Telecommunications reform: cities lose power

Feb 1st, 1996

STEPHEN N. BROWN

When the U.S. Congress completes its deliberations on telecommunications reform legislation, the final bill sent to President Clinton will be a collection of compromises designed to avoid the president`s veto.

Thirty-five separate issues were reconciled in December. The most intractable ones were price deregulation of the cable-TV industry, the entry of regional Bell holding companies into the long-distance market, the media concentration issue--setting the maximum overall percentage of market audience covered by radios stations, television stations and newspapers owned by one company--and the percentage of foreign ownership allowed in the U.S. communications industry. When compromise pervades legislation, there is rarely a clear winner, but there is often a clear loser. City governments have lost more ground than any other private or public institution while state institutions such as utility commissions fared well.

Cable deregulation and entry in the long-distance market affect the continuing development of mass markets that use fiber cable and auxiliary components. But the power of cities and state regulators is important, too. The four issues are intertwined. Deregulation of the cable industry affects its construction schedules and its rate of purchases from suppliers. The entry of the regional Bell holding companies into the long-distance market affects the time and money they will devote to developing local video dial-tone markets and fiber-based switched interactive markets. The cities have the power to tax the services provided by both industries, and state utility commissions retain substantial influence.

Overview

In a surprise victory for the states, the final version of telecommunications reform omitted any reference to a federal ban on so-called rate-of-return regulation. For years, state regulation was directed at a company`s profit level. If profits were too high, state regulators ordered a price reduction. If profits were too low, prices rose. The regional Bell holding companies have long supported an alternative form of regulation, so-called price caps, where prices remain relatively unchanged over a long period of time regardless of the company`s profit level. At the insistence of the companies, many states adopted price-cap regulation, but the companies wanted an outright nationwide ban on rate-of-return regulation. After intense lobbying by the National Association of Utility Commissioners, Congress agreed that a ban was not needed. Ironically, it was the Bells` success at the state level that prompted the state`s victory. According to a spokesman for Sen. Ernest Hollings (D-SC), the states were already on the price-cap road and federal intervention was not justified.

Cable-TV rates will continue to be regulated through 1999 and then terminated forever. The Clinton Administration believed that immediate price deregulation would have been a mistake because incumbent cable companies face no competition that would deter them from raising prices. Without competition, consumers supposedly faced a dilemma: Pay higher prices or cancel the service. The consumer`s dilemma was an opportunity for the cable industry. It needs up-front capital to build and expand its coaxial-cable and fiber networks to meet the expected competition from the telephone companies` video dial-tone networks. The telephone companies viewed cable`s price deregulation as a thinly disguised "head-start" that would make it more difficult for video dial-tone service to capture market share. Extending price regulation for a "one-time-only" three-year span apparently was a satisfactory compromise for the telephone and cable companies and for consumers. In addition, the regional Bell holding companies are not guaranteed entry into the long-distance market: Before offering long-distance service, they have to pass certain tests demonstrating that their local telephone markets are governed by competition in action rather than competition in principle. Local markets will continue to be a center of telecommunications politics, so there must be some truth to the saying that "all politics is local."

The legislation proves the point because reform reduces local government`s power over the cable and telephone industries. The power had derived from a city`s authority to issue a franchise. However, the legislation prohibits cities from requiring a cable company to obtain an additional franchise to provide local telephone service. Nor can cities extend a franchise requirement to telephone companies offering video services over telephone lines. The issue was decided in 1994 by federal courts when the cable industry challenged Bell Atlantic`s plans to offer dial-tone service. Thus, the cities have to abandon franchising as the method to capitalize on the growing markets in video and local telephone services.

The only exception to this may be the competitive access provider, which offers itself as a third-party alternative to the incumbent telephone and cable companies. Its third-party status may isolate the competitive access provider. For example, incumbent cable and telephone companies do not need a second franchise to cross over to each other`s market. If the provider offers video and voice service over its network, the law gives no assurance that it would be liable for one franchise instead of two. However, this will not be a long-term problem. Competitive access providers generally position themselves to be purchased under favorable conditions by the incumbent cable or telephone company. Competitive access providers do not give cities an opportunity to resurrect the once-pervasive power of the franchise.

