Federal Communications Commission

BEFORE THE FEDERAL COMMUNICATIONS COMMISSION

WASHINGTON, D.C. 20554

In the Matter of ) ) Annual Assessment of the Status of ) MB Docket No. 02-145 Competition in the Market for the ) Delivery of Video Programming )

COMMENTS OF AT&T CORP.

Mark C. Rosenblum WILLKIE FARR & GALLAGHER Stephen C. Garavito Three Lafayette Centre AT&T Corp. 1155 21st Street, N.W. 295 N. Maple Avenue Suite 600 Room 1131M1 Washington, D.C. 20036-3384 Basking Ridge, NJ 07920 (202) 328-8000 (908) 221-8100

Douglas Garrett James H. Bolin, Jr. AT&T Broadband 188 Inverness Drive West Englewood, CO 80112 (303) 858-3510

July 29, 2002

TABLE OF CONTENTS

PAGE

I. INTRODUCTION AND SUMMARY ...... 1

II. THE VIDEO PROGRAMMING DISTRIBUTION MARKETPLACE CONTINUES TO EXPERIENCE ROBUST COMPETITION...... 4

A. The Vigorous Growth and Ubiquitous Availability of DBS Providers, Combined with Their Ability to Easily Expand Output, Is Sufficient to Constrain Any Attempt by Cable Operators to Exercise Market Power...... 4

B. Broadband Service Providers Continue to Compete Aggressively Against Cable Operators...... 8

C. Broadcasters Are Significant Cable Competitors in the Video Programming Distribution and Acquisition Markets, and the Commission Should Formally Incorporate Broadcasters into Its Market Share and Other Analyses in This Proceeding...... 10

III. CLUSTERING IS A PRO-CONSUMER STRATEGY THAT HAS BEEN ADOPTED BY CABLE INCUMBENTS AND BROADBAND SERVICE PROVIDERS ALIKE...... 14

A. Clustering Creates Economies of Scale and Scope That Have Accelerated the Rollout of New and Advanced Services in AT&T’s Cable Systems...... 14

B. Clustering Has Also Facilitated the Creation of More Local and Regional Program Services...... 17

C. Cable Operators Are Not Using Their Clustered Systems to Act Anticompetitively in the Regional Programming Market...... 18

D. Broadband Service Providers’ Clustering Strategies Demonstrate That Clustering Is a Normal Competitive Response in the MVPD Marketplace, Especially for Distribution Offering Multiple Advanced Services...... 20

IV. THE COMMISSION’S PRIOR FINDINGS CONCERNING THE CURRENT LEVEL OF VERTICAL INTEGRATION IN THE CABLE INDUSTRY ARE OVERSTATED...... 21

V. CONCLUSION...... 24

BEFORE THE FEDERAL COMMUNICATIONS COMMISSION

WASHINGTON, D.C. 20554

In the Matter of ) ) Annual Assessment of the Status of ) MB Docket No. 02-145 Competition in the Market for the ) Delivery of Video Programming )

COMMENTS OF AT&T CORP.

AT&T Corp. (“AT&T”), by its attorneys, hereby files its comments in response to the

Commission’s Notice of Inquiry (“Notice”) in the above-captioned proceeding.1

I. INTRODUCTION AND SUMMARY

In its first video competition report, the Commission recognized that “the 1992 Cable

Act’s regulatory scheme serves as a transitional mechanism until competition develops and consumers have adequate multichannel video programming alternatives.”2 Yet, nine years since the Commission issued that first report, the Commission continues to reaffirm those

“transitional” mechanisms notwithstanding that the current video programming distribution market is vigorously competitive. In particular:

· Competition from DBS. The Commission must accept the D.C. Circuit’s directive in Time Warner II that it consider more than static market shares in its

1 In re Annual Assessment of the Status of Competition in the Market for the Delivery of Video Programming, Notice of Inquiry, MB Docket No. 02-145, FCC 02-178 (rel. June 14, 2002) (“Notice”).

2 1994 Video Competition Report, 9 FCC Rcd. 7442 ¶ 6 (1994).

158774.10

assessment of competition in the video distribution marketplace. Time Warner II requires a more dynamic analysis, which focuses on the “availability” of competitive alternatives to cable and rigorously assesses how those alternatives constrain cable operators’ ability to exercise market power. Although the Commission has recognized that DBS’s market share is significant and increasing -- DIRECTV and EchoStar now serve almost 19 million customers, or 20.4% of the MVPD market -- it has yet to acknowledge, as the court in Time Warner II requires, that DBS’s ubiquitous nationwide availability and its ability to easily expand output effectively prevent cable operators from exercising market power.

· Competition from Broadband Service Providers. In addition, cable operators face increased competition from broadband service providers (“BSPs”) who continue to experience substantial growth. Significantly, these BSPs have begun to develop strong regional clusters. Over six million existing cable customers have a BSP franchised to compete in their service area, meaning that such customers have or soon will have a fourth MVPD alternative in their market.

· Competition from Broadcasters. Broadcasters are significant competitors in the video programming distribution and acquisition markets. AT&T commends the Commission for broadening the relevant market under review to encompass all video programming, including broadcast programming, rather than simply multichannel video programming delivered by MVPDs. Once broadcasters are properly included in the analysis, consumers have many more video programming distributors from which to choose. To ensure that the competitive impact of broadcasters is accurately assessed in the Commission’s annual report going forward, AT&T suggests that the Commission formally incorporate broadcasters into its market share and other analyses in this proceeding, such as by augmenting the denominator of its market share formula (i.e., total MVPD subscribers) by adding the number of consumers who “subscribe” solely to broadcast services (currently approximately 13.3 million consumers).

