By: Bruce Bahlmann - Contributing Author (your feedback is important to us!)

Created: March 22, 2006

Legislation that has held firm for nearly 40 years is about to change and with it, the possible fortunes of many of the largest US broadband network operators. In this article we will explore some of the most interesting aspects of the movement to a national video franchise and some possible fallouts.

History

Video franchises evolved out of the need for cable operators to gain the right-of-way to run cables through residential neighborhoods in exchange for some small percentage of the gross revenues that cable operators' earned off each respective franchise. Over the years, as these franchise agreements came up for renewal, the cities governing these agreements began to leverage these agreements as if granting the cable companies a pseudo video monopoly was worth increasingly more fees and concessions. Cable operators generally obliged these fees and concessions to the point where they declared these agreements as real assets of their respective companies. Today, franchise fees can command up to 5 percent of the gross cable revenue for that city's residents - a ceiling that exists for these fees which is set by congress. To get some idea of how much money we are talking about, a city with 30,000 residents and 85% cable penetration paying an average of $30 a month for video programming might receive a yearly payment of $460,000 for their granted video franchise - this amounts to approximately $15 per resident per year. The Alliance for Community Media believes the national average for video services is around $50 per month and that incumbents are careful not to include other "information services" such as voice and data services on franchise agreements which are approaching on 50% of their revenues.

In addition to franchise fees collected, cities might receive rights to broadcast public information channels to their residents, network all the city buildings, as well as receive certain video programming in the schools. Franchise agreements may even include use of institutional networks (cable or fiber networks) that are maintained by cable operators but are free for cities to use -- all of which add up to a significant savings and income for most cities. Such concessions have been on the rise with the advent of the capped franchise fee.

While these local video franchise fees are miniscule in comparison to the real profits video services generate, the actual agreements represent a significant barrier to entry for newcomers wanting to string up video carrying cables along side those maintained by the cable companies. Negotiating each local video franchises can take anywhere from a few months to over 18 months for larger franchises. AT&T recently was recently quoted that if they were able to miraculously sign one video franchise each business day it would take them seven (7) and one half years to obtain all the franchises they would require to delivery video to the cities their network services (as many as 2,000 franchises).

Advent of the National Video Franchise

As legislation proceeds that will create a national video franchise that supersedes all these local video franchises the fallout will be significant including:

• New Opportunities: Cities previously relying on cable operators for their telecommunications networking needs, will need to begin looking for a new managed network service provider. This niche will create a whole new array of companies that specialize in servicing communities and city governments - at least until larger companies can create tailored services that address the unique needs of these organizations. Alternatively, cable operators may be able to go back to their long time partner (each city they service) and make a deal to continue such services for a discounted fee.
• Reclassifying Asset: Cable companies currently listing their local cable franchises as assets will need to figure out a new way to capitalize on this local relationship, reclassify these video franchise assets, or possibly write off these video franchise assets. For example, Comcast currently lists its cable video franchises as nearly half ($51 billion) of its over $104 billion dollars of assets. It is able to list this asset as until the national video franchise is realized, the local cable franchise represented a pseudo monopoly to provide video services to a community's residents. However, the advent of a national video franchise eliminates these pseudo video monopolies so the value of these franchises that are declared as assets could come in to serious question by the financial community.
• Cities Must Get Creative: Losing an important source of revenue and telecommunications assistance, cities must get creative in finding a way to replace the revenue earned from franchise fees or cut back expenses/bodies to account for their loss in proceeds from franchise fees. One possible way is to increase the fees for permits that will be required by network operators to install such networks. Perhaps even come up with new or higher cost permits required to park a truck along busy streets. Bottom line is someway, somehow, broadband service providers are going to pay cities to operate in their communities.
• Expensive Content: Even with these obstacles removed, newcomers attempting to offer video services that compete with incumbent video service providers face a difficult road ahead. Starting from scratch in terms of video subscribers places newcomers at a significant disadvantage when it comes to negotiating favorable carriage deals for video content. Content media giants like Time Warner, Sony, Disney, and News Corporation sit atop a mountain of video programming to the point where they can dictate prices. ESPN has been notorious in commanding a high premium for their content and raises rates every year. In the mean time, network operators with little or no content assets face increasing rates and dwindling margins. Essentially their only recourse is to raise rates to maintain profit margins. Newcomers with little or no subscribers pay premium carriage rates for content over incumbents with tens of millions of subscribers. The presence of this parity alone place newcomers at a big disadvantage because even if they match the incumbents price they are still paying a premium over and above what their competition is paying for the same content.
• Target Penetration: As newcomers begin rolling out video services, the legislation enabling the national video franchise also permits an interesting opportunity for the newcomers. Rather than requiring newcomers to approach the rollout of these services in a non-discriminatory broadcast mode, newcomers are able to initially target specific markets until such time as they achieve 15% of their competitors' video service subscribers. Certainly this is how the incumbents rolled out these services. However, there has been an upheaval about this detail but it is necessary to permit the newcomer to move in and establish a reasonable chance to complete without facing damaging price cuts by incumbents that could undermine their successful entry. Allowing newcomers to market to premium subscriber markets provides the greatest possible chance for success while giving such markets the best possible choices and prices for premium services. While no network operator ever wants to face competition, is has proven to be the best form of regulation and usually spurs innovation, selection, and increasingly affordable products and services.

