Federal Communications Commission Office of Plans and Policy 445 12th Street, SW Washington, DC 20554 OPP Working Paper Series Broadcast Television: 37 Survivor in a Sea of Competition September 2002 Jonathan Levy Marcelino Ford-Livene Anne Levine The FCC Office of Plans and Policy's Working Paper Series presents staff analysis and research in various states. These papers are intended to stimulate discussion and critical comment within the FCC, as well as outside the agency, on issues in telecommunications policy. Titles may include preliminary work and progress reports, as well as completed research. The analyses and conclusions in the Working Paper Series are those of the authors and do not necessarily reflect the views of other members of the Office of Plans and Policy, other Commission staff, or the Commission itself. Given the preliminary character of some titles, it is advisable to check with authors before quoting or referencing these Working Papers in other publications. This document is available on the FCC's World Wide Web site at http://www.fcc.gov/opp/. The inside back cover contains a partial list of previous titles. i Broadcast Television: Survivor in a Sea of Competition Jonathan Levy∗ Marcelino Ford-Livene Anne Levine Federal Communications Commission September 2002 OPP Working Paper No. 37 The FCC Office of Plans and Policy's Working Paper Series presents staff analysis and research in various states. These papers are intended to stimulate discussion and critical comment within the FCC, as well as outside the agency, on issues in telecommunications policy. Titles may include preliminary work and progress reports, as well as completed research. The analyses and conclusions in the Working Paper Series are those of the authors and do not necessarily reflect the views of other members of the Office of Plans and Policy, other Commission staff, or the Commission itself. Given the preliminary character of some titles, it is advisable to check with authors before quoting or referencing these Working Papers in other publications. ∗ The authors would like to thank then numerous staff from the television and cable networks, the investment analysis community, advertising agencies, and trade associations who gave generously of their time and expertise to help us. The authors alone are responsible for the analysis and conclusions herein. Special thanks to Kenneth R. Carter of OPP for crucial assistance in preparing this report. i Abstract The television broadcast industry has entered the new millennium in good shape, but with many challenges on the horizon. Although the past decade has seen a continuing erosion of broadcast audience and advertising shares, television advertising prices and revenues have continued to grow. DBS and the expansion in cable availability and channel capacity have created an increasingly competitive environment for television broadcasting. This will lead to continuing audience fragmentation and further pressure on broadcast advertising revenues. The increasing competition for program production resources has led to an increase in production costs. The future profitability of the broadcast industry will depend on