Brito & Ellig Reg Analysis And Cable Franchising 2008


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Brito & Ellig Reg Analysis And Cable Franchising 2008

  1. 1. Regulatory Analysis and the Video Franchising Debate Jerry Brito and Jerry Ellig Senior Research Fellows
  2. 3. Regulatory Analysis in Plain English <ul><li>Figure out what you’re trying to do and how you’ll know you did it </li></ul><ul><li>Figure out why government needs to do it </li></ul><ul><li>Figure out what level of government needs to do it </li></ul><ul><li>Think about different ways to do it and find the most effective one </li></ul><ul><li>Figure out what you have to give up to do whatever you’re trying to do </li></ul><ul><li>Weigh the pros and cons </li></ul>
  3. 4. How we got here … <ul><li>Cable often had monopoly franchises (but not always) </li></ul><ul><li>1984 Cable Act requires local franchising </li></ul><ul><li>1984-99: On-again, off-again price regulation </li></ul><ul><li>Local authority can regulate “basic” price if cable lacks effective competition (but 90% of customers buy “expanded basic”) </li></ul><ul><li>Franchising in 1992 Cable Act </li></ul><ul><ul><li>Monopoly franchises prohibited </li></ul></ul><ul><ul><li>Local authority may not “unreasonably refuse” to award a competitive franchise </li></ul></ul>
  4. 5. Basic elements of franchising <ul><li>Firm gets permission to use rights-of-way and enter market </li></ul><ul><li>Franchise fee (capped at 5%) </li></ul><ul><li>“ Nonprice concessions” </li></ul><ul><li>Price regulation of basic service if effective competition is absent </li></ul>
  5. 6. Early 2006 … <ul><li>New entrants claim franchising is still a barrier </li></ul><ul><li>Proposed federal legislation </li></ul><ul><li>State legislation </li></ul><ul><li>FCC proceeding </li></ul><ul><ul><li>FCC claims authority to define “unreasonable” refusal to grant a franchise </li></ul></ul><ul><ul><li>Sought comment on what should be considered unreasonable </li></ul></ul>
  6. 7. Are these unreasonable? <ul><li>Monopoly based on “crowded” rights-of-way </li></ul><ul><li>Require entrant to match incumbent’s capital expenditures </li></ul><ul><li>Require entrant to cover incumbent’s entire territory </li></ul><ul><li>Long delay </li></ul><ul><li>Nonprice concessions </li></ul>
  7. 8. 1. Identify the outcome <ul><li>Widespread agreement: consumer welfare </li></ul><ul><li>Possible measures: Price, quantity, variety, new services </li></ul><ul><li>Causation: remove barriers to entry, competitors enter, competition improves consumer welfare </li></ul><ul><li>Empirical support </li></ul>
  8. 9. 2. Assess systemic problem <ul><li>Federal law requires cable franchises </li></ul><ul><li>“ Unreasonable” refusals and remedies not defined </li></ul><ul><li>GAO surveys find competitors pick markets based in part on local officials’ openness to competition </li></ul><ul><li>Not a problem in ALL markets, but a problem in some </li></ul>
  9. 10. Systemic problem Part II: Justifications for franchise monopoly <ul><li>“Unsustainable” natural monopoly </li></ul><ul><ul><ul><li>Never proven, frequently refuted </li></ul></ul></ul><ul><ul><ul><li>Requires effective price regulation </li></ul></ul></ul><ul><li>Specific capital and risk reduction </li></ul><ul><ul><ul><li>Unclear if possible in theory </li></ul></ul></ul><ul><ul><ul><li>Never proven </li></ul></ul></ul><ul><ul><ul><li>Requires effective price regulation </li></ul></ul></ul><ul><li>Management of rights-of-way </li></ul><ul><ul><ul><li>Requires pricing or rules, not monopoly </li></ul></ul></ul><ul><ul><ul><li>Irrelevant for entrants already using rights-of-way </li></ul></ul></ul>