In these circumstances, the Commission should plainly acknowledge that competitive market forces are driving the video distribution market today, and should take the increasingly dynamic, highly competitive nature of the market into account in making policy decisions regarding future regulation of this industry.

The widespread use of clustering by cable incumbents and BSPs also reflects the competitive nature of the video marketplace. As the Commission and other governmental agencies have acknowledged, clustering provides substantial consumer benefits, including the accelerated rollout of new and advanced services over the cable plant and the development and

2 158774.10 launch of local and regional programming services. Contrary to the claims of cable competitors, cable operators are not using their clustered systems to act anticompetitively in the regional programming market. As shown below, marketplace evidence suggests just the opposite. In fact, the widespread use of local and regional clusters by BSPs demonstrates that clustering is a natural competitive response to the evolving advanced services market.

Finally, the Commission should reassess its conclusions about the level of vertical integration in the cable industry. AT&T believes that the Commission’s prior conclusions are flawed in at least two respects. First, the conclusion that, notwithstanding AT&T’s spin-off of

Liberty, there was no reduction in the level of vertical integration in the industry last year because Liberty owns several small cable systems in Puerto Rico, is untenable. A more realistic assessment is that the spin-off of Liberty by AT&T constituted a significant reduction in the actual level of vertical integration in the industry. Second, if Liberty’s programming interests are not counted, according to the Commission’s own data, the level of vertical integration in the cable industry is around 22%, not 31% as the Commission previously stated.

3 158774.10

II. THE VIDEO PROGRAMMING DISTRIBUTION MARKETPLACE CONTINUES TO EXPERIENCE ROBUST COMPETITION.

The number of DBS subscribers has grown to 18.9 million customers as of June 1, 2002.3

In just the past two years, DBS subscribership has increased over 47% and is well on its way to meeting analysts’ projections that it will end 2002 with approximately 20 million subscribers.4

In the second quarter of 2002 alone, DIRECTV added 202,000 subscribers, a 53% improvement over the second quarter of 2001, and now has 10.74 million subscribers.5 For the first quarter of

2002, EchoStar’s DISH Network added 335,000 net new subscribers, a 25% increase over first quarter 2001.6 Much of this increase has been fueled by aggressive marketing campaigns that

3 See Kagan World Media, Media Index Database, Kagan Media Money, June 18, 2002, at 8 (“Kagan Media Index”).

4 See Karim Zia et al., Deutsche Bank Securities, Inc., DBS Signals: Undergoing a Renaissance of Growth at 18 (May 8, 2002) (“DBS Signals”) (predicting that there will be over 19.6 million DBS subscribers by the end of 2002); Josh Bernhoff et al., Forrester Research, Inc., How Cable TV Can Beat Satellite at 6 (April 2002) (predicting that DBS subscribers will total 20.1 million at the end of 2002).

5 See Press Release, Hughes Elecs. Corp., Hughes Second Quarter 2002 Results Driven By Strong DIRECTV U.S. Financial Performance (July 15, 2002), at http://www.hughes.com/ir/pr/02_07_15_earnings.xml.

6 See Press Release, Echostar, Echostar Reports First-Quarter 2002 Results (May 2, 2002), at http://www.corporate-ir.net/ireye/ir_site.zhtml?ticker=dish&script=410&layout=- 6&item_id=289521. As of March 2002, DISH Network reported subscribership of approximately 7.16 million. See id.

4 158774.10 tout special offerings not available on cable.7 While cable subscribership has also increased in recent years, these increases have been modest compared to DBS’s growth.8

DBS’s substantial growth has continued even after the cable industry’s broad deployment of digital video technology, cable Internet service, and other advanced offerings.9 Indeed, four out of five new multichannel video customers choose DBS over cable, and almost one-half of

7 See EchoStar Communications Corp., Dish Latino (describing EchoStar’s Dish Latino package as “the most complete Spanish language package available - anywhere - featuring: TV Azteca, now available exclusively on DISH Network”), available at http://www.dishnetwork.com/content/programming/packages/dish_latino/index.asp?viewby=1& packid=10092&sortby=1 (last visited July 22, 2002); Press Release, DIRECTV, Inc., DIRECTV “Glides” Into 2002 Mega March Madness With Clyde Drexler As Official Spokesman (Mar. 7, 2002) (describing DIRECTV’s NCAA basketball tournament package that is “not available on cable or any other source”), at http://www.directv.com/DTVAPP/aboutus/headline.jsp?id=03_07_2002A. See also Niraj Gupta, Solomon Smith Barney, Cable Reality Check at 7 (May 17, 2002) (explaining that “[c]able has historically been at a severe disadvantage to DBS providers, in that satellite providers . . . have enjoyed a powerful national retail presence, a national advertising platform, [and] a vastly superior product offering”).

8 See Karim Zia et al., Deutsche Bank Securities, Inc., Cable Signals: The Golden Era Faces a Crisis of Confidence at 8 (Apr. 1, 2002) (reporting that the highest rate of growth for any cable operator in 2001 was 1.6% while three cable operators actually lost customers). Indeed, for the past two years, “basic video subscriber growth [has not] kept pace with household formation in franchise areas, resulting in falling penetration and a loss of market share [for cable operators], most probably to DBS.” Raymond Lee Katz et al., Bear Stearns, Cable TV & Broadband: Show Me The Next Leg of Growth in Cable Television and Broadband, at 111 (May 2002).

9 DBS Signals, supra note 4, at i (“Despite the nearly ubiquitous availability of digital cable and cable modems, the DBS industry is sustaining strong subscriber gains while continuing to derive the majority of its growth from cable in the large urban/suburban markets.”); see Anthony N. Gikas & Mark N. Argento, US Bancorp, Broadband Cable System Primer at 58 (May 2002) (“Digital cable has 45% share of the digital video market with 15.5 million digital subscribers estimated at the end of 2001, compared to 54% market share for [DBS] and other satellite video service providers.”).