how it responds to competition and cost pressures, and on whether it can harness new technologies such as DTV and interactive services to its benefit. ii Contents I. INTRODUCTION 1 II. THE MARKET FOR VIDEO MEDIA 3 III. THE ECONOMICS OF TELEVISION FINANCING METHODS 7 INTRODUCTION 7 THE IMPACT OF FINANCING METHODS ON VIDEO PROGRAMMING AVAILABILITY 7 AGGREGATE TRENDS IN VIDEO ADVERTISING 9 IV. BROADCAST TELEVISION 18 OVERALL INDUSTRY TRENDS 18 TELEVISION NETWORKS 27 TELEVISION STATIONS 29 SUMMARY 38 V. CABLE TELEVISION 40 THE NATURE OF CABLE TELEVISION 40 AVAILABILITY AND SUBSCRIBERSHIP OF CABLE TELEVISION 44 CABLE OPERATOR REVENUES 45 THE COMPETITIVE IMPACT OF CABLE ON BROADCAST TELEVISION 46 CONCLUSIONS 49 VI. DIRECT-TO-HOME SATELLITE TRANSMISSIONS 51 DIRECT-TO-HOME SATELLITE SERVICES 52 DBS PUBLIC INTEREST OBLIGATIONS 56 DBS AS A COMPETITOR IN THE MARKET FOR MULTICHANNEL VIDEO PROGRAMMING DISTRIBUTION 56 CONCLUSION 61 VII. OTHER VIDEO MEDIA DELIVERY PLATFORMS 62 INTRODUCTION 62 MMDS 62 OVERBUILDERS 64 UTILITIES 65 LOCAL EXCHANGE CARRIERS 66 THE INTERNET 68 HOME VIDEO PRODUCTS 71 THEATRICAL FILMS 73 VIDEO AND PC GAME PLATFORMS AND APPLICATIONS 73 CONCLUSION 75 VIII. TECHNOLOGICAL DEVELOPMENTS 76 INTRODUCTION 76 VIDEO COMPRESSION TECHNOLOGIES 77 DIGITAL TELEVISION 78 iii DIGITAL RIGHTS MANAGEMENT 90 INTERACTIVE TELEVISION 92 PERSONAL VIDEO RECORDERS 96 CONCLUSION 100 IX. ADVERTISING MARKET DEVELOPMENTS 102 INTRODUCTION 102 CHANGES IN ADVERTISING MARKET STRUCTURE 102 CURRENT TRENDS AND NEW ADVERTISING FORMATS 106 INTERACTIVE ADVERTISING TARGETING CHILDREN RAISES CONCERNS 110 PRIVACY AND INTERACTIVE ADVERTISING 112 CONCLUSION 112 X. THE MARKET FOR BROADCAST AND NON-BROADCAST VIDEO PROGRAMMING 114 INTRODUCTION 114 REPEAL OF SYNDICATION AND FINANCIAL INTEREST RULES 114 THE PROGRAMMING MARKETPLACE 115 FROM PITCH TO FALL LINE-UP 116 PRIME TIME PROGRAMMING TRENDS 117 INDEPENDENT PRODUCTION 118 REPURPOSING AND SUMMER PROGRAMMING 120 SPORTS PROGRAMMING 122 CABLE PROGRAMMING 123 COMPARATIVE EXPENDITURES 130 CONCLUSION 133 XI. CONCLUSIONS 134 TELEVISION STATIONS 134 TELEVISION NETWORKS 135 RIVAL DELIVERY SYSTEMS 136 TECHNOLOGICAL CHANGE 136 PROGRAMMING 138 THE FINAL ANALYSIS 139 iv Tables TABLE 1: AVAILABILITY OF VIDEO MEDIA 4 TABLE 2: END-USER EXPENDITURES ON VARIOUS VIDEO MEDIA 1990-2000 6 TABLE 3: TOTAL ADVERTISING VOLUME, VIDEO ADVERTISING VOLUME, AND GDP 10 TABLE 4: COMPONENTS OF VIDEO ADVERTISING (MILLIONS OF CURRENT $) 13 TABLE 5: COMPONENTS OF VIDEO ADVERTISING (MILLIONS OF 1982-84 $) 14 TABLE 6: COMPONENTS OF VIDEO ADVERTISING (PERCENTAGE OF TOTAL VIDEO ADVERTISING VOLUME) 15 TABLE 7: TELEVISION STATIONS ON AIR 19 TABLE 8: TV VIEWING BY CABLE AND NON-CABLE HOUSEHOLDS, 1990-91 AND 2000- 01 (HOURS/WEEK) 20 TABLE 9: ALL DAY VIEWING SHARES, CABLE AND NON-CABLE HOUSEHOLDS 21 TABLE 10: PRIME TIME VIEWING SHARES BY CHANNEL TYPE 23 TABLE 11: COMPARISON OF CABLE TELEVISION SHARE OF TOTAL VIDEO ADVERTISING REVENUES AND CABLE TELEVISION ALL-DAY VIEWING SHARES 24 TABLE 12: PRIMETIME HOUSEHOLD DELIVERY (IN THOUSANDS) 25 TABLE 13: AVERAGE REVENUE PER TELEVISION STATION BASED ON AGGREGATE DATA, CURRENT AND CONSTANT DOLLARS 32 TABLE 14: AVERAGE REVENUES, EXPENSES, PRE-TAX