Trade Commission has characterized the
CON process as used in hospital markets as a "classic 'barrier to entry' under every
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definition of that term,,,17 noting in particular the ability of incumbents to use this
process to forestall entry.18 	Even when entry regulation is motivated by objectives
other than the prevention of "excessive competition" (the ostensible rationale for
CON programs), there nonetheless persists a danger that the incumbent will be
able to exploit this process to insulate itself from competition that would benefit
consumers.
.- _ The history of cable franchising in Sacramento, California, illustrates how
the franchising process may have been used for anticompetitive purposes. 19 There,
the city granted the initial franchise to an affiliate of a large multiple system
operator. 	Another firm later applied for a franchise to "overbuild" the city, but its
franchise application was denied. 	The potential overbuilder then brought suit
against the city and the incumbent cable operator alleging, inter alia, a violation of
Section 1 of the Sherman Act.2o The jury found, and the judge agreed, that the
city had conspired with the incumbent operator to exclude the overbuilder in
exchange for increased cash payments and provision of free cable services to the
city government.21
The details of the review process tha t would be created by HB 622 are not
17 See Hospital Corporation of America, 106 ET.C. 298,491 (1985), affd, 807 F.2d
1381 (7th Cir. 1986), cert. denied, 481 U.s. 1038.
18 Id. at 492.
19 For a more expansive factual account, see Pacific West Cable Co. v. City of
Sacramento, 672 E Supp. 1322 (E.D. Cal. 1987).
20 Id. at 1325.
21 Id. at 1328. 	The court adopted this finding of fact from the jury's special
verdict despite its decision to dismiss the plaintiff's antitrust claims against the
city as immune under the state action doctrine. 	Id. at 1325. 	See also Preferred
Communications, Inc. v. City of Los Angeles, 754 F.2d 1396, 1411-15 (9th Cir. 1985)
(interpreting California statutes to be sufficiently specific so as to constitute a
"clearly articulated and affirmatively expressed" state policy to displace
competition in the cable television industry), affd on other grounds, 474 U.s. 979
(1986).
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necessarily identical to those that characterize hospital CON regulation, or that
existed in the Sacramento market at the time the aforementioned events took
place. 	However, these examples are suggestive, in a general way, of the types of
competitive risks that can be created by the franchising process. 	In creating a
regulatory mechanism to assess a legitimate policy issue (e.g., potential disruption
to public rights-of-way), there is a trade-off between ensuring that the issue is
adequately addressed and ensuring that the system itself does not become a means
to impede beneficial entry_ 	The Assembly may wish to take account of this trade-
off when considering the merits of the Bill.
IV. CONCLUSION
Enactment of HB 622 may result in the protection of incumbent cable
systems from socially beneficial competition. 	Previous experience suggests that
consumers' interests are unlikely to be served by requiring prospective entrants to
demonstrate the benefits of competition in a regulatory proceeding.
Franchising authorities have a legitimate interest in regulating access to
public rights-of-way. 	However, experience suggests that even regulations designed
to address legitimate policy objectives may have adverse, if unintended,
competitive consequences. 	The Assembly may wish to take these possible
consequences into account when evaluating the merits of HB 622.
Sincerely,
~/
~~ark D. Kindt
8