5 158774.10 existing DBS subscribers are former cable customers.10 This is unsurprising considering that

DIRECTV and EchoStar price their services “with the objective . . . to gain market share by luring away consumers from the leading cable providers.”11

The foregoing market share data actually understate the level of competition in the video distribution market. As the D.C. Circuit emphasized in its Time Warner II decision, any

“assessment of a real risk of anticompetitive behavior” must take account of the “availability” of competition and the extent to which that competition constrains a cable owner’s ability to exercise market power.12 The Commission has likewise observed that “the availability of an alternative MVPD outlet affords programmers access and consumers choice, and erodes cable’s

10 See NCTA Comments, filed in CS Dkt. No. 01-129, at 8 (Aug. 23, 2001) (“NCTA 2001 Video Competition Comments”); J.D. Power & Assocs., 2001 Syndicated Cable/Satellite TV Customer Satisfaction Study at 79 (Sept. 2001). See also DBS Signals, supra note 4, at 24 (noting that “the majority of new DBS subscribers are increasingly former cable subscribers”); Bernhoff et al., supra note 4, at 6 (“Nearly two-thirds of new satellite subscribers said that they had cable last year, and 22% report that they had digital cable before they switched to the dish.” (emphasis in original)); DIRECTV Comments, filed in CS Dkt. No. 01-129, at 11 (Aug. 3, 2001) (“According to internal subscriber data, roughly half of DIRECTV customers were cable subscribers at the time that they first subscribed to DIRECTV. Of these, the majority cancelled their cable subscription once they activated DIRECTV.”).

11 Declaration of Robert Willig, Consolidated Application of EchoStar Communications Corp., General Motors Corp., and Hughes Electronics Corp. for Authority To Transfer Control, filed in CS Docket No. 01-348 ¶ 10 (Dec. 3, 2001). According to the DBS operators, “the companies collect detailed data on cable pricing of many systems and, as necessary, adjust their pricing to remain competitive on a national basis.” Id.

12 Time Warner Entm’t Co. v. FCC, 240 F.3d 1126, 1133-34 (D.C. Cir 2001). The D.C. Circuit explained that “normally a company’s ability to exercise market power depends not only on its share of the market, but also on the elasticities of supply and demand, which in turn are determined by the availability of competition.” Id. at 1134.

6 158774.10 or an MSO’s market power irrespective of current market share.”13 As AT&T has previously explained, DBS providers have the essential characteristics of firms that constrain or eliminate the market power of a firm with a substantial market share, including: (1) unlimited capacity to increase the number of customers they serve; (2) the ability to rapidly expand output because of their national footprint; and (3) low marginal costs associated with serving additional customers.14

Although the Commission has recognized that DBS’s market share is significant and increasing, it has yet to acknowledge, as the court in Time Warner II requires, that DBS’s ubiquitous nationwide availability and its ability to easily expand output effectively prevent cable operators from exercising market power. For example, the Commission’s recent extension

13 In re Implementation of Section 11 of the Cable Television Consumer Protection and Competition Act of 1992, The Commission’s Cable Horizontal and Vertical Ownership Limits and Attribution Rules, Further Notice of Proposed Rulemaking, 16 FCC Rcd. 17312 ¶ 50 (2001) (“Cable Ownership FNPRM”). See also id. ¶ 60 (Commission recognizing that a dynamic analysis that uses measures of market power rather than market share for purposes of determining an appropriate horizontal ownership limit would: (1) “be more sophisticated than market share measures in that it would target directly the source of the potential harm: the cable industry’s control over programmers access to the home”; (2) “conform to the intent of Congress as expressed in the statute to prefer competition over regulation”; and (3) conform “with the opinion of the court in Time Warner.” Id.

14 See AT&T Comments, filed in CS Dkt. No. 01-129, at 11-15 (Aug. 3, 2001) (“AT&T 2001 Video Competition Comments”) (also noting that cable operators’ behavior reflects significant marketplace constraints imposed by DBS); NCTA 2001 Video Competition Comments at 13-17; AT&T Comments, filed in CS Dkt. No. 98-82, at 35-39 (Jan. 4, 2002) (applying the Time Warner II dynamic market power analysis with respect to the video programming marketplace). Cf. In re Motion of AT&T Corp. to Be Classified as a Non- Dominant Carrier, Order, 11 FCC Rcd. 3271 ¶¶ 58-59 (1995) (concluding AT&T lacked market power in the long distance telephony market because, inter alia, “AT&T’s competitors possess the ability to accommodate a substantial number of new customers on their networks with little or no investment immediately” (internal quotations omitted)).

7 158774.10 of the program access exclusivity prohibition was predicated on a static market share calculation and did not include the dynamic market power analysis required by Time Warner II.15

B. Broadband Service Providers Continue to Compete Aggressively Against Cable Operators.

BSPs are significant players in the video distribution market and have proven their ability to attract new customers with their state-of-the-art networks and innovative service bundles.16 In just the last two years, BSPs have increased their customer base by almost 42%, and currently serve approximately 1.2 million subscribers.17 This growth has occurred in all regions of the country. For example:

· RCN, which provides service primarily in Boston, New York, and Philadelphia, reported that as of April 2002 it had over one million connections, approximately half a million of which are video customers.18

· Knology, a BSP in the Southeast, increased its subscribership by 16% between the first quarters of 2001 and 2002, from 105,859 to 122,823 homes.19

15 See In re Implementation of the Cable Television Consumer Protection and Competition Act of 1992, Sunset of Exclusive Contract Prohibition, FCC 02-176 ¶ 46 (June 28, 2002) (“Program Exclusivity Order”) (finding that “cable operators still control a formidable share of the market with 78 percent of MVPD subscribers receiving their video programming from a cable operator”).

