When Capitalists Go Bad: Some Reflections on Cable Franchising, “Red-lining,” and “Level Playing Fields”

by on December 28, 2004

Like a lot of other Americans, I once had a big beef with the U.S. cable industry. Limited channel capacity and poor quality service were the primary reasons for my discontent. I remember the cable system my family subscribed to in the mid-1980s. It was like a Third World government operation at times. And I think we only had about 20 channels.

Jokes about “the cable guy” were common for a long time, of course. This made it easy for DBS providers like DirecTV and EchoStar to come in and pick off a lot of customers like me throughout the 1990s. By 1996, I had two satellite dishes on my roof and three DirecTV set-top boxes throughout my house. I thought I’d never talk to “the cable guy” again.

And then one day the industry woke up and started taking the competition and their own service quality problems seriously. The results were remarkable. By all accounts, this industry has made an amazing rebound. The quality and quantity of service provided has improved markedly. The investment the industry made to upgrade their systems in the late 1990s totaled over $90 billion (and counting). The industry basically put a match under their old house, burned that shack to the ground, and then built a beautiful new palace in its place. The digital plant they have in the ground now is a state-of-the-art, high-capacity beast that has the satellite and telephone companies wondering how the hell they are going to compete.

As a result, cable won a lot of old customers back, including me. When I moved into a new home in the Virginia suburbs two years ago, just for kicks, I decided to pull up the local cable company’s web page and take a look at what they had to offer. Now, I am a VERY demanding video customer, and didn’t think cable would be able to stack up to DBS. I was shocked to find out how wrong I was. Cable offered just about every channel that I wanted (including many HDTV stations), plus they could bundle in the fastest broadband on the market at a pretty good price. On top of that, VoIP telephone service would soon be part of the bundle too. In other words, voice, video, and data connectivity all in one bundled bill. That sounded great to me, but I feared what would happen when I called up the cable company and tried to get an installer out to my house. How long would that take? How badly would they botch my beloved HDTV connections? How many times would I have to call them back to get them to do it all right? Well, I’m happy to report that everything was done in a few hours and done quite professionally. And my entire experience with the cable installers and customer service representatives has been a breeze from the start. As a result, I boxed up all my satellite hardware and sold it to an old friend down the road. I was back in the cable camp and am still very happy today (especially since the HDTV offerings continue to steadily increase).

A Tale of Two Market Responses

I tell you this long-winded story for a reason: I think the cable industry provides an admirable example of how an industry should respond to new marketplace challenges. Cable companies rose to the challenge before them by improving their business model and finding new and better ways to respond to the very serious threat posed by DBS operators.

Just a few weeks ago, however, I heard my friends in the cable industry say something that has me very nervous again.

National Cable & Telecommunications (NCTA) President & CEO Robert Sachs delivered a speech to the Washington Metropolitan Cable Club calling on cable operators to fight telephone company plans to circumvent local franchising requirements “to gain unfair competitive advantage by red-lining.” Here are some highlights of his speech taken from the NCTA website:

* “Cable operators must be vigilant about plans by phone companies to circumvent the local franchising process to gain unfair competitive advantage by red-lining or any other means.”

* “Serving only high and middle income neighborhoods in a community is both discriminatory and anti-competitive.” [Sachs went on to specifically accuse SBC Communications of “red-lining” by serving “medium-” to “high-value” neighborhoods.]

* “My point simply is that people need to look hard at the assumptions underlying the regional Bells’ fiber deployment plans, and determine for themselves whether these plans are realistic. Are construction costs reasonable? Are programming strategies? Are projected penetration levels?”

OK, now let’s step back and think seriously about what Mr. Sachs is saying here.

“Red-lining” in Perspective, or Understanding the Nature of Networks

It goes without saying that the cable guys are more than a little nervous about the new competition they face from the telephone giants. After all, DBS was one thing, but the Baby Bells are quite another. The Bells have a well-established wireline infrastructure, healthy cash flow (at least for now), and plenty of local connections with the same policy makers cable has to deal with. Moreover, the Bells are more than a little irritated about cable eating into their traditional wireline phone business margins by offering VoIP. Thus, the Bells are rising to the challenge and aggressively deploying advanced DSL and fiber services to many neighborhoods.

Needless to say, as cable already knows, upgrading a massive wireline infrastructure is a formidable task. It takes lots of money and time to essentially rebuild an empire of wires after the old system has been rendered obsolete. Just think about how difficult it would be to wire your own neighborhood and then start multiplying that job by every neighborhood you’ve ever driven through in your state. That’s the task the Bells face as they seek to upgrade their network to compete with cable. With cable’s head start, it will be difficult for the Bells to play catch-up, especially with wireless options increasingly nipping at their heels. So, the Bells are slowly pushing their networks out block-by-block, neighborhood-by-neighborhood to offer better service.

Now, I don’t have any inside knowledge regarding which neighborhoods that the Bells are targeting first, but I would suspect that they indeed might be going after “medium-” to “high-value” neighborhoods first. Oh my gosh, my golly gee! That’s red-lining! The Bells are bunch of redneck racists who hate the poor! Right?

Wrong. The Bells are doing the only thing they can do: trying to attract whatever customers they can at this point who are willing to pay the price for high-speed access. This stuff isn’t free, after all. The Bells have to make money here somewhere or else the build-out will ultimately fail. So they have to find paying customers RIGHT AWAY. Where will they likely find them? In “medium-” to “high-value” neighborhoods, of course.

