1    Introduction to Broadcasting and Cable

Timothy Pecaro and John S. Sanders

On the face of it, broadcasting and cable appear to be relatively simple industries—the first supported primarily by advertising, and the second by subscriber fees. Neither has inventory in the traditional sense, eliminating the need for storage facilities and inventory-tracking systems associated with traditional businesses.¹

However, both industries have unique and complex financial issues that are dealt with in substantial detail in the body of this publication. These issues have grown even more challenging as the industries have evolved due to increased competition and the implementation of new technologies. As an introduction, this chapter provides an operating background and abbreviated history of each industry segment, and then discusses the regulatory environment in which these businesses operate. It is important to understand this environment because it impacts all the financial issues and systems discussed in this book.

General Industry Structure

Although the fundamental science that underlies broadcasting and wireless telecommunications was developed in the late 1800s and early 1900s, a true broadcasting industry did not develop in the United States until the 1920s, when radio stations licensed by the U.S. government began regularly scheduled broadcasts. Television broadcasts began in the late 1940s, and television ownership became widespread in the 1950s. The cable industry was born at that time, originally to broadcast signals to communities that could not receive over-the-air signals as a result of terrain or distance, a far cry from the telecommunications conglomerates, such as Time Warner and Comcast, that define the industry today.

The broadcasting industry in the United States is unique in the world because the government has played the role of a relatively detached overseer of the airwaves, and not an actual broadcaster. In the United Kingdom, for example, the British Broadcasting Corporation (BBC) was (and is) a government agency that not only regulated broadcasting, but was also responsible for producing and airing programming.

In contrast, the regime of broadcasting in the United States, from day one, was based on the premise of private ownership and management. The primary regulatory agency, the Federal Communications Commission (FCC), is responsible for technical matters such as allocating electromagnetic spectrum for uses ranging from broadcasting to cellular telephony.

The FCC was created by Congress in the Communications Act of 1934. Among the agency’s responsibilities are “regulating interstate and foreign commerce in communication by wire and radio so as to make available, so far as possible, to all the people of the United States a rapid, efficient, nationwide, and worldwide wire and radio communications service … . ” (The FCC says that “radio” in “its allinclusive sense also applies to television.”) The Communications Act charges the FCC to “make such regulations not inconsistent with law as it may deem necessary to prevent interference between stations and to carry out the provisions of [the] Act.”

In exchange for a nominal license fee and a commitment to comply with the regulations made by the FCC, businesses are granted licenses for different portions of the spectrum, and as indicated above, the FCC ensures that they do not interfere with each other. Stations’ commitments include such things as fostering public understanding of community issues by presenting programs and/or announcements about local issues (known as “localism,” this commitment is usually fulfilled with local news programming); providing a specified number of hours of children’s educational programming; limiting commercial advertising in programming targeted at children 12 and under; closed captioning of television programming to aid the hearing-impaired; participation in the Emergency Alert System; and many, many others.

Although the FCC does regulate content in some areas such as indecency, it does not dictate what a station will air or how a station is formatted as long as the station follows general licensing guidelines. Consistent with the First Amendment, and in contrast to many other countries, the FCC does not approve the editorial or news programming that a station or cable system can air. It is important to note that the FCC’s ability to regulate content does not extend to cable programming networks such as MTV or ESPN because they do not use the broadcast airwaves to transmit their programming and because customers must pay a fee to receive them.

This relatively minimal level of government involvement sets the United States apart and has fueled the vibrancy of the media sector. Station owners develop programming based upon the preferences and needs of their audience. This has spawned extraordinarily popular programming evolving from I Love Lucy in the early days to The Simpsons today, a vibrant television-news industry, and entire networks that cater to the needs of specific sectors of the population, as evidenced by the large number of Spanish-language stations. Specialized cable channels have grown in response to demand for sports, history, and educational programming. Although controversies are ongoing regarding indecency, children’s programming, and the like, decisions regarding broadcasting and cable programming are made in the marketplace, not in a government agency. Similarly, with some exceptions for public stations, broadcasting and cable are financed by selling services and raising capital in the markets, not by taxation or government assessments.

Broadcasting

The commercial broadcasting industry in the United States consists of approximately 600VHF (very high frequency) and 800UHF (ultrahigh frequency) television stations, along with approximately 5,000AM (amplitude modulation) and 6,500FM (frequency modulation) radio stations. VHF stations broadcast on Channels 2 through 13, and UHF stations broadcast on Channels 14 and above. The channels allocated for VHF service are in the 30MHz (megahertz) to 300MHz range, whereas UHF channels are in the 300MHz to 3,000MHz range. Due to the higher frequency, UHF signals are generally inferior to VHF signals and require significantly more electricity. Similarly, FM radio stations operate in the 88MHz to 108MHz range, and are generally associated with better fidelity than AM stations, which broadcast in the 535 kHz (kilohertz) to 1,705 kHz range. This difference in fidelity explains why the FM band has a higher proportion of musical programming, and the AM band has a higher proportion of news/talk programming.