Reversal of fortune

Two things caused local governments` reversal of fortune. There was a broad perception that local officials were suppressing cable competition in local markets--for instance, the cable company`s exclusive franchise amounted to a monopoly, which cities liked because they shared the benefits. Thomas W. Hazlett, a professor at the University of California and a long-time critic of the cable industry, wrote: "The difficulties faced by competitive entrants [into the cable business] arise not so much from natural monopoly conditions as from the ability of incumbent suppliers to transfer monopoly rents [prices and revenues higher than what are expected in a competitive market] to municipal officials so as to protect their exclusive franchise." This sentiment also appeared in the 1992 Cable Act that directed local officials not to "unreasonably refuse" a competitor`s request for a franchise.

Another reason for local government`s waning influence is the cable industry`s need to establish interconnected networks stretching beyond local areas. Recently, several state cable associations, including Florida, Georgia, Illinois, Michigan, New Jersey, Pennsylvania and Tennessee, openly considered interconnecting cabling systems through fiber and microwave links. Today, most of the interconnections are being established under the auspices of the large multiple system operators. In fact, an interconnected cable network not bound by local jurisdiction is the basis for local competition between the telephone and cabling industries. With federal legislation promoting local competition, the cities could not maintain their influence. The cable-TV bidding wars of the 1980s--when the industry promised everything to city councils and took on substantial public service obligations to win franchises--are gone forever, as are the revenue streams unless the cities adapt.

Chicago is adapting. In November, the city administration`s finance committee proposed a 7% tax on "any paid television programming, whether transmitted by wire, cable, fiber optics, laser, microwave, radio, satellite or similar means." The tax applies to amusement and already extends to such activities as baseball games, movies, symphonies and live theater. The cable and satellite-broadcasting industries oppose the tax, as does the Illinois Retail Merchants Association. Dave Vite, president of the association, said, "Retailers are very concerned that the city of Chicago has a plan to tax in-home entertainment sources beyond cable TV and the effect [that] this increased cost will have on retail sales of electronics equipment." Several states have proposed similar video taxes.

If Chicago were successful, other cities would follow. Therefore, Chicago Cable TV, owned by Tele-Communications Inc., and Prime Cable TV threatened to sue the city. They suggested the tax was not constitutional and was a way to avoid the federal statutory limit of a 5% ceiling on franchise fees. The companies argue that the tax would not be fair unless it were applied to newspapers, magazines and broadcast TV. The amusement tax represents a shift in the tactics of municipalities. Like their private sector counterparts, cities want their "fair" share of benefits from the expanding video market. Cities were the original seed ground for wired video service. They provided the community in the phrase Community Access Television, whose acronym, CATV, originally described the cable business. But the franchise fee is capturing a declining share of the video market; therefore, a tax makes perfect sense for cities. It is the best tool they have, now that the franchise authority is weakened.

The cities still have one card to play in the local competition game: direct ownership of a cable and telephone system. Palo Alto, CA, may acquire the ownership by assisting the Cable Co-op, a subscriber-owned cable company serving the city and nearby communities. The cooperative may sell its business to the highest bidder, but the company has also asked the city if it would be willing to invest $5 million to $10 million with the cooperative so it can upgrade its system with fiber optics. Palo Alto City Councilman Ron Andersen responded to Cable Co-op`s inquiry: "We are certainly interested in exploring the city owning a fiber-optic system. ...We want to make certain we have as many competing forces in this city as possible." Palo Alto`s plans may draw opposition from Tele-Communications Inc., which is considered a likely buyer of Cable Co-op if it sells the business. Regardless of the outcome in Chicago and Palo Alto, their actions make it clear that cities will not be bystanders in local telecommunications markets.

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