16 The most prominent BSPs include RCN Corp./StarPower, Seren Innovations (operating under the Astound Broadband brand name), Knology, WideOpenWest, Grande Communications, and Altrio Communications.

17 See Kagan Media Index, supra note 3, at 8.

18 Press Release, RCN Corporation, RCN Announces First Quarter 2002 Results (May 7, 2002), at http://www.rcn.com/investor/press/pr.php?id=111.

19 Press Release, Knology Broadband, Inc., Knology Reports Strong Operating Results in First Quarter of 2002 While Continuing to Focus on Capital Structure Improvements, (May 14, 2002), at http://www.knology.com/news/index.details.cfm?pkey=165.

8 158774.10

· Astound Broadband, which began service in 2000 and currently passes approximately 30,000 homes in the Concord and Walnut Creek, California market, installed its 10,000th customer in those markets on March 13, 2002.20 This followed Astound’s announcement on July 13, 2001 that it installed its 10,000th customer in St. Cloud, Minnesota, representing “nearly 40 percent of the potential subscribers along the company’s network.”21

· Altrio Communications, which serves Arcadia, California, recently reported that it “converted its 1,000th customer in just under four months of operations.”22 Altrio’s Chief Executive Officer also boasts that his company has achieved a “20% or better penetration [rate] in [its] early neighborhoods.”23

Indeed, AT&T estimates that it faces competition from BSPs in over 20 markets in which AT&T serves a combined 2.2 million customers.

There are strong indications that many BSPs will continue to be vigorous competitors to cable operators. BSPs have received high customer satisfaction rates, suggesting they will be able to limit customer churn.24 In addition, many BSPs have achieved financial stability, reporting positive earnings and reducing, or eliminating, their reliance on venture capital for

20 Press Release, Astound Broadband, Astound Broadband Reaches 10,000-Customer Milestone in Concord and Walnut Creek (Mar. 13, 2002) (noting that 10,000 “represents nearly one third of the potential subscribers along the company’s network” within that market), at http://www.seren.com/press/2002-03-13.htm.

21 Press Release, Astound Broadband, Astound Broadband Reaches 10,000-Customer Milestone in St. Cloud Area (July 13, 2001), at http://www.seren.com/press.2001-07-13.htm.

22 Press Release, Altrio Communications, Altrio Communications Hits 1,000-Customer Milestone in Arcadia (Apr. 30, 2002) (emphasis added), at http://www.altrio.net/sub_main.asp?level1=1&level2=5&level3=5.

23 Id.

24 See Shirley Brady, The Bottom Line on Customer Satisfaction, Cable World, July 15, 2002, at 58 (noting that RCN outperformed all cable operators and DBS providers in the American Customer Satisfaction Index with a customer satisfaction score of 70.3).

9 158774.10 funding.25 BSPs are also continuing to deploy fiber and offer service in new markets. “Knology is busy building out a new network in Knoxville, [Tennessee], which it has been able to fund because of success in other southern markets where it has been generating revenue.”26

WideOpenWest recently announced that it will be providing cable services to Ohio State

27 University. Grande Communications received franchises to offer service in Round Rock,

Leander, Cedar Park, and Kyle, Texas.28 These franchises, along with twenty-six others Grande received in the I-35 and Houston corridor, will allow it to pass more than 1.6 million homes over the next five to seven years.29

AT&T commends the Commission for broadening the relevant market under study in the

Notice to encompass the distribution of all video programming, including broadcast

25 Duffy Hayes, Are Overbuilders Keeping Pace?, CED, Apr. 1, 2002, at 58 (noting that StarPower, the Washington, D.C. BSP that RCN co-owns with PEPCO Communications, achieved positive EBIDTA in May 2002). See also Press Release, RCN Corporation, RCN’s Washington, DC Joint Venture Achieves Positive EBITDA (May 2, 2002), at http://www.rcn.com/investor/press/pr.php?id=110 (noting that RCN’s “Boston, Central New Jersey and Lehigh Valley, Pennsylvania markets” have also achieved positive EBIDTA). Knology went EBITDA positive in the third quarter of 2001. See Hayes, supra note 25, at 58.

26 Hayes, supra note 25, at 58.

27 Press Release, WideOpenWest, WideOpenWest Wins Bid to Provide Cable Television Services to Ohio State University (July 18, 2002), at http://www.wideopenwest.com/00_frame_news.html.

28 Press Release, Grande Communications, Grande Communications Receives Franchises To Offer Bundled Internet, Phone And Cable Services In Four New Central Texas Cities (Nov. 29, 2001), at http://www.grandecom.com/About/pressroom_release.jsp?PR_ID=_PR215.

29 Id.

10 158774.10 programming, not simply multichannel video programming delivered by MVPDs. As

Commissioner Martin correctly pointed out at the June 13, 2002 agenda meeting introducing the

Notice,30 such an approach is faithful to Congress’s directive in Section 628(g) that the

Commission report on “the status of competition in the market for the delivery of video programming.”31

Broadcasters compete directly with cable operators for viewers and advertising revenue, and that competition will only intensify with the transition to digital television, as broadcasters begin to deliver multicast services and become even larger distributors of video programming.32

Local broadcasters present a significant competitive video distribution alternative to cable, a fact that is perhaps best highlighted by the nearly 13.3 million consumers who do not subscribe to any fee-based MVPD, but rather rely solely on free broadcasters for their video programming.33

Competition from broadcasters should also further vitiate any concerns the Commission may have about the ability of cable operators to act anticompetitively in the program acquisition market.34 Although program packagers may focus on cable, DBS, and other MVPD distribution outlets for their services, studios sell many of their shows to broadcast television stations and

30 See Commissioner Kevin Martin, FCC, Remarks at FCC Agenda Meeting (June 13, 2002), available at http://www.fcc.gov/realaudio/agendameetings.html. See also Notice ¶ 5 n.5 (noting that the Commission “generally seek[s] information regarding all video programming distribution technologies” (emphasis added)).