There are additional stations that operate on noncommercial licenses or are licensed as low-power stations, translators, or boosters. In all, almost 28,000 licenses have been granted to operate broadcasting facilities in the United States. The FCC has granted each station a license that provides the primary authorization to operate. The license also stipulates certain technical parameters such as location, antenna height, and transmitting power. Station owners can petition the FCC in an open process if they wish to change a tower location or other technical parameters; entities that object to the change can then participate in the process.

With the advent of digital technology, the differences between the bands are diminishing. Radio stations are already broadcasting digital high definition (HD) programming, which permits them to multicast several channels of CD-quality programming on the spectrum allocation that had previously accommodated only one analog channel. Similarly, in February of 2009, television stations will be required to surrender their old analog channels to the Federal Communications Commission and broadcast exclusively on their new digital spectrum allocations.

It is estimated that over 600 million radio receivers are in use by the American public. Approximately 98 percent of all households in the United States are equipped with television receivers; 75 percent of all households own more than one television set.

Under the regulatory regime in the United States, viewers and listeners do not pay fees to the government in exchange for the right to receive programming. These stations provide entertainment, news, music, and other forms of programming to the public free of charge. In order to cover the costs of operation, commercial stations sell advertising time to local and national businesses, government agencies, and political organizations that are seeking to deliver information to the general public. Over time, though, they have also developed ancillary sources of revenues such as production fees, program syndication, tower space rentals, event sponsorships, Internet sites, and the like. More recently, television stations have begun to receive retransmission fees for the carriage of their programming on cable systems. With the advent of digital technology, other sources of revenue from multicasting and the provision of additional services such as data transmission may create more demands on financial systems.

Noncommercial stations cannot accept advertising in the traditional sense, although they generate revenue through sponsorships, contributions, merchandise sales, and government funding.

The link between audience size and advertising revenues is fundamental to the broadcasting industry. Broadcasters constantly seek to provide programming that will develop the widest appeal among radio listeners and television viewers. The more effectively the broadcaster is able to meet the preferences of the public, the larger the station’s audience will be. The larger the audience that a station can offer to advertisers, the more advertisers will be willing to pay for time on the station. This relationship between audience size and advertising revenues is axiomatic in the broadcasting industry, and is the primary determinant of success or failure among station operators.

The quality of the audience that a station delivers is also an important factor in driving revenues. Services such as Arbitron and Nielsen provide detailed information on gender, age, income, ethnicity, and other factors that may make certain programs more attractive to advertisers of certain products than to others.

In recent years, the broadcasting industry has become increasingly competitive. The FCC has issued additional licenses for radio and television stations in almost every market in the country. Moreover, traditional broadcast operators have come under increasing pressure from satellite-distributed program services, cable television systems, compact discs (CDs), digital video discs (DVDs), portable music devices (iPods), Internet businesses, and other competing technologies. “Fragmentation” has become a buzzword in the media as a revenue pie that was once dominated by three major television networks—ABC (American Broadcasting Companies, now known as ABC, Inc.), CBS (Columbia Broadcasting System, now known as CBS Broadcasting Inc.), and NBC (National Broadcasting Company, now known as NBC Universal, Inc.)—has come to be divided among a growing number of outlets and technologies.

In order to build the largest audience share possible, stations invest heavily in tangible assets, such as tall towers and powerful transmitters, and intangible assets, such as on-air talent, broadcast rights, and syndicated programming agreements. Similarly, investments in equipment and intangible assets, such as managerial talent, may be oriented toward controlling costs and increasing profitability.

The importance of intangible assets is another factor that makes broadcasting unique. At a typical television or radio business, the preponderance of value will typically lie in intangible assets such as FCC licenses, advertising contracts, talent contracts, programming rights, and the like. Not surprisingly, industry parlance for the product sold by these industries, “airtime,” describes something that can be extremely valuable, but cannot be seen or touched. Measuring, monitoring, and reporting about these intangible assets create unique challenges for financial reporting.

Ownership

In the Telecommunications Act of 1996, the FCC relaxed many of the rules regarding broadcast station ownership. This marked an important chapter in a process of deregulation that has dramatically changed the nature of the broadcasting industry. In the early days of the industry, for example, no single company could own more than 12 radio stations.

Because of the act, groups that had been limited to ownership of no more than a few dozen stations could now own hundreds of stations—and potentially could serve almost every major market in the country. The ownership limits within each market were also relaxed. For television, “duopoly” ownership was allowed, whereby an existing owner could acquire a second station in the same market as long as only one of the stations was among the top four stations in the market. The rules for radio were more complex, and were based upon market size and the number of competing stations within a market, including noncommercial stations. In the largest markets, an owner can own as many as eight stations, of which five can be in the same service (AM or FM). During this time period, many broadcasters grew rapidly; Clear Channel Communications, for example, grew to own over 1,200 radio stations. Increased demand during this period made FCC licenses much more valuable in the marketplace; in fact, licenses doubled and even tripled in value as companies competed to acquire additional stations.

