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20-344 O - 73 - 29

cost nature.

But, in practice, the

behavior of

cable systems is

increasingly limited by local and federal reg

ulation, and by competition among firms for franchises.

Both of

these forces sharply restrict the ability of cable firms to adjust

price or output at will.

Present regulation and competition for new franchises, plus

the threat of more extensive regulatory action if firm behavior

is perceived as excessive, has kept monthly subscriber rates

virtually constant in current prices over several years.


in 1970, found most recently franchised systems charging between

$5.00 and $7.00 per month.

In their sample of Factbook systems

Comanor and Mitchell reported a mean price of $5.00 per month.

Park in 1972 has an annual average price of $63 for his sample of

A-contour cable systems.

The assumption that moderate cost increases,

including copyright fees, cannot be passed on in the form of higher

prices is consistent with the recent market experience.

Assuming no price response by cable firms if a 16.5% surcharge

were imposed requires further discussion. Firms would doubtless

make strong representations to local authorities about the need for

higher prices, and bids for new franchises would quote higher


But granting for the moment that regulators allowed part

or all of the surcharge to be translated into higher subscriber

rates, how would cable profits be affected?

The answer depends primarily on how rapidly penetration would

decline as prices were raised; in technical economic terms, on the

elasticity of demand.

If, for example, a 16.5% increase in price,

from $5.00 per month to $5.83, results in a 16.5% decrease in pene

tration, say from 30% to 25% of homes passed, then the higher price

has (approximately) 4/ no effect on total subscriber revenue--it is

fully offset by reduced demand for service.

A basic result of economic theory states that consumers' demand

for a service will be increasingly sensitive to its price as more

and closer substitutes are available for that service.

Thus house

holds in areas with a diversity of broadcast signals, with generally

clear reception and with a variety of entertainment alternatives can

be expected to decline service rapidly as prices rise.


availability of good substitutes for CATV describes most top 100


The econometric work of R.E. Park confirms this degree

of price elasticity of demand in such areas; in fact, the figures

in the example above correspond almost exactly to Park's statistical

findings . 5) 6/

4 calculating the percentage changes, for convenience, in terms

of the original price and penetration, results in a slight approximation. A more exact result is obtained using the

average of the old and new price and penetration. 5 Park, "Prospects for cable...", p. 140. 6 for a discussion of the effect of demand elasticity on maximum

rates permitted by a regulatory authority, see Comaner and Mitchell, "The costs of Planning: The Fcc and cable Television: How, then would cable systems' profits be affected by a 16.5%

copyright payment and a concommitant rise in subscriber rates?

Revenues would be unchanged, while operating costs would increase

sharply by the amount of the copyright payments.

There would

be some small offsetting changes in other incremental costs,

resulting from the saving achieved by not serving the subscribers who

do not purchase service at the higher price.

For typical systems,

there are rather small costs of installing additional drop lines,

additional maintenance and billing expenses and slightly higher

taxes and dues related to numbers of subscribers.

In consequence, the net effect of allowing higher subscriber

rates in conjunction with 16.5% copyright fee payments would be to

reduce rates of return to nearly the same levels as would be

achieved by holding subscriber rates unchanged with the same 16.5%

copyright fees.

In addition, penetration would be lower, providing

a narrower base for future leased-channel services capable of

generating additional payments from cable systems to program suppliers.

we remind the reader that the discussion in the preceeding

several paragraphs assumed a degree of upward price adjustment which

has not been observed.

In the remainder of this study we adhere

to a fixed monthly price of $5.00 ] for maximum cable broadcast

service allowed by the FCC rules. 8/

An analysis of the profitability of systems under the alternative

assumption of higher rates and consequently reduced penetration

would yield approximately the same findings.

7 Plus $1.00 for second television sets in 20% of households. 8/ One other reminder may be in order. Since we are considering all

prices and costs in 1972 terms, increases in the monthly subscription rate at about the rate of increase of consumer prices generally will not contradict our observation that real subscription rates cannot be adjusted.


To summarize the profitability of the typical cable systems

of this study we will calculate the (pre-tax) financial rate of

return on total capital invested in each system.

The financial

(or internal) rate of returng/is the single comprehensive measure

of investment in a cable system.

Unlike ratio measures for a

particular year (e.g. net revenues divided by total capital) it

correctly recognizes the opportunity cost of front-end financing,

i.e. that several years are required before systems achieve full

penetration, during which time invested funds are needed.


the financial rate of return permits us to compare the profitabil

ity of funds invested in CATV systems with other types of invest

ments, and thus the likelihood of cable systems being constructed.

The rate of return required to induce investment in a cable

system will depend on the proportion of total capital which can be

obtained through debt instruments and the associated borrowing

rates, and the minimum return demanded by equity investors.


cause the cable industry more closely resembles a high-risk growth

industry than a public utility, at least at the present time, both

lenders and investors demand higher rates of return than for

seasoned investments.

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The internal rate of return is that discount rate which equates

the present value of revenues and costs over the lifetime of the system. For further discussion, see Comanor and Mitchell, "Cable Television and the Impact of Regulation," p. 184.

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