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Thursday, February 9, 2006

Initial Thoughts on the FCC's Revised A La Carte Report
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It seems that the cable industry has once again become everyone's favorite public policy punching-bag. The "government-knows-best" crowd is practically foaming at the mouth about the need for "Net neutrality" mandates on cable's broadband offerings, censorship of speech on various cable channels or programs, and "a la carte" mandates for cable's video lineup.

On this last item, the FCC has just today released a revised version of an earlier staff report conducted during Chairman Michael Powell's tenure. The Powell era FCC report revealed that a la carte would raise prices and hurt program diversity. By contrast, today's report, which new FCC Chairman Kevin Martin requested, argues that the old report got it completely wrong and that a la carte would lead to lower prices and not hurt diversity. So, within the span of 18 months, we have an expert regulatory agency coming to diametrically opposed conclusions on the same issue. (Makes you wonder about those old theories of scientific bureaucracy!) What are we to make of these contradictory results?

Lessons From the Past

A little bit of history is useful here to put this issue into context. Almost fifteen years ago, Congress gave us the Cable Act of 1992, which spawned a complex new price control regime for cable. Our benevolent protectors in Congress and at the FCC told us that they had our best interests in mind and that their new price controls would protect us from our evil cable overlords, whose heinous crime was to charge a bit more money for improved service and expanded channel capacity.

At the time, a number of economists predicted that these new price controls would do little to improve consumer welfare and actually might diminish it instead. Why is that? One of the (few) universal truths in the field of economics is that price regulation will have myriad unintended consequences. Sure, government can control the price of certain inputs or outputs, but other variables will fluctuate as a result. Specifically, government can try to control price, but either quantity and quality (or even both) will be negatively affected. We could freeze the price of milk or gas at 50 cents a gallon tomorrow, for example, but few of us would be surprised if a shortage of both developed a few weeks later. In sum, price controls distort markets and hurt consumer welfare.

And, wouldn't you know it, that is exactly what happened when government regulated cable rates. Here's how George Mason Law School Prof. Thomas Hazlett, one of the nation's leading experts on cable industry regulation, summarizes the dismal results of this misguided regulatory experiment:

"The controls flunked the market test: consumer acceptance. Lower quality-adjusted prices would have attracted more customers just as the FCC predicted. In fact, the number of new cable subscribers plummeted in 1993-94, and basic networks such as A&E and CNN saw years of ratings growth come to a halt. The 5% subscriber growth rate averaged by the top 13 basic cable networks in the two years prior to the 1992 Cable Act was slashed to 2.5% in the two years following. The message was so overwhelming that the FCC quietly declared defeat in late 1994. The failure of rate caps had been hammered home, by basic cable networks like A&E, Discovery and C-Span, which adamantly argued that rate controls destroyed quality programming while boosting home-shopping channels (which pay for carriage). The result was that rates, still officially "controlled," were permitted to increase about 5% a year after inflation, almost identical to the "price gouging" under deregulation in 1987-92. But the fig-leaf regulatory plan worked, as subscriber growth bounced back in 1995."

(See Tom's longer analysis of cable rate controls here.)

And so, with subscribership falling, quality suffering, and service upgrades floundering, the FCC abandoned this misguided regulatory effort just a few years after it got underway. By 1999, rates were almost completely deregulated.

After cable price controls were relaxed, some critics complained that the nominal price of monthly cable service rose higher than the rate of general inflation. But these critics consistently ignore what consumers are getting for their money: More channels and more diversity of programming. According to FCC data, in 1990, only 70 total video programming networks existed for consumers to choose from. (That's just cable or satellite-delivered channels; it does not include over-the-broadcast networks.) As of the end of 2004, there were 388 networks available for carriage over cable, DBS and other systems. Meanwhile, the number of "niche audiences" served has increased significantly. As the FCC concluded in its 2003 media ownership report: "We are moving to a system served by literally hundreds of networks serving all conceivable interests." And video-on-demand, high-definition television, and broadband Internet access have been rolled out too. Thus, the "quality-adjusted price of service" has actually gone down over time. You get a lot more video service and diversity for your dollar today than in the past.

Lesson Forgotten

One would hope that the FCC's miserable experience with cable rate regulation was still fresh in their minds as they began considering a la carte controls. And, at least during the first go-round on the issue, the agency did appear to comprehend the lesson that regulation has consequences, many of them quite unintended and anti-consumer. The FCC's first a la carte report concluded that the agency:

"finds legitimacy to programmers' concerns about an a la carte regime. Existing networks sold on an a la carte basis spend a significant amount of their revenue marketing themselves to consumers. Under an a la carte mandate, networks formerly sold in tiers would need to significantly increase their marketing expenses to induce consumers to affirmatively select the network. Moreover, any type of a la carte requirement would have a significant negative effect on a program network's advertising revenues and license fee structure. The loss of cost savings, combined with the loss in advertising revenue and the likely rise in license fees to compensate such losses, may cause many program networks to fail, thus adversely affecting diversity. The most likely to feel the brunt of such a mandate would be networks serving small niche interests, such as religious programming, programming aimed at minority interests, arts programming and independently owned networks. The impact on program networks seems likely under either a mandatory or voluntary a la carte regime."