In 2002, as an outgrowth of its congressionally mandated biennial ownership review, the FCC began a proceeding to review all of its ownership rules affecting broadcasting. Its intent was to relax ownership rules even further. On June 2, 2003, the FCC adopted new rules governing local and national television ownership; local radio ownership; and local cross-ownership of radio stations, television stations, and daily newspapers. Before the new rules took effect, however, the United States Court of Appeals for the Third Circuit imposed a stay on their effectiveness pending review. Although a detailed treatment of the ownership regulations is beyond the scope of this chapter, it should be noted that many of the ownership limits are still in a state of flux based upon judicial and FCC review.

Partially as a result of the regulatory uncertainty regarding ownership limits, and partially because of the downturn that hit the technology and media sectors after the year 2000, the pace of consolidation slowed. However, a significant number of television, radio, and cable businesses continue to change hands each year, and placing these businesses on the books of the acquirer is one of the most important financial functions in the industry.

It is in this marketplace, one defined by a strong relationship between audience size and revenues on one hand, and increasing competition on the other, that the broadcasting industry operates.

Cable

The cable television (CATV) industry developed in the late 1940s in order to provide television service to communities in rural Pennsylvania that were too isolated to receive over-the-air television broadcasts. The first systems consisted of a simple antenna placed on a tall hill that could receive television stations from distant markets. The cable system owner ran cables from this antenna location to households throughout the community, sometimes for free, in order to sell television sets locally. Like broadcasting, the industry has grown and diversified to provide a broad range of educational, entertainment, cultural, and sports programming to large urban areas and rural communities alike. These systems now provide telephony, high speed Internet, and business support services as well.

According to data from the National Cable and Telecommunications Association (NCTA), the cable industry in the United States consists of approximately 11,800 operating systems serving over 34,000 communities throughout the country. In addition, approximately 100 additional cable television franchises have been approved but have yet to be constructed.

The cable industry now serves almost 67 million basic subscribers, representing a 59 percent penetration of the approximately 113 million television households nationwide. Approximately 77 percent of basic subscribers also subscribe to a premium tier of service. Like broadcasting, cable television plays a significant role in the U.S. economy. For example, the NCTA says that cable systems spent $12.4 billion for capital and paid $2.8 million in franchise fees to local municipalities in 2006 alone.

Each system has been granted a franchise by its local municipal government or, more recently, by a state franchising authority. Municipal franchisees generally include guarantees that the cable operator will make expensive investments in local employment, local programming, and system technical design. The efforts of competitors from the telephone industry have resulted in statewide franchises that allow a competitive system to be built without approval from local municipalities.

The construction of a cable television system is extremely capital intensive. The cost of installing aerial cable is often the single largest investment made by a cable television system operator. Underground cable television installation is even more expensive, when considered on a per-mile basis. Additionally, investments must be made in headend facilities, satellite-receiving equipment, call centers, installation and service vehicles, warehouse and office facilities, and subscriber equipment such as converter units, which ultimately deliver cable television services to households.

Numerous changes have occurred in the development of cable television technology. Original systems used vacuum tube electronics and provided only a few off-air channels to subscribers. Companies have had to “rebuild” distribution plants over the years, installing cable with greater signal capacity and increasing amounts of fiber-optic cable and replacing the old vacuum tube technology several times over. Modern systems are capable of providing hundreds of channels of service, including satellite signals and locally originated programs. These systems use solid-state amplifiers and addressable converter equipment to control subscriber service levels.

Cable television systems provide movies, entertainment, news, music, and other forms of programming to the public. The cable operator must pay a fee, usually calculated on a per-subscriber basis, to program suppliers. These fees may either be determined on a fixed basis or calculated as a percentage of system revenues.

In order to cover the costs of operation, systems sell “basic” services such as local television signals, local origination programs, and some satellite services for a fixed monthly fee to all subscribers. Customers also have the option to subscribe to additional “premium,” or “pay,” services—such as HBO (Home Box Office) or Showtime—which offer movies, sports, entertainment, and original programming. Additional programming can be purchased in packages called “tiers,” which can include additional news and information, specific sports programming, foreign language programming, high definition channels, and/or other types of programming networks.

Given the substantial fixed costs resulting from the capital requirements of the business, as well as high programming costs, cable operators seek to maximize system penetration. Two types of system penetration are of paramount importance in the industry.

The first is basic penetration, which is a measure of the number of homes subscribing to cable television as a proportion of the homes that are passed by cable. If 600 homes subscribed to cable service in a community of 1,000 homes, basic penetration would be 60 percent.

