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Key Variables in Calculating Cable System Profitability
1. Measurement of Profitability
2. Revenues
3. Operating Costs
4. Capital Costs
5. Summary



Selection of Appropriate Values for the Variables
1. Calculation of Internal Rates of Return
2. Revenues

Subscription Revenues
b. Ancillary Revenues
3. Subscriber Penetration
4. Operating Costs
5. Capital Costs

a. Underground Construction
b. Timing of Capital Expenditures


The Rate of Growth of Profits Expected by Cable Owners

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During the past year, following the implementation of new regulatory policy via the Federal Communications Commission's Cable

1 Television Rules, ` representatives of the cable television industry and copyright owners have been attempting to negotiate a schedule of copyright fee payments. Agreement would facilitate passage of copyright legislation and "erase an uncertainty that now impairs cable's ability

,,2 to attract the capital investment needed for substantial growth. The passage of such legislation would further help meet the FCC's regulatory

1,3 objective: "to get cable moving...

To assist in these negotiations, the National Cable Television Association (NCTA) commissioned a study by Bridger Mitchell of the effects of the new regulatory policy and various proposals which have been made for a copyright fee schedule. The study concluded that "the outlook for early development of cable television service in the major cities is at best mixed" because of poor prospective profitability and that "to require more than quite limited copyright payments will signifi

,,6 cantly retard or halt CATV expansion in urban markets. The report includes results of calculations which suggest that only the very largest systems, located at the edge of the top 100 television markets, or outside these markets altogether, could possibly pay as much as 5 percent of their gross revenues for copyright fees. This report is in many respects 'Federal Communications Commission--Cable Television Service; Cable Television Relay Service, Federal Register, Vol. 37, No. 30, Feb. 12, 1972. 2Ibid.,

. p. 3260, paragraph 65. Sibid., p. 3259, paragraph 58. *Bridger M. Mitchell in association with Robert H. Smiley, Cable Television Under the 1972 FCC

Rules and the impact of Alternative Copyright Fee Proposals, An Economic Analysis. Sept. 30, 1972. Sibid., p. 43. bibid., p. 43.

7 an "update' of a previous work' which came to similarly gloomy conclu

8 sions in 1970 and with which we took issue.

The conclusions of Mitchell's study, if valid, would seriously affect the negotiations and the prospective legislation because they imply that cable television system operators would be unable to pay copyright fees in any significant amounts. Indeed, they suggest that "getting cable moving" is a hollow phrase because systems in the center of the top 100 markets, which represent the bulk of cable television's future potential for development, can develop rates of return of only 2.4 percent to 10.4 percent--rates which are below their estimated cost of capital --even in absence of any copyright payments.

Fortunately, cable owners are not faced with such bearish prospects. Mitchell's projections are faulty for two reasons.

1. They project revenues per subscriber of $64. 60 per year

ad infinitum despite many indications that revenues will

increase over time; and 2. They assume a very low rate of penetration in the largest

markets on the basis of one academic study, despite the expectations of major cable system operators, as reported by the NCTA, which projected subscription rates nearly

twice as high.

While Mitchell allows for wage inflation in his cost formulation, he fails to allow revenues per subscriber to rise over the life of the franchise. He projects a yield of $64.60 per subscriber per year forever despite the potential which new services, pay channels, and subscriber fee increases promise in the very near future. We shall show below that cable owners are currently anticipating an effective rate of growth in revenues per subscriber of approximately 4 percent per annum. 7 William S. Comanor and Bridger M. Mitchell, The Economic Consequences of the Proposed FCC

Regulations on the CATV Industry, Dec. 7, 1970.
Lionel L. Fray and John D. Wells, Comments on the National Cable Television Association's
Independent Economic Study, Feb. 8, 1971.

In addition, Mitchell uses the most pessimistic extant statistical study to project subscriber demand in the top 100 markets. This study predicts that only 22 to 45 percent of homes passed in these

largest markets will eventually subscribe. The NCTA's own projections, obtained from a survey of its members, place mature penetration at 65 percent of homes passed, a statistic which we accept as the best informed estimate of cable potential in these markets.

In the analysis described below, we have reestimated the prospective profitability of cable television, and we reach much more optimistic conclusions. While we utilize Mitchell's cost parameters throughout with only minor modifications, we are confident that these estimates are accurate only for systems of approximately 10,000 subscribers at maturity. For smaller systems, Mitchell's cost estimates are too high and for larger systems they are too low. Minor modifications have been made in the extent of underground construction man dated by local communities and in the temporal pattern of investment. Otherwise, our only adjustments in the basic assumptions employed by Mitchell involve projections of mature subscriber levels in the top 100 markets and the rate of growth of revenues per subscriber. When the cable industry's own projections of these magnitudes is substituted for Mitchell's unrealistically low estimates, profitability is increased substantially. The difference between our estimates, based upon a conservative 2 percent growth in revenues per subscriber, and Mitchell's are presented in Table A-1.


Don Andersson, The CATV Industry - Current Subscriber Penetration, Projected Subscriber Growth, Capitalization, by 5 Year Periods 1972-1992. With Special Emphasis on Existing and Potential Cable Systems Within 35-Mile Zones on the Top-100 Television Markets.


This section describes the calculations performed in determining cable system profitability and introduces the most important variables that affect these calculations.

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Critical to Mitchell's study and our calculations is the internal rate of return--a fundament al measure of the profitability of capital investments. The internal rate of return on any investment project is that discount rate which equates total future discounted revenues to total discounted future costs. Since the discounted value of any revenue or expense item is directly proportional to its absolute magnitude and inversely proportional to its temporal distance from the present, both the timing and the magnitude of revenue or expenditure items play a critical role in the final calculations. This is not an idle point, as we shall see, for Mitchell has made some very important implicit assumptions about the timing of both revenues and costs.

The precise method for calculating the value of the rate of return is easily described. If we call p (t) the average revenue per subscriber at time t and S (t) the average number of subscribers at time t, the present value of all future revenues is:

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Defining operating costs in each period as OC (t) and capital outlays as
K(t), we may express the present value of all future outlays as:

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