PROFITS, AND CASH FLOW OF COMMERCIAL TELEVISION STATIONS, 2000 33 TABLE 15: AVERAGE REVENUES, EXPENSES, PRE-TAX PROFITS, AND CASH FLOW OF COMMERCIAL TELEVISION STATIONS, 1990 34 TABLE 16: AVERAGE PROFITS OF COMMERCIAL TV STATIONS AS A PERCENTAGE OF NET REVENUES, 1975-2000 34 TABLE 17: AVERAGE INFLATION-ADJUSTED NET REVENUES OF COMMERCIAL TV STATIONS, 1975-2000 (1982-1984 = 100) 36 TABLE 18: EXPENSE ITEMS OF COMMERCIAL BROADCAST STATIONS BY SELECTED MARKET SIZE, 2000 (% OF TOTAL EXPENSES) 37 TABLE 19: EXPENSE ITEMS OF COMMERCIAL BROADCAST STATIONS BY SELECTED MARKET SIZE, 1990 (% OF TOTAL EXPENSES) 37 TABLE 20; PROGRAMMING EXPENSES OF COMMERCIAL BROADCAST STATIONS, 1975- 2000 (% OF TOTAL EXPENSES) 38 TABLE 21: CABLE SUBSCRIBERS AND HOMES PASSED 41 TABLE 22. CABLE OPERATOR REVENUES ($MIL) 46 TABLE 23; SYSTEM CAPACITY, JULY 2001 48 TABLE 24: DIRECT-TO-HOME SUBSCRIBERS AND CABLE SUBSCRIBERS 51 TABLE 25: ESTIMATED SHARE OF U.S. TV HOME SET USAGE BY PROGRAM SOURCE 62 TABLE 26: INTERNET VIDEO STATISTICS 70 TABLE 27: VCR PENETRATION 71 TABLE 28: HOME VIDEO SPENDING, RENTAL AND RETAIL ($ MILLIONS) 72 TABLE 29: VIDEO AND PC GAME GROWTH 74 TABLE 30: CONSUMER HDTV SURVEY 82 TABLE 31: TELEVISION ADS NOT WATCHED (PRIME TIME) 99 TABLE 32: PROGRAMMING EXPENDITURES ($MIL) 131 v Figures FIGURE 1: CABLE AND SATELLITE USAGE: SUBSCRIBERS/TVHH (%) 52 FIGURE 2: SAMPLE DIAGRAM OF ONE TYPE OF DATA BROADCAST NETWORK ARCHITECTURE 89 FIGURE 3: TOLLIN/ROBBINS ROSTER (2002-2003 SEASON) 119 vi I. Introduction This study updates Office of Plans and Policy Working Paper 26, released in June 1991 (“Working Paper 26”). That paper and this one address changes over time in the competitive position of the television broadcasting industry and present some cautious predictions for the future. The approach is to examine audience shares, advertising revenues, and profitability of television networks and stations in some depth based primarily on published sources, supplemented with some discussions with network staff, analysts, and representatives of the advertising community. That examination is followed by a review of developments in the cable and direct broadcast satellite sectors, the major multichannel video program distribution platforms. The paper also considers developments in technology, advertising, and programming. Working Paper 26 concluded that broadcast television “has suffered an irreversible long-term decline in audience and revenue share, which will continue throughout the current decade.” This prediction has proved to be accurate, but it is fair to say that Working Paper 26 overestimated the severity of the impact on actual television industry performance and profitability. The decline in broadcast advertising as a share of total video advertising revenues was much smaller than the decline in broadcast audience shares. Moreover, the absolute level of both network and station advertising revenues actually increased, even in real terms (with the exception of a dip in 2001, from which it appears that the industry will recover). The television broadcast industry is larger, in terms of stations on the air, than it was then, and no full power stations have gone