So, we return to Mr. Sachs’ accusation that “Serving only high and middle income neighborhoods in a community is both discriminatory and anti-competitive.” That is just nonsense. It’s all they can do at this point, but the Bells want to serve every neighborhood they possibly can in the long-run. The value of their networks (and all networks for that matter) is greatly dependent upon attracting and retaining as many customers as possible. Doing so also helps push down average costs. But just as the first indoor flush toilets probably appeared in wealthy, urban neighborhoods before they popped up in homes throughout rural America or less affluent neighborhoods, so too with many of these broadband services.

Mr. Sachs and the cable industry can call this “red-lining” but they know all too well that this is the way every network that has ever existed has unfolded, including their own. Apparently, therefore, his motivation for saying this is to get regulators to impose “build-out” mandates on telephone companies similar to those some cable companies have faced as part of their franchising arrangements. We turn to that question next.

When You Can’t Beat ‘Em, Join ‘Em, or, Local Franchising for All!

Again, Mr. Sachs’ concluded his speech by noting: “My point simply is that people need to look hard at the assumptions underlying the regional Bells’ fiber deployment plans, and determine for themselves whether these plans are realistic. Are construction costs reasonable? Are programming strategies? Are projected penetration levels?”

Hmmm… Exactly which “people” is it that Mr. Sachs believes “need to look hard” at these things? Could it be local regulators?!? And, assuming that is what he’s really getting at here, why in the world would he want local officials to be sitting in judgment of “the assumptions underlying the regional Bells’ fiber deployment plans, and determine for themselves whether these plans are realistic”?

And regarding the questions about: (1) “Are construction costs reasonable?” (2) “Are programming strategies?” (3) “Are projected penetration levels?” Answer: (1) Who Cares (2) Who Cares (3) Who Cares.

Frankly, this is none of government’s business. Unless cable would like to see a bunch of intrusive mini-industrial policies for broadband, this is a disastrous idea to be putting forward. (And why is the head of the cable trade assocation so worried about program strategies, construction costs, and the general quality of his leading competitor’s product? Why would he want the government to take steps to improve these things in the first place!)

Moreover, all this could certainly come back to bite the industry in the ass at some point. Perhaps cable believes that they’ve already (quite literally) paid their dues and now it’s time the Bells to give up a pound of flesh too. But think about that for a minute. If all the same stupid franchising rules and fees were forced on the Bells too, it very well could force them out of the business of providing broadband to many neighborhoods. And then it would just be cable left alone facing the regulators again. The regulators are not going to roll over an play dead at that point. They’ll still want blood.

If, on the other hand, Mr. Sachs is just saying that the “people” who should be scrutinizing the Bells’ deployment activities are financial analysts and market watchers, that’s fine of course. But I think it’s clear that he thinks there should be some regulatory oversight of this process too to help “level the playing field.”

Concluding Thoughts on “Level Playing Field” Problems in Public Policy

Now, at this point, I know a few of you out there right now are saying: “Hey, you idiot, this is just the way cable always plays ball. They’re just greedy bastards once again trying to use the law to protect their turf.” If you believe that, you are wrong. Very wrong.

At least over the past 15 years that I have been monitoring communications markets and policy developments, I have always been consistently impressed with the cable industry’s restraint when it comes to trying to wield the club of Big Government against competitors. Compared to so many other sectors out there (like broadcasting, for example), cable has risen to the competition by getting their own act straight first and finding creative ways to satisfy consumer demand. The industry’s trade association, the NCTA, has become a rarity in Washington too. They spend 99 percent of their time fighting to keep government out of the way. By comparison, the broadcast industry’s trade association (the National Association of Broadcasters), sends armies of lobbyists up to Capitol Hill to line up in front of congressional doors and ask for favors and special treatment.

That’s what makes this current episode so troubling. It’s unlike NCTA or even Mr. Sachs to be suggesting that the best response to this new competitive threat might be regulatory in character. I know they are genuinely and rightly concerned about the proverbial level playing field problem here. That is, they have gotten screwed over the years with some really stupid franchising requirements and fees. But, the solution to level playing field problems is simple: deregulate down, don’t regulate up. That is, don’t try to put everyone on equal legal footing by imposing all the old, inefficient regulations and taxes on new technology or competitors. Instead, fight together to reduce these burdens or eliminate them altogether.

Consider how this same sort of “level playing field” problem has done great damage in the debate over Internet taxation. Traditional “bricks-and-mortar” retailers have foolishly joined with the Dark Side of the Force (i.e., state and local tax officials) in calling for sales taxes to be imposed on e-commerce vendors. As a result, the retailers have missed the best chance they ever had to join forces with a formidable new ally (Net retailers) in a unified fight against excessive sales taxes in general. Who knows, such an alliance might have been able to abolish sales taxes altogether! Instead, the old retailers basically said to themselves: “Hey, we’ve already been screwed many times over, and there’s little chance we’ll ever get rid of these nasty taxes, so let’s just advocate rolling them onto the new kid in town since he won’t be able to pay them anyway and he will likely get driven out of business as a result.” What a shame. A great opportunity has been missed because the “playing field” will be “leveled” by regulating (or taxing) up, instead of down. But, the funny thing is, if the old retailers and state and local tax officials ultimately succeed in killing many e-commerce retailers with heavy sales tax burdens, where will that leave the old retailers? Answer: Still stuck with significant sales tax burdens; maybe even greater burdens than they face today.

For the sake of the cable industry, I hope this same scenario doesn’t play out in the debate between cable and the Bells over local franchising requirements. When you dance with the Devil, there’s hell to pay in the long run. I hope the cable industry considers that before inviting the government in to whack the Bells over the head with burdensome “build out” requirements or franchising fees.

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