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Exclusivity. In its 1972 rulemaking, the FCC provided exclusivity protection to local stations in the top 100 markets by requiring that cable systems black out imported signals when they contain programs which are also shown by local stations in a specified period. In order to allow for the effect of this exclusivity protection upon cable penetration, Mitchell reduces the number of imported signals by a proportion which purportedly reflects the percentage of time which the signals will be blacked out. Unfortunately, this calculation is based upon only the most
19 scanty evidence assembled by Park. More importantly, there is no evidence that penetration will respond proportionately to reductions in the time independent signals are available. Thus, we do not attempt to replicate Mitchell's conjecture, but instead allow for the importation of two additional independent "standby" signals by building in six additional microwave hops (for importing the two signals) to our capital costs.
The calculation of the necessary operating costs of cable systems is far from a simple matter. Comanor-Mitchell provide a very detailed breakdown of all operating costs of systems which they believe to be typical, but these data are not fitted by standard statistical techniques to the operating performance of extant systems. Rather, they are judgments derived by the authors after consultation with their clients and others in the industry. Not surprisingly, they have been viewed by some critics as rather high, but there is only scant evidence in published financial reports with which to compare them.
An important source of the apparent economies of scale in Comanor-Mitchell lies in the assumption that all cable systems with more than 3, 500 subscribers will undertake the same origination expenses. This origination activity contributes $43,000 per year to operating costs
19R. E. Park, The Exclusivity Provisions of the Federal Communications Commission's Cable
Television Regulations, The Rand Corporation, R-1057-FF/MF, June 1972.
and $38,000 to capital costs for each system. Thus, for a 10,000 subscriber system, origination alone contributes nearly $5 per subscriber per year to total costs, but for a 25,000 subscriber system, the additional cost is only $2 per subscriber.
A review of the financial statements of five major M.S.O.'s in the past 3 years reveals that C-M have undoubtedly overestimated the economics of large size inherent in cable system operation. Table C-4 summarizes the performance of these M.S.O.'s and Table C-5 provides a comparison of each company's operating costs with the estimates which derive from the C-M cost parameters for systems of the same subscriber penetration, average size, and population density. It is quite clear that C-M provides a reasonable estimate only at an average size of 10,000 subscribers, overestimating costs for smaller systems and underestimating costs for larger systems. Since we are forced to rely upon the C-M operating cost data for our simulations in Section E, below, we present results only for a typical 10,000 subscriber system. Any other results based upon C-M cost parameters would be seriously biased.
5. Capital Costs
Since cable television is an extremely capital-intensive activity, Mitchell's assumptions about capital expenditures are crucial to his rate of return calculations. There are four major reasons why his estimates of capital expenditures lead to a downward bias in calculated profitability:
He assumes that underground cable percentages are far above actual and prospective underground percentages in the most dense markets.
American Stock Exchange Listing Application No. 8797, October 16, 1970.
He assumes that the entire plant is built at the beginning of the first year.
He fails to account for a less expensive method of
He asumes that the entire plant is rebuilt in each generation even though some components of capital expenditure may never be replicated after initial construction.
We shall take issue explicitly with the first two of these assumptions, citing data collected from middle-market systems either in operation or under construction at the present time. In addition, we shall cite a recent Rand study of the prospects for cable in the Dayton-Miami Valley
20 area and the projected temporal pattern of construction for this system. The third and fourth items will be discussed, but we do not alter the assumptions made by Mitchell in these respects in our calculations in Section E, thus again biasing our results downward.
Underground Construction. Mitchell's assumptions about the extent of underground construction are unrealistic. He predicts that the average percentage of underground construction will vary by market and by proximity to the middle of the market. A tabulation of these percentages appears as Table C-6.
20L. L. Johnson, et al., op. cit.