31 47 U.S.C. § 548(g).

32 See AT&T Cable Ownership Comments at 33-34.

33 See Kagan Media Index, supra note 3, at 8.

34 See Cable Ownership FNPRM ¶¶ 10-17 (inviting comment in cable horizontal ownership remand proceeding on the market for program packaging).

11 158774.10 broadcast networks, which are generally viewable by customers that do not have cable -- and, because of the must-carry and retransmission consent rules, by cable subscribers as well.35

Broadcast television networks are particularly important outlets for programmers because they attract much larger audiences and generate much higher advertising revenues.36 In short, broadcasters compete head-to-head with cable operators for the rights to programming, thereby further constraining cable operators’ power over programmers.

To ensure that the competitive impact of broadcasters is accurately assessed in the

Commission’s annual report going forward, AT&T recommends that the Commission formally incorporate broadcasters into its market share and other analyses in this proceeding. For example, whereas in the past the Commission’s annual reports have calculated market shares for cable, DBS, SMATV, and others based on a percentage of total MVPD subscribers, now that the

Commission has acknowledged that the relevant market is the broader video programming distribution market, an adjustment to this formula should be considered. AT&T suggests that the

Commission augment the denominator of its market share formula by adding to the total MVPD subscribers (currently 92.8 million) the number of consumers who “subscribe” solely to free

35 See AT&T 2001 Video Competition Comments at 22-23; AT&T Cable Ownership Comments at 33-34 & Ordover Decl. ¶¶ 109-110. See also 2001 Video Competition Report, 17 FCC Rcd. 1244 ¶ 14 (2002) (“Broadcast networks and stations are competitors to MVPDs in the advertising and program acquisition markets.”).

36 See 2001 Video Competition Report ¶ 78 (noting that broadcast advertising revenues reached $41 billion in 2000 while cable programming networks earned $10.3 billion in advertising revenues), ¶ 80 (noting that for the 2000-2001 television season, network affiliates accounted for a combined average 57% share of prime time viewing among all television households).

12 158774.10 broadcast services (currently approximately 13.3 million consumers).37 Although this approach does not remove the Commission’s obligation to undertake the dynamic market power analysis required by Time Warner II, it will present a more accurate picture of the relative percentages of the video distribution market (as opposed to the MVPD market) served by cable, DBS, and other video distribution alternatives.

* * *

In sum, the current video programming distribution market is vigorously competitive.

DBS continues to experience substantial subscriber growth, and its national footprint ensures that nearly all video households have access to at least three compelling MVPD alternatives.

Meanwhile, over six million existing cable customers have a BSP franchised to compete in their service area, meaning that many of those customers have or will soon have a fourth MVPD alternative.38 And, when over-the-air broadcasters are included in the analysis, as required by the Communications Act, consumers have many more video programming distributors from which to choose.39 In these circumstances, the Commission should plainly acknowledge that competitive market forces are driving the video distribution market today, and should take the increasingly dynamic, highly competitive nature of the market into account in making policy decisions regarding future regulation of this industry.

37 See Kagan Media Index, supra note 3, at 8.

38 This six million subscriber figure was derived by cross-referencing the markets in which the major BSPs claim to offer service with Warren Communications’ Television & Cable Factbook 2002 subscriber numbers for the incumbent cable operators in those markets.

39 In this regard, the Commission’s statement in the Program Exclusivity Order that “most consumers have limited choices among video distributors” is simply unsupportable. See Program Exclusivity Order ¶ 45.

13 158774.10

III. CLUSTERING IS A PRO-CONSUMER STRATEGY THAT HAS BEEN ADOPTED BY CABLE INCUMBENTS AND BROADBAND SERVICE PROVIDERS ALIKE.

The Commission again invites comment on the effects of clustering of cable systems on competition in the video programming distribution market.40 In particular, the Notice asks whether clustering may “make it harder for broadband service providers to remain viable.”41 As

AT&T demonstrates below, clustering does provide substantial consumer benefits, including the accelerated rollout of new and advanced services over the cable plant. However, cable operators are not using their clustered systems to act anticompetitively in the regional programming market. Moreover, BSPs are pursuing clustering strategies, as well. This fact demonstrates that clustering is a normal competitive response in the video (and the converging broadband) marketplace.

A. Clustering Creates Economies of Scale and Scope That Have Accelerated the Rollout of New and Advanced Services in AT&T’s Cable Systems.

As AT&T and other MSOs have demonstrated in previous filings, clustering provides the very types of benefits that enable cable operators to compete more effectively for video and non- video customers.42 In particular, clustering allows cable operators to: (1) spread costs over a number of systems and a larger subscriber base; (2) deliver a higher quality signal to consumers;

(3) offer more local and regional programming; (4) provide better customer service and fewer

40 See Notice at ¶ 30.

41 See id.

42 See, e.g., AT&T 2001 Video Competition Comments at 16-19; AT&T Reply Comments, filed in CS Dkt. No. 01-129, at 5-7 (Sept. 5, 2001); AT&T Comments, filed in CS Dkt. No. 00- 132, at 6-12 (Sept. 8, 2000) (“AT&T 2000 Video Competition Comments”); Comcast Comments, filed in CS Dkt. No. 01-129, at 12-13 (Aug. 3, 2001).