Because an a la carte regime would have such negative impacts, the FCC originally concluded that "the average household would likely face an increase in their monthly bill under a la carte sales of between 14% and 30%."

But the political winds have shifted again and there's a new sheriff in town whose agenda includes "cleaning up" content on cable TV. Thus, a la carte needed to be given greater legitimacy as an economic solution to what FCC Chairman Martin and others argue is a serious social or cultural problem: "indecent" or "excessively violent" programming on cable. And so, along comes a new report that castigates the earlier FCC report for "problematic assumptions" and "incorrect and biased analysis." (Geez... are the people at the FCC who wrote that old report reading this? I wonder what they have to say about being told by their new boss that they were "biased" in their analysis 18 months ago. This must make for highly entertaining water cooler chats at the FCC!) The bottom line: the new FCC concocted a new economic model that estimates consumer savings of anywhere from 3 to 13 percent, as opposed to the 14 to 30 price increases predicted under a la carte in the earlier report.

Who to believe? I'm not going to cast judgment on which FCC report gets the numbers right because I subscribe a school of economic thinking that believes that an economic model will spit out whatever numbers you want it to if you torture it enough. All economic models are based on series of simplifying assumptions, and rivers of ink can be spilled about whether or not those assumptions are appropriate or accurate. The new FCC basically says the old FCC got it wrong because of an over-reliance on numbers provided by Booz Allen. But the Booz Allen study and numbers in question were hardly the only evidence submitted to the FCC during its extensive review of this issue two years ago. Numerous economists and organizations submitted filings and testimony coming to much the same conclusion: a la carte will like raise prices and almost certainly diminish the diversity of programming available to consumers. And the General Accountability Office conducted its own review of a la carte proposals and concluded that:

"an a la carte system could impose additional costs on subscribers in the near term because additional equipment -- which many subscribers do not currently have -- will be required on every television attached to the cable system to unscramble networks the subscriber is authorized to receive. Moreover, an a la carte system could alter the current economics of the cable network industry, wherein cable networks derive significant revenues from advertising. In particular, cable networks experiencing a falloff in subscribers could also see an associated decline in advertising revenues, since the amount that companies are willing to pay for advertising spots is based on the number of potential viewers. Although cable networks may take steps to reduce their production costs to compensate for the decline in advertising revenue, cable networks may also raise the license fees charged to cable operators for the right to carry the networks. If license fees rise, some of the increase is likely to be passed on to subscribers."

(No word yet on whether the FCC will be seeking to revise the GAO report too!)

But, here's the really important point to take away from all this back-and-forth between the old and new FCC reports: At some point, both reports agree that consumers will witness an increase in their monthly bills under an a la carte regime. Using the old Booz Allen assumptions, the FCC originally reported that consumers could choose as many 17 channels on an a la carte basis before their total monthly bill would increase over their average monthly bill today. Using "corrected" assumptions, the new FCC report states that consumer could receive at least 20 channels -- a whopping 3 channels more! -- before their bills go up.

So, regardless of which FCC report you choose to believe, the FCC is stating that you ARE going to start paying more in an a la carte world after you get just 17-20 channels. Are those 3 extra channels enough for you? You might be inclined to say YES on the assumption that those 20 channels will be exactly channels you want. But will your favorite channels be able to stay afloat under an a la carte regime?

What This Debate is Really All About

The "consumer choice" flag gets waved back-and-forth endlessly in this debate, but in the end, this debate is really a moral debate about what some people think should be on cable or satellite television. I have addressed this issue at great length in other essays (see this one in particular).

For some critics, it's not enough that our government is only able to regulate speech on broadcast TV, they now want them to control subscription-based television in some way too. Because of the constitutional limitations on government regulation of pay TV, a la carte (and schemes like "family-friendly" tiering) become a surrogate for full-blown censorship. But if government can regulate the economic underpinnings of a media sector, it can affect speech in that sector in important ways too, or even open the door to future meddling in ways we cannot imagine today.

What do you think pro-regulatory policy makers would do after they impose a la carte but then witness the demise of the more "wholesome" networks they desire while the "smutty" ones keep rolling right along? Well, they'll claim "market failure," of course, and then propose the direct regulation of the content seen on those channels. An a la carte regulatory regime just greases the skids for that sort of power grab.

In conclusion, therefore, for those who would willing hand over to the FCC the power to regulate the economic business model upon which this industry has been built, I can only say this: Be careful what you ask for. Are you willing to allow your government to conduct a grand regulatory experiment with an industry's successful business model if the cost could be the death of the wonderful diversity we see on cable and satellite TV today? Are you willing to allow it if it could lead to federal meddling with speech for subscription-based media services in the future? Some will say "Sure, I'll take that gamble." If you're one of those people, don't start screaming and writing dirty letters when your favorite network disappears from the airwaves and Congress tries to regulate the content on the ones left standing.

posted by Adam Thierer @ 2:33 PM | A La Carte , Cable , Free Speech , Mass Media

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