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Cable Operators

Rate Riddle

5/21/2012 12:01 AM Eastern

How much is too much?

That’s a question pay TV providers are pondering as
they try to resolve what to pay for video — and what to
charge.

Pay TV rates are climbing for consumers — by up to 5%, a ceiling
of sorts for the past decade — as operators struggle with rising programming
costs and are emboldened, in part, by their perennial
profit engine, broadband service.

In the past five years, as cable lost about 6.9 million video customers,
broadband has been the muscle behind much of cable’s growth.
Cable operators have added more than 11.6 million broadband subscribers
since 2007. At the same time, broadband has been a profit
engine for cable as well — its 90%-plus profit margins dwarf the
30% to 40% margins for video.

The gap seems to have widened in the past quarter. In the
first quarter, Comcast
added about 439,000
high-speed data customers,
more than its
main telco rivals — Verizon
Communications’
FiOS TV and AT&T’s Uverse
TV — combined.
In 2011, Comcast added
1.2 million broadband
customers, more than
the 750,000 subscribers
added by the seven
top telcos combined,
according to Leichtman
Research Group.

“High-speed data as
a product is, in many
ways, now carrying
these businesses,” said
ISI Group media analyst
Judah Ri f kin.
“What’s more, as is
widely known by those
who follow the industry,
programming-rate increases
are far outpacing
the trajectory of rate
increases passed on by
operators to consumers.
At some point, especially
for the cable companies who can leverage the bundle, they’re effectively
conceding that they don’t want to completely destroy their
economics, so they’ll risk alienating some of their customers with
premium pricing. In essence, there aren’t a lot of other options out
there that are more competitive.”

While video margins have sunk as subscribers leave and costs
climb, overall gross margins, thanks to broadband and phone, have
risen by more than 8 full percentage points in the past 10 years, from
63.2% in 2001 to 71.3% in 2011, Rifkin estimated. (Costs not directly
related to subscribers — like billing and customer service — aren’t
included, so reported gross margins are likely lower than 70%.)

The math underscores a fundamental change in the business model
that cable operators have depended upon for years: Broadband is giving
cable the fuel to weather programming increases and the resolve to
raise video prices.

Rifkin est imates that
overall, based on a detailed
audit of dozens of cable rate
cards across a broad swath
of the country, cable rates
have climbed between 4%
and 5%, a full percentage
point above the previous
year, when rates climbed an
average of 3% to 4%.

Miller Tabak media analyst
David Joyce agreed that
broadband is giving operators
the courage to test the
limits of video-rate increases,
echoing other concerns
that programming costs,
particularly from sports
programming and retransmission
consent, are beginning
to force operators’
hands.

“The differentiated
speeds that are offered for
data to retain customers
and bring in DSL and telco
customers do give the cable
companies potentially more
leverage or justification to
keep those rates around
the same, but raise video,
since they have the obvious
increase in expenses that
they pass through,” Joyce
said. “They don’t have those
increases in operating expenses
on the broadband
product.”

Joyce estimated that in
the past few years, programming
rate increases averaged
between 5% and 6% for
most distributors. This year,
high-single digit increases
are expected to be the norm.

“Under no realistic scenario will price increases keep
pace with rising programming costs,” Sanford Bernstein cable
and satellite analyst Craig Moffett said in a recent report.
And that, he said, puts cable operators in a bit of a quandary.

“Raise prices too slowly and Wall Street will conclude
that distributors are stuck in a vise between inexorable
programming cost increases and escalating competition,”
Moffett wrote. “Raise them too fast and Wall Street
will conclude that distributors are courting disaster with
low-end consumers, and that they are only making online
video alternatives that much more attractive. Now more
than ever, price increase announcements are therefore a
Rorschach test unlikely to please … anyone.” And that includes
Congress, which has never been shy about cablerate
regulation.

Even normal rate increases won’t go unnoticed in a national
economy still in flux, and that’s not a minor point.
Rifkin noted that cable operators he’s spoken to “are
pleased with the fact that their competitors are actually
acting rationally. They’re coming to the same conclusion.”
Operators also seem to be more willing to let customers
drop from the video rolls as long as they keep one of
the more profi table advanced services. While all continue
to view video as the core product, according to SNL Kagan,
the number of non-video subscribers rose about 20%
in 2011, from 3.26 million to 3.9 million.

Still, to help ease any potential sticker shock, cable operators
such as Comcast and Charter are also spreading rate
increases throughout the year, instead of the traditional
January and June timeframes. So far, Verizon Communications
hasn’t imposed a big rate hike for 2012, but No.
2 telco video service provider AT&T has increased video
rates about 8.5% nationwide for its U-verse TV U-100 video
package (video off erings saw increases of 1.7% to 5.6%
for the year), according to reports. And this was after a 10%
increase in video rates in 2010.

While Verizon has been quiet on the rate front, it has refused
to jump into price battles as it has in the past. Earlier
this year, Cablevision Systems (which has no plans for
a rate increase this year) offered a $69.95 per month video,
voice and data bundle, to which Verizon responded with a
$90 per month package.

PRICING CAUSES CONFUSION

All this rationality hasn’t stopped some politicians from
expressing their outrage over what they call exorbitant
cable-rate increases. Part of the confusion lies in cable’s
pricing structure, with its myriad packages and pricing
schemes, and discounts for new customers and for bundling
with other services. So while the price for a broadcastbasic
package may rise 7% or 8% during a given year, the
price for expanded basic (the package that most customers
take) may rise only by half that amount or less. Adding
digital channels, premium channels and high-speed data
and phone could also affect a customer’s monthly rate.