14 158774.10 outages; (5) create more interconnected networks that enhance educational and governmental uses; (6) develop more attractive joint consumer promotions and discounts with retailers and others; and (7) increase advertising revenues that can, in turn, be used to offset a portion of programming and system upgrade expenses.43

The Commission previously has acknowledged these benefits, as have GAO and NTIA.44

As early as its first video competition report, the Commission recognized that “[f]uture cable networks that offer multiple services (voice, video, and data) may require companies to serve larger markets in order to fully take advantage of economies of scale and scope.”45 In particular, the Commission observed that:

[i]nterlinked cable systems will eliminate the need for costly duplication of expensive capital equipment required for these new services. If duplication is required, the access

43 See AT&T 2001 Video Competition Comments at 16-19. See also Lara Warner et al., Credit Suisse First Boston, U.S. Cable Industry at 26 (May 2, 2002) (“If the industry could create larger, more contiguous footprints, it could improve network and marketing efficiencies, and better leverage fixed costs across its networks such as network operations centers, telephony switches, labor, and trucks.”).

44 See 2001 Video Competition Report ¶ 140 (noting benefits of clustering); 2000 Video Competition Report, 16 FCC Rcd. 6005 ¶ 166 (2001) (noting that the 30% ownership limit “permits cable operators to acquire and cluster systems in order to gain efficiencies related to economies of scale and scope resulting in lower administrative costs, enhanced deployment of new technologies, and encouraging the extension into previously unserved areas”); 1999 Video Competition Report, 15 FCC Rcd. 978 ¶¶ 161-165 (2000) (noting that clustering “can create greater economies of scale and size,” thereby enabling “cable operators to offer a wider variety of broadband services at lower prices to customers in geographic areas that are larger than single cable franchise areas,” and thus, “make cable operators more effective competitors to LECs whose local service areas are usually much larger than a single cable franchise area”); 1998 Video Competition Report, 13 FCC Rcd. 24284 ¶¶ 144-148 (1998). See also General Accounting Office, Telecommunications: The Changing Status of Competition to Cable Television at 28 (July 1999); Letter from Larry Irving, Asst. Secretary of Commerce, to Janet D. Steiger, Chairman, Federal Trade Commission, Jan. 12, 1995, at 1.

45 1994 Video Competition Report ¶ 153.

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costs related to innovative services may not warrant their provision in less densely populated or rural cable markets. However, if a group of markets were all served from a central location, a standard product could be served to all customers within the cluster. If so, consumers will benefit as the new services will be deployed more rapidly to all markets.46

The Commission’s predictions about clustering have been born out as cable operators have moved from multiple small systems each requiring their own technical, operational, management, and marketing infrastructures to larger clustered systems that share the same infrastructures. Such clustering has created efficiencies that have allowed cable operators to develop and deploy new services more rapidly.47

For example, AT&T, which has diligently pursued a clustering strategy, has been the industry leader in the deployment of digital video services (almost 4 million digital video customers and a 30% penetration rate) and high-speed cable Internet service (almost sixteen million marketable homes in AT&T’s service areas).48 Clustering has also been critical to

AT&T’s rollout of cable telephony. Economies of scale and scope have made clustered systems particularly attractive for initial deployments of cable telephony, and AT&T has enjoyed considerable success thus far in those markets. At the close of the second quarter of 2002,

AT&T had brought telephony competition to 7.6 million homes in 16 markets and had achieved

46 Id. ¶ 152.

47 Some analysts predict that as cable’s “business mix shifts toward more fixed-cost, scalable businesses, the power of scale becomes important. As a result, the second transformation that . . . the industry must undergo if it is to continue to grow and deliver returns on the $60 billion of capital it has spent in the past six years, is to begin larger, more rational clustering to drive scale economies.” Lara Warner et al., supra note 43, at 26.

48 AT&T Corp., Earnings Commentary Quarterly Update -- Second Quarter 2002, at 10-11 (July 23, 2002), at http://www.att.com/ir/pdf/022q_cmnt.pdf.

16 158774.10 an average penetration of 16%, or 1.2 million customers.49 However, in 55 communities in clustered systems, AT&T achieved penetration rates of 25% or higher. In its Chicago cluster, for example, AT&T reached penetration rates as high as 41%, while its Pittsburgh cluster has penetration rates as high as 32%. AT&T’s successful deployments in these clustered systems has helped make it the industry leader, and will facilitate the launch of cable telephony service in new markets.

B. Clustering Has Also Facilitated the Creation of More Local and Regional Program Services.

Local and regional programming services, such as news and sports, are often difficult for any single cable operator to develop if its systems cover only a fraction of a given metropolitan area. Efforts to develop and operate such programs with other cable operators can be cumbersome and inefficient. By clustering its systems, a cable operator is able to spread the costs of programming over a greater number of customers within a region, increasing the prospects of success and, therefore, the likelihood that the operator will incur the cost of developing local and regional programming. Cable operators’ successful clustering strategies have resulted in a substantial increase in the number of local and regional programming services.