  10. 11. 3. Federal role? <ul><li>Local officials often captured by incumbent cable company </li></ul><ul><ul><ul><li>Franchise fees </li></ul></ul></ul><ul><ul><ul><li>Public/Educational/Government (PEG) channels </li></ul></ul></ul><ul><ul><ul><li>Free networks for local govt. </li></ul></ul></ul><ul><ul><ul><li>Outright corruption </li></ul></ul></ul><ul><li>Some states enacted statewide franchising </li></ul><ul><li>Federal Cable Act is one source of the systemic problem </li></ul>
  11. 12. Local authorities’ incentives <ul><li>Municipal governments discovered that they could extract substantial rents by awarding licenses on favorable terms to the applicant. In the 1960s, New York Mayor John Lindsay proclaimed cable franchises “urban oil wells beneath our city streets.” This produced a decided bias in favor of monopoly, which would improve expected returns and so raise the “bid” from prospective applicants. </li></ul><ul><li>-- Thomas Hazlett </li></ul><ul><li>Cable Television , in Handbook of Telecommunications Economics: Technology Evolution and the Internet, Vol. 2, (Sumit K. Majumdar et al. eds., Elsevier Science 2006). </li></ul>
  12. 13. 4. Effectiveness of Alternatives <ul><li>FCC rulemaking, federal legislation, state legislation, litigation </li></ul><ul><li>FCC alternatives </li></ul><ul><ul><ul><li>Declare video offered by telcos is not cable </li></ul></ul></ul><ul><ul><ul><li>Pre-empt local laws that deny franchises unreasonably </li></ul></ul></ul><ul><li>Extent of reform </li></ul><ul><ul><ul><li>Introduce competition </li></ul></ul></ul><ul><ul><ul><li>Limit/eliminate nonprice concessions </li></ul></ul></ul><ul><ul><ul><li>Limit/eliminate franchise fees </li></ul></ul></ul>
  13. 14. 5. Costs of franchise monopoly <ul><li>Market power raises price, lowers quality </li></ul><ul><li>Nonprice concessions raise costs </li></ul><ul><ul><li>16% of capital and 11% of operating costs in 1984 survey </li></ul></ul><ul><ul><li>PEG fees on bills ≈ 1% </li></ul></ul><ul><li>5% maximum franchise fee raises price </li></ul>
  14. 15. Wireline competition (FCC data 2002-04) <ul><li>“Monthly rate” 12-15% lower with competition </li></ul><ul><li>6-7% more channels </li></ul><ul><li>Price per channel 19-21% lower </li></ul><ul><li>Digital tier 3-6% lower </li></ul><ul><li>5-7% more digital channels </li></ul><ul><li>Price per digital channel 6-12% lower </li></ul>
  15. 16. Raw averages may mislead <ul><li>Some markets may be mis-classified </li></ul><ul><li>Need to control for other factors affecting prices </li></ul><ul><li>GAO study addresses both problems </li></ul>
  16. 17. US Govt. Accountability Office analyses <ul><li>2004: cable rates 16 percent lower with direct wireline competition, after controlling for other factors </li></ul><ul><li>Paired case study finds 15-41 percent rate difference </li></ul><ul><li>Consistent with 20 years of government and independent research finding wireline competition lowers cable rates </li></ul>
  17. 18. Total wealth transfers $8.4 billion 67.4 million N.A. Total all markets $96 million 3.4 million $2.33 + Franchise fees $16 million 3.4 million $0.39 Nonprice concessions Markets with wireline competition $8.3 billion 22.5 million (digital) $5.00 (digital) + Market Power - Digital $8.2 billion 64 million $9.83 + Franchise fees $5.8 billion 64 million $7.56 + Nonprice concessions $5.5 billion 64 million $7.10 Market Power – Basic, extended, equipment Markets without wireline competition Wealth Transfer Subscribers Monthly Price Change Effect
  18. 19. Understanding unseen consumer costs <ul><li>Higher prices = fewer consumers subscribe </li></ul><ul><li>These consumers lose difference between what the service is worth to them and what they would have paid for it </li></ul><ul><li>Loss is big when demand is sensitive to price; 1% price increase causes 1.5-3% reduction in video subscribers </li></ul><ul><li>Reduced competition also reduces quality (# channels) </li></ul>