In the case of incumbents, this 15% trial period for newcomers will be very challenging but because newcomers are starting from scratch there will be amble time to improvise, overcome, and adapt so there isn't any need to get too alarmed. Essentially, it is the incumbent's market to loose so the more incumbents can consolidate, cross sell, and package their services right now the more difficult it will be for newcomers to make their belated case to entice a switch. For some customers, all they want is the cheapest price - and these customers will always flock to the best deal going. However, for the masses, it largely boils down to delivering good services for a  fair price. The key is to not provide reasons for your customers to switch.

The other serious challenge for incumbents could be the competitive technology plane created by newcomers. For example, if the only way incumbents can compete on this new technology plane is to deploy a similar or better network architecture there may not be anything to borrow against to build out such a network. From 1996-1999 incumbent cable operators spent $100 billion upgrading their networks to HFC to permit broadband services. However, if nearly 50% of incumbents' assets (local video franchises) become null in void in the next two years, incumbents may not have enough innate value left to command the kind of loan needed to upgrade their network again in order to compete with newcomers. It is scary to think that within 3 years HFC networks could be obsolete - but it should come as no surprise to the financial community as fiber or high speed wireless has always been the end game. Only until recently has the price for fiber become a realistic option to run all the way to the home. I think it is safe to say that the first broadband service provider to the home with fiber will likely be the only one that wall street will fund as no one else would be foolish enough to fund someone trying to compete head to head with fiber to the home. Certainly, incumbents will have a difficult time going back to the financial community asking for another $100 billion extend fiber to the home.

A Word About Competition

There isn't really a lack of competition for video services. Most markets are blanketed by free broadcast (over the air) video, Satellite video, and those provided by cable. However what newcomers want is not just video but the triple or quadruple play. Meaning, they want to be able to sell any type of service (voice, video, data, or wireless) to subscribers and fiber is the best way to do this by offering infinitely upgradeable bandwidth with the greatest possible lifespan.

Making Up for the Losses

Perhaps the most difficult but least discussed fallout from a national video franchise will be what cable companies do with assets that they have classified as local video franchises. Somehow these franchises need to be turned into a real revenue stream before they become a liability on their balance sheet. One possible way is to spearhead a widespread renegotiation with each city to turn a once cost center into one that generates revenue. One way to do this might be to take over as the managed network service provider for each city they service. Another way might be to somehow cater to local businesses in such a way that instead of the cable franchise agreement becoming a liability, it becomes an important introduction to the city's most trusted family of vendors and contractors.

In conclusion, the half-full way of looking at a national video franchise is to think opportunistically. It really is a way for cable operators and cities to work even more closely together, collaborate on building community infrastructure, and above all a reason to invest more heavily in the design, build out, and deployment of new services to premium customers. While it will no doubt be healthy for competition in larger more lucrative video markets, it isn't going to lead to broadband services being available in Horton, Iowa any time soon.

Check out these other Birds-Eye.Net papers/products regarding broadband policy:

• Local Video Franchise: Asset or liability - A journey from local video monopoly to a true broadband free market economy
• Skype Loop Hole - How Skype exploited holes in telecommunications legislation and hype from Forbes and Red Herring

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