For example, AT&T provides New England Cable News (“NECN”), a regional public affairs network, in its Boston cluster. Likewise, Comcast has launched Comcast SportsNet and

CN8 in its Mid-Atlantic cluster. In addition, Cablevision offers MetroChannels, a suite of channels providing local and regional programming in the greater New York metropolitan area, and AOL Time Warner offers New York News 1, a network that employs over 25 full-time

49 See id. at 11.

17 158774.10 reporters and provides 24-hour news coverage of all five New York City boroughs, to its New

York City customers. In short, clustering has played a significant role in the development and deployment of local and regional programming services. Of course, both Congress and the

Commission have consistently touted the benefits to consumers associated with such local and regional programming.50

C. Cable Operators Are Not Using Their Clustered Systems to Act Anticompetitively in the Regional Programming Market.

Since 1994, when the Commission issued its first video competition report, cable competitors have consistently alleged that cable operators will utilize their clustered systems to deny competing distributors access to programming by, for example, shifting affiliated programming to terrestrial delivery to avoid the program access rules or by extracting anticompetitive concessions from unaffiliated programmers.51 However, these is no evidence that cable operators have acted in such an anticompetitive manner.

As an initial matter, if cable operators had the incentive and ability to deny their competitors programming by migrating affiliated programming to terrestrial delivery, there

50 See, e.g., H.R. Conf. Rep. No. 102-862 (Sept. 14, 1992) (stating that there is “substantial government interest in ensuring” the continuation of local origination of programming); In re Implementation of Sections 12 and 19 of the Cable Television Consumer Protection and Competition Act of 1992, Development of competition and Diversity on Video Programming Distribution and Carriage, First Report & Order, 8 FCC Rcd. 3359 ¶ 65 (1993) (stating that “there may well be circumstances in which exclusivity could be shown to meet the public interest test, especially when the launch of local origination programming is involved”); In re New England Cable News, Memorandum Opinion & Order, 9 FCC Rcd. 3231 ¶ 42 (1994) (granting NECN the ability to enter into exclusive contracts in part based on a finding that the increased programming diversity provided by NECN weighed favorably in the public interest analysis).

51 1994 Video Competition Report ¶ 232 (noting such allegations).

18 158774.10 would surely be evidence that such migration has actually occurred, particularly at a time when cable is facing ever increasing competition from DBS and other MVPDs. The Commission’s own data, however, prove the opposite.

Since the Commission began tracking regional programming services in 1998, the number of all such services has grown from 61 to 80 (39 are vertically integrated), while the number of regional sports programming services has increased from 27 to 28 (24 are vertically integrated).52 Of the 24 vertically-integrated regional sports programming services, 21 remain satellite delivered, and thus continue to be subject to the program access rules, including the ban on exclusive agreements that the Commission recently extended for five years.53 It defies logic to suggest that vertically-integrated cable operators have the incentive and ability to harm their competitors by migrating programming to terrestrial delivery when only three of the regional sports services are delivered terrestrially and when only one of those three has been the subject of a (failed) program access complaint.54

There is also no evidence that cable operators with clustered systems have exerted, or are able to exert, monopsony power to extract concessions or obtain exclusive contracts with unaffiliated regional programming services. To the extent such conduct might occur, the

52 See Program Exclusivity Order ¶ 19 (citing the 1993 Video Competition Report and the 2001 Video Competition Report).

53 See id. ¶ 19 n.52 (noting that the “large majority of these regional sports programming services are currently satellite delivered”).

54 See In re DIRECTV, Inc. v. Comcast Corp., Memorandum Opinion & Order, 13 FCC Rcd. 21822 ¶ 25 (1998); EchoStar Communications Corp. v. Comcast Corp., Memorandum Opinion & Order, 15 FCC Rcd. 22802 (2000), aff’d 292 F.3d 749 (D.C. Cir. 2002).

19 158774.10 program carriage rules provide relief.55 Yet, in the ten years since those rules were adopted, there has been only one complaint, which resulted in a settlement.56 Thus, cable competitors’ continued assertion that clustering enhances cable operators’ ability and incentive to engage in anticompetitive conduct is misplaced and is disproved by marketplace evidence.

Given the marketplace benefits associated with clustering as described above, it is unsurprising that BSPs have followed similar clustering strategies in building their own networks. For example, RCN has created clusters in four areas, including a regional cluster in the Northeast (encompassing Boston, New York, Philadelphia, and Washington, DC), and metropolitan clusters in Chicago, San Francisco, and Los Angeles.57 Indeed, RCN has emphasized that it is “building a national telecommunications presence by focusing on clusters of communities in the most densely populated regions of the country.”58 Similarly,

WideOpenWest has system clusters in Chicago, Cleveland, Columbus, OH, and Detroit, while

Grande Communications has established system clusters along the I-35 corridor from Austin to

55 47 C.F.R. §§ 76.1300-1302 (2001) (prohibiting cable operators from discriminating against an unaffiliated programming service or requiring a financial interest in, or exclusive rights to, a service as a condition of providing carriage).

56 See In re Classic Sports Network, Inc. v. Cablevision Sys. Corp., Memorandum Opinion & Order, 12 FCC Rcd. 22100 (1997).

57 See Top 25 MSOs, Broad. & Cable, Apr. 29, 2002, at 28.

58 Press Release, RCN Corp., RCN’s Megaband Network Expands to Philadelphia Suburb of Folcroft, Pennsylvania (Mar. 27, 2000) (noting that), at http://www.rcn.com/pennsylvania/community/news/03-27-00/03-27-00.html.

20 158774.10

San Antonio, as well as in Waco, Corpus Christi, and Midland/Odessa. Likewise, Knology has focused its clustering in the Southeast, including Montgomery, AL, Columbus, GA, Panama

City, FL, and Charleston, SC.59 These examples clearly demonstrate that clustering is a normal competitive response in the MVPD marketplace, especially for distributors offering multiple advanced services.

IV. THE COMMISSION’S PRIOR FINDINGS CONCERNING THE CURRENT LEVEL OF VERTICAL INTEGRATION IN THE CABLE INDUSTRY ARE OVERSTATED.