So when Boston Mayor Tom Menino complained Comcast’s
rates increasing by 4.9% in 2012 — and by more than
80% over the past three years — he was talking about its
lowest tier of service. The Greater Boston area saw cable
rates rise an average of 2.9% in 2012.

Menino has asked the Federal Communications Commission
to recertify the city of Boston to regulate Comcast
rates, a request that the agency granted earlier this month.
However, Comcast and many observers believe that recertification will not pass the agency’s effective-competition
test, which says that the government cannot regulate
a cable operator if at least 15% of the market subscribes
to an alternate provider. Comcast’s competition in Boston
includes DirecTV, Dish Network and overbuilder RCN.

“With the amount of competition in the city, we expect
to easily meet the so-called ‘Competing Provider’ test,”
Comcast said in a statement back in April.

And for its part, Comcast’s rate increases overall have
been among the lowest in the industry. “We continue making
investments in next-generation technology to add value
to our products and improve service and, in just the last
year alone, we’ve added several channels, and launched
new interactive applications and multiplatform content that
customers want and value,” Comcast spokeswoman Jenni
Moyer said. “While we’ve worked hard to hold down price
adjustments, the average customer bill will increase by 4.3%
beginning with the January 2012 billing cycle because of the
impact of higher programming costs and increased operating
expenses. These adjustments will not impact more than
half of our customers because they currently receive services
as part of a promotional offer.”

At Cox Communications, which said it is increasing
rates but would not reveal by how much, programming
increases are the main culprits.

“The rise in sports-programming costs and the rising
costs associated with retransmission have both been major
catalysts for the rise in the retail price of cable TV,” Cox
Communications spokeswoman Gretchen Crawford said.

Cable rates have consistently outpaced infl ation — according
to the FCC’s annual cable report released in March, expanded basic-cable rates rose 3.7% in the 12 months
ended Jan. 1, 2010 (the latest figures available). The general
inflation rate for the same period was 2.5%, according to
the FCC. For the 15 years between 1995 and 2010, expanded
basic-cable rates rose at a 6.1% compound annual rate,
again ahead of the 2.5% inflation rate over that same span.

But as cable operators like to point out, cable customers
appeared to be getting more for their money. According
to the FCC report, the average price per channel in the
12 months ended Jan. 1, 2010, fell 7.3% for cable to 56 cents.
For the 15-year period, the number of channels offered in
the expanded-basic package annually grew at a 4.9% clip
while the price per channel rose less than 1% per year, less
than half the rate of inflation.

Some evidence suggests distributors are willing to sacrifice short-term video subscriber growth to bring their
costs more in line. In the first quarter, every multichannel
video programming distributor that had a rate increase
of 4% or more had weaker-than-expected video-customer
growth.

Comcast, which lost about 37,000 video customers in the
quarter — better than the previous year, but worse than
the 25,000 losses some analysts were expecting — blamed
the weaker showing on its rate increases. Time Warner Cable,
which lost about 94,000 basic video customers in the
period (worse than the 66,000 it lost in the same period in
2011) had some of the highest rate increases in the sector.

Time Warner Cable sdeclined to comment, but according
to several published reports, TWC’s rates have risen as
high as 9.6% in some markets, like San Diego.

DirecTV, which implemented a 4% rate hike for 2012,
added 81,000 net new customers, less than half the 184,000
it added in the same period in 2011.

Against convetional wisdom, Charter Communications,
which had a 3% rate increase, added 20,000 video customers
in the period, its best showing in five years.

Not every multichannel video provider is raising rates.
Cablevision Systems and Dish Network both resisted imposing
rate increases in the first quarter, although Dish
is coming off a hefty 11% rate hike in 2011. (Dish effectively
took a three-year rate increase in one year; it has
pledged to freeze rates until 2013.) Dish and Cablevision
added 104,000 and 7,000 net new customers in the quarer,
respectively.

Between the first quarter of 2010 and the fourth quarter
of 2011, standard broadband pricing declined less than
1%. Telco broadband prices fell by 5% and cable prices
rose by 6% during the period, according to Maclean, Va.-
based telecom research firm Telogical. Also during that
time frame, cable broadband prices were $9.87 more expensive
than telco plans in the fourth quarter of 2011, after
being $4.35 more expensive in the first quarter of 2010.
That seems to be leveling off a bit this year.

DRIVING TO THE BUNDLE

The strategy behind the flexibility in pricing is to drive
customers to more profitable bundles. At Time Warner
Cable, bundled penetration has risen from
58.2% of customers in the first quarter of
2010 to 61.1% in the first quarter of 2012.
At Charter, the bundled rate has risen
from 58.4% to 62.9% in the same time
frame.

At Massillon Cable, rates for single-
play video customers rose 5%
from $58 per month to $61 per month this year, president
Bob Gessner said. For double-play customers — basic cable
and Internet — rates rose about $2.25 per month, or
2%, and triple-play customers only saw their bills rise 1%,
or about $1.25 per month.

Gessner said he has maintained around the same level
of rate increases for several years, based on the level
of programming costs increases the company must
weather,
For Gessner, who has about 43,000 customers in rural
Ohio, raising video-only rates serves two purposes:
It helps cover his rising costs and it serves as an incentive
for customers to upgrade to broadband and phone
packages.

Massillon implements its rate increase in February,
so in January Gessner unveiled a series of promotions
that would make the transition to double- and triple-play
packages easier.

“I do think it makes a difference as to whether they stay
or leave,” Gessner said of product bundling. “I’m not sure
it’s the percentage [increase]; it’s the cost itself. When you
start paying $60 a month for video, they start to get to the
theoretical point that they don’t think it’s worth it.”

September