Our results demonstrate that large and intermediate size cable systems in the top 100 markets could expect to earn high rates of return even after payment of copyright fees. These conclusions differ sharply with the Mitchell study which concluded that no system in the top 100 markets could realize a rate of return in excess of its cost of capital, even with no copyright fee payments. An alternative interpretation of our results is to specify the extent to which prospective cable profits exceed a rate of return sufficient to attract new capital. If we posit this rate of return to be 15 percent, our results show that the excess return available for typical systems, expressed as a percentage of revenues, is as follows: Percentage of revenues available after allowance for 15 percent return Top 50 markets__ Market 101 plus.. Percent Thus, these systems could afford to pay more than 13 percent of their revenues for copyright fees, and still earn sufficient profits to attract the capital required to sustain their growth. The above results reflect certain reasonable assumptions regarding the growth rate of revenues, system location, size, and so forth. As Section E of the report shows, somewhat higher and lower values may be obtained via other sets of assumptions, but the general conclusions remain the same-the systems are on the whole far from unprofitable. Our conclusions are different from Mitchell's for two major reasons. First, we employ cable owners' predictions of future penetration which are substantially higher than those used by Mitchell. And second, our estimates of revenues per subscriber are higher, reflecting current reality and anticipations revealed by cable owners in their sales of current systems. In short, our assumptions, which are based upon rather solid evidence from the industry itself, lead us to more cheering conclusions regarding the industry's future. Our calculations suggest that cable owners should prosper and that their profits should be sufficiently above the level required by investors that they should not find copyright fees an impediment to future growth. Moreover, these results are consistent with a very significant alternative source of data-the valuations of cable television systems sold in recent years, and the expected profitability they reveal. ROBERT W. CRANDALL Robert W. Crandall is currently Associate Professor of Economics at the Massachusetts Institute of Technology where he has taught since 1966. His principal research interests are in the fields of industrial organization, antitrust policy, and public regulation, and he has published a number of articles on the economics of television broadcasting, vertical integration in the United States automobile industry, and the effects of subsidies upon low-skill labor demand. While teaching at M.I.T., Professor Crandall has served as a consultant to the Antitrust Division of the United States Department of Justice, the Federal Trade Commission, the Urban Institute, and several private concerns. Prior to joining the faculty at M.I.T., he was a Johnson Research Fellow at the Brookings Institution where he pursued research on his doctoral dissertation. He received an A.B. degree from the University of Cincinnati in 1962, an M.A. in economics from Northwestern University in 1965, and a Ph.D. in economics from Northwestern University in 1968. LIONEL L. FRAY Mr. Fray is a Senior Executive Consultant at Temple, Barker & Sloane, Inc., a management and economic counseling firm, where he is active in business and financial planning, with emphasis in the communications industry. Prior to joining TBS, Mr. Fray was Vice President of Harbridge House where he headed a group of consultants concerned with business planning and financial analysis. Mr. Fray's experience in the cable television field began in 1966 when he undertook an assignment for CBS. Since then, he has directed a planning study for the Cable Television Bureau of the FCC; prepared evaluations of proposed business plans for a number of cable system operators, including Time, Inc.; and directed economic studies of the cable industry for a group of major film production companies. Mr. Fray received S.B. and S.M. degrees in electrical engineering from the Massachusetts Institute of Technology, and the M.B.A. degree from the Harvard Graduate School of Business Administration. The Profitability of Robert W. Crandall Associate Professor M.I.T. April 25, 1973 Lionel L. Fray Senior Executive Consultant T.B.S. The Rate of Growth of Profits Expected by Cable Owners Results of Calculations D. E. F. Conclusions Appendix Detailed Calculations of Rates of Return A. INTRODUCTION AND SUMMARY CONCLUSIONS 1 During the past year, following the implementation of new regulatory policy via the Federal Communications Commission's Cable 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 to attract the capital investment needed for substantial growth. The passage of such legislation would further help meet the FCC's regulatory objective: "to get cable moving..."3 ,,2 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"5 because of poor prospective profitability and Federal Communications Commission--Cable Television Service; Cable Television Relay Service, 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. p. 43. 5Ibid.. 6Ibid., p. 43. 7 an "update" of a previous work which came to similarly gloomy conclusions in 1970 and with which we took issue. 8 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. 2. They project revenues per subscriber of $64.60 per year ad infinitum despite many indications that revenues will increase over time; and 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. 7William S. Comanor and Bridger M. Mitchell, The Economic Consequences of the Proposed FCC Regulations on the CATV Industry, Dec. 7, 1970. 8Lionel L. Fray and John D. Wells, Comments on the National Cable Television Association's Independent Economic Study, Feb. 8, 1971. |