Over the past year, the Commission has based, in part, its conclusions about the status of competition in the video programming market, as well as the need for continued regulation of cable operators in certain areas, on the level of vertical integration in the industry.60 AT&T believes that the Commission’s current methodology for calculating affiliated programming overstates the level of vertical integration in the cable industry and should be revised.

In its Cable Ownership FNPRM issued last September, the Commission correctly noted that “the percentage of programming networks that were affiliated with at least one cable MSO declined from 53 percent to about 25 percent” from 1994 to 2001.61 However, the Commission

59 See Top 25 MSOs, supra note 57, at 28; WideOpenWest, WOW! Cable Communities, at http://www.wideopenwest.com/00_frame_avail.html (last visited July 18, 2002); Press Release, Grande Communications, Grande Communications, Clearsource Join Forces to Become Largest Provider of Bundled Broadband Services in Texas (Apr. 29, 2002), at http://www.grandecom.com/About/pressroom_release.jsp?PR_ID=_PR221; Knology, Inc., Knology Cities, at http://www.knology.com/services/cities.cfm (last visited July 18, 2002).

60 See Program Exclusivity Order ¶ 18; 2001 Video Competition Report ¶ 158; Cable Ownership FNPRM ¶ 79.

61 Cable Ownership FNPRM ¶ 79 & n.181 (noting that “[t]he September 2001 figure reflects AT&T’s spinoff of Liberty Media Inc.”).

21 158774.10 subsequently revised this figure upwards to 35% in its 2001 Video Competition Report,62 concluding that Liberty’s ownership of several small cable systems in Puerto Rico meant that all of its programming interests should continue to be counted as vertically integrated.63 The

Commission then relied on this determination six months later in extending the program access exclusivity prohibition for five years.64

The Commission’s conclusions are faulty in two important respects. First, even assuming that a purely mechanical application of the attribution rules would treat Liberty’s program services as affiliated with a cable operator, the conclusion that there has been no reduction in the level of vertical integration in the industry notwithstanding the AT&T spin-off of Liberty is untenable. It cannot be the case that Liberty’s vertical relationship with the Puerto

Rico system is somehow equivalent to its vertical relationship with AT&T, the largest cable operator in the United States serving 13.3 million subscribers. Such an analysis defies marketplace reality and common sense. A more realistic assessment is that the spin-off of

Liberty by AT&T constituted a significant reduction in the actual level of vertical integration in

62 2001 Video Competition Report ¶ 157 (finding that 104 of 294 national programming networks are vertically integrated).

63 Id. ¶ 158. The Commission asserts that, if Liberty’s programming interests were excluded the percentage of programming networks that are affiliated with a cable operator decreases from 35% to 31%. Id. ¶ 158 n.511; Program Exclusivity Order ¶ 18 n.42. According to Liberty’s 2001 Annual Report, Liberty owns Liberty Cablevision of Puerto Rico, Inc., which serves 125,000 of the 442,000 homes in its service area. See Liberty Media Corp., 2001 Annual Report 15 (2002).

64 See Program Exclusivity Order ¶ 18. In essence, the Commission’s conclusions in the Program Exclusivity Order are based on the theory that Liberty would be willing to forego licensing fees and advertising revenues it would derive from making its programming available to the approximately 23 million non-cable MVPD customers in order to protect its Puerto Rico cable system from losing some of its 125,000 customers. This theory defies logic.

22 158774.10 the industry. Indeed, this conclusion is compelled by Time Warner II’s mandate that the

Commission take a more dynamic and pragmatic approach when assessing the status of competition in the marketplace.

Second, the level of vertical integration in the cable industry is actually far below the

31% figure the Commission cited if Liberty’s programming interests are not counted. According to the Commission’s data, there are 104 vertically-integrated national networks, of which 37 or

52 programming services are wholly owned by Liberty.65 Hence, again using the Commission’s own data, if Liberty’s wholly-owned programming is not included in the calculations, the level of vertical integration ranges between 18% (i.e., 104 minus 52, divided by 294) and 22.8% (i.e.,

104 minus 37, divided by 294).

In short, the Commission’s prior findings regarding the level of vertical integration in the cable industry are flawed and should be revised. In all events, given the importance of these data to the Commission’s continued regulation of the cable industry, the Commission must strive for more accurate and realistic assessments of the level of vertical integration in the industry by looking beyond mere static percentages to analyze the real world effects of changes in the marketplace, as required by Time Warner II.

65 Compare 2001 Video Competition Report at Table D-1 (citing 37 wholly owned Liberty networks), with Program Exclusivity Order ¶ 18 n.43 (citing 52 wholly owned Liberty networks).

23 158774.10

V. CONCLUSION

For the foregoing reasons, AT&T respectfully urges the Commission to adopt a report to

Congress that: (1) reflects the current, highly-dynamic, vigorously competitive state of video distribution and program acquisition; (2) acknowledges the pro-consumer benefits of clustering to incumbent cable operators and BSPs alike: and (3) reassesses its calculations of the level of vertical integration in the cable industry.

Respectfully submitted,

/s/ Michael H. Hammer Mark C. Rosenblum Michael H. Hammer Stephen C. Garavito Francis M. Buono AT&T Corp. Jonathan A. Friedman 295 N. Maple Avenue Ryan G. Wallach Room 1131M1 Basking Ridge, NJ 07920 WILLKIE FARR & GALLAGHER (908) 221-8100 Three Lafayette Centre 1155 21st Street, N.W. Douglas Garrett Suite 600 James H. Bolin, Jr. Washington, D.C. 20036-3384 AT&T Broadband (202) 328-8000 188 Inverness Drive West Englewood, CO 80112 Attorneys for AT&T Corp. (303) 858-3510

July 29, 2002