  19. 20. Total cost to consumers $10.4 billion $8.4 billion $2 billion 28.1 million Total all markets $102 million $96 million $5.8 million 413,000 + Franchise fees $16.2 million $16 million $160,000 69,000 Nonprice concessions Markets with wireline competition $10.3 billion $8.3 billion $2 billion 4.8 (channels) +Quality effect $10 billion $8.3 billion $1.6 billion N.A. + Market Power – Digital $9.8 billion $8.2 billion $1.6 billion 28 million + Franchise fees $6.8 billion $5.8 billion $964 million 21 million + Nonprice concessions $6.3 billion $5.5 billion $850 million 20 million Market Power – Basic, extended, equipment Markets without wireline competition Total consumer cost Wealth Transfer Forgone consumer surplus ∆ in no. of subscribers Effect
  20. 21. Absence of competition costs municipalities (e.g., expanded basic only) <ul><li>Current: </li></ul><ul><ul><li>64 million subs. x $45.52 x 12 x .05 = $1.7 billion </li></ul></ul><ul><li>Competition: </li></ul><ul><ul><li>84 million subs. x $38.42 x 12 x .05 = $1.9 billion </li></ul></ul><ul><li>Local govts. forego $200 million on expanded basic </li></ul><ul><li>Govt. loses revenue whenever the elasticity of demand for the service > 1. </li></ul>
  21. 22. Sensitivity Analysis $10.43 billion $8.48 billion $1.95 billion 30.1 million 11.5 percent price effect All MVPD subscribers $9.53 billion $7.62 billion $1.91 billion 32.1 million 11.5 percent price effect Mutatis mutandis $10.87 billion $8.42 billion $2.45 billion 35.1 million Elasticity = -2.5 $9.99 billion $8.42 billion $1.58 billion 21.1 million Elasticity = -1.5 Change in assumption $10.43 billion $8.42 billion $2.01 billion 28.1 million Baseline Total consumer cost Wealth Transfer Forgone consumer surplus ∆ in # of subscribers
  22. 23. 6. Net Benefits and Incidence <ul><li>Liberalization of franchising generates net benefits (increase in consumer surplus + increase in producer surplus for cities) </li></ul><ul><li>Cable companies lose wealth transfer, gain some profit on expanded sales, worse off on net </li></ul><ul><li>Local govts. retained their wealth transfers and got to tax a larger market </li></ul><ul><li>Local officials have fewer opportunities to extract private rents from entrants </li></ul>
  23. 24. What we recommended <ul><li>Refusal is unreasonable if based on natural monopoly, risk reduction, or rights-of-way management unsupported by overwhelming empirical evidence that monopoly is necessary </li></ul><ul><li>“ Nonprice concessions” unrelated to cable system are unreasonable </li></ul><ul><li>Excessive delay in making decision (120 days?) is unreasonable </li></ul><ul><li>Aspects of “level playing field” laws are unreasonable </li></ul><ul><ul><li>Capital expenditures equal to incumbent </li></ul></ul><ul><ul><li>Serve all of incumbent’s area </li></ul></ul><ul><ul><li>Buildout requirement faster than incumbent’s actual buildout </li></ul></ul><ul><li>Require franchise authority to explain reasons for denying franchise in writing </li></ul>
  24. 25. What the FCC Did <ul><li>Franchise deemed granted if negotiations go too long </li></ul><ul><ul><ul><li>90 days if applicant already uses public right-of-way </li></ul></ul></ul><ul><ul><ul><li>6 months otherwise </li></ul></ul></ul><ul><li>Unreasonable build-out requirements are unreasonable refusals to grant franchise </li></ul><ul><li>Contributions to Peg operating costs count toward 5% franchise fee limit </li></ul><ul><li>Note: Our calculation assesses benefits of liberalization, not necessarily all attributable to the FCC’s action </li></ul>