The second important measure is pay penetration, which gauges the popularity of pay services among those households that subscribe to basic cable service. If each of the 600 cable households in the example subscribed to 2 pay services, pay penetration would be 200 percent.

The linkage between basic penetration, pay penetration, and customer development is fundamental to the cable industry. Operators constantly seek to provide programming and services that will develop the widest appeal among local households. The more effectively the cable operator is able to meet the preferences of the public, the larger the system’s subscriber base will be. This relationship between subscribers and revenues is axiomatic in the cable industry, and is the primary determinant of success or failure among system operators.

As is the case with broadcasting, the cable industry relies heavily upon intangible assets, although the capital asset requirements for a cable system are also tremendous. Multiple headend facilities—which contain satellite downlink and cable and fiber-optic transmission facilities—are required, as well as miles of buried and aerial cable, and additional assets at each household location. Fleets of installation and repair vehicles are also necessary. However, the value of these assets is often eclipsed by intangible assets, such as franchise agreements (which authorize the right to provide cable service in municipalities) and the base of paying subscribers.

Although cable program networks collectively have made significant inroads, traditional broadcast television stations continue to be the mainstay of television viewing in the United States. Even at their best, cable network viewing rarely exceeds 5 percent of U.S. households, and usually falls in the low single digits, whereas popular programming on any of the major broadcast networks can routinely fall in the 10 to 15 percent range.

Cable Regulation

Cable television franchises were initially awarded by municipalities based upon a competitive application process. Cable operators received an exclusive franchise, and in exchange agreed to pay a fee, usually calculated as a percentage of revenues. They also agreed to adhere to certain standards regarding buildout timetables, service quality, channel offerings, the provision of service to educational institutions, and the like. Similar to the broadcasting regulatory regime, the government leaves alone the management of the business, and theoretically steps in only when a franchisee runs afoul of the regulations.

In October 1992, following a period of significant deregulation that began in 1984, the cable television industry was placed under increased federal and local regulatory control as a result of public concerns regarding rates and service levels. Under the provisions of the Cable Television Consumer Protection and Competition Act of 1992 (“the Cable Act”), the FCC was directed to develop policies and regulations that would address current cable television rates, future rate increases, competition, franchising, broadcast station carriage, and service standards. Several subsequent regulations stipulated price rollbacks and price controls affecting virtually all cable systems. The financial pressure in these regulations also impacted cable programming networks working to be added (or “launched”) on cable systems.

Since 1996, the cable industry has undergone significant consolidation, with the largest cable companies (MSOs, or multiple system operators) acquiring many of the medium- and smaller-sized operators. The strategy of these operators was to consolidate systems into regional clusters. These clustered systems could be operated more efficiently and could utilize centralized technical facilities (headends) to distribute programming throughout the metropolitan service area. The largest cluster, Cablevision’s New York City system, serves more than 3 million subscribers. Large clusters in metropolitan markets such as Boston; Washington, D.C.; and parts of Los Angeles each serve more than 1 million subscribers. Consolidation also allowed the system to begin selling advertising on its cable channels to create an additional revenue source.

These companies invested heavily in upgrading their distribution systems with fiber-optic cables to provide substantially increased channel capacities and the ability to provide advanced services such as digital cable tiers, high speed Internet access, and telephone service. As a result of the anticipated cash flow from these new services, benchmark prices for cable systems increased dramatically. Because of the numerous revenue streams—including video subscriber fees from basic service, digital tiers, and HDTV, advertising revenue, high speed Internet access, and telephone service—the revenues of clustered cable systems can dwarf those of the most successful local television stations. However, the expenses can also be extraordinary to construct and operate the systems.

Cable programming networks have also seen significant consolidation since the late 1990s. Increased consolidation on the cable system side of the business gave cable operators significant power in carriage discussions with independent networks. In response, cable networks with strong brand identity have either acquired lesser-known networks or launched new channels on their own, using the strength of the popular networks as leverage when negotiating carriage agreements for lesser-known networks.

In Conclusion

Although seemingly mundane, finance can be as interesting as the industry that it serves. Fortunately, the broadcasting and cable industries continue to evolve and flourish, spurred not just by the government, but by the dynamism of competition and private-sector ingenuity. This environment will provide ample stimulation and challenge for those involved in finance and accounting. These functions provide the vital controls that ensure the success of the business, and also provide to nonfinancial managers information that facilitates effective planning and decision making. To support and track the progress of a business, there must be proper accounting for income, expenses, assets, liabilities, and equity. As the entertainment and communications businesses have grown to the forefront of American society, the role of finance and its systems has adapted, grown, and improved to meet the challenge. The years ahead will be exciting ones indeed for financial professionals in the broadcasting and cable fields.

Notes