Cable TV: From Community Antennas to Wired Cities
The cable television industry has long outgrown its roots as a source of better TV reception to achieve its present place as a key player in the emerging telecommunications infrastructure. That change, writes HBS Professor Thomas R. Eisenmann in Business History Review, amid different managerial respondes to the twin—and sometimes competing—objectives of stabilty and growth. In this excerpt, Eisenmann looks at the formative years of the industry, from 1948 to 1975.
John Walson launched the first commercial cable television system in Mahanoy City, Pennsylvania, an Appalachian town eighty-six miles from Philadelphia. 1,2 Walson worked as a lineman for Pennsylvania Power & Light and also owned a local appliance store, which held an inventory of unsold TV sets. To demonstrate the sets, he secured informal permission from his employer to string an electrical wire from a local hilltop to serve as an antenna for the reception of signals from Philadelphia stations. When customers who purchased TV sets asked to be connected to Walson's antenna, he recognized a business opportunity. Walson charged two dollars a month for this service, and by the middle of 1948 had 727 customers. He and other entrepreneurs soon began setting up similar "Community Antenna Television" systems in rural areas where television reception was poor. By 1955, there were about 400 such systems with a total of 150,000 subscribers. Thus, cable TV was born of necessity very shortly after the mass market for television broadcasting began to grow. 3
The first CATV systems carried only three channels, which matched or exceeded the number of TV stations locally available in the rural areas where cable got started. By the end of the 1950s, however, cable technology had improved to the point where 12-channel systems were commonplace. 4 Cable entrepreneurs used these additional channels along with microwave relay systems to import broadcast signals from distant markets. By expanding program choice in this manner, cable operators were able to increase prices and attract more customers. Cable entrepreneurs also saw an opportunity to create "cable-only" channels by acquiring programming rights from movie studios and sports franchises. Cable operators then could charge customers a premium for access to these "pay TV" channels, above the monthly subscription charge for what came to be known as the "basic tier" of broadcast channels.
The first forays into pay TV were vigorously opposed by movie theater owners and by advertising-supported television broadcasters. Movie studios, afraid of alienating theater owners and broadcasters, their largest customers, generally were unwilling to provide pay TV operators with programming. The Federal Communications Commission (FCC), concerned that pay TV would divert viewers and thereby undermine ad-supported broadcasting stations, promulgated a series of regulations that retarded the growth of pay TV. As a result, early efforts to develop pay TV were unsuccessful. 5
The FCC's opposition to pay TV was consistent with a broad reversal of its policy toward cable television that began during the late l950s. Through most of that decade, the Commission had adopted a laissez-faire stance toward cable, on the grounds that it lacked jurisdiction over the industry, and that, in any case, extending the reach of broadcast signals served the public interest. 6 By the late l950s, however, it was impossible for the FCC to ignore the enmity that cable TV was generating from broadcasters. TV station owners asserted that cable operators' importation of distant signals reduced their audiences. Stations whose signals were imported complained that cable operators profited from their programming without paying for it. The FCC, committed to developing a robust local broadcasting industry, first intervened to restrict a cable operator's actions in the Carter Mountain case of 1959, when it denied the Riverton, Wyoming cable company permission to import distant broadcasters' signals. 7 After the Carter Mountain decision survived court challenges, the FCC formalized its policies concerning the importation of broadcast signals. In 1966, the Commission required cable operators operating in the 100 largest television markets (where 87 percent of the U.S. population then lived) to obtain formal permission—which almost never was granted—before importing distant signals. 8
The FCC's restrictions may have slowed cable's expansion into urban markets, but the overall rate of growth for the industry actually accelerated during the late 1960s. The total number of homes subscribing to cable grew at a compound annual rate of 30 percent between 1966 and 1970, and reached 4.5 million at the end of that period. By contrast, the compound annual growth rate in subscribers for the 1961 to 1965 period was 15 percent, and for 1955 to 1960 was 21 percent. Cable's rapid growth during the late 1960s was spurred by high profits. Typical cable systems outside the top 100 markets earned rates of return on net investment (before taxes and interest expense) over 40 percent. 9
Wired Cities: 1970-1975 (10)
With industry growth surging through the 1960s, cable began to draw attention from policy makers and academics who looked beyond its economic impact on the broadcasting business, and saw a potentially revolutionary communications medium. These policy makers and academics were influenced by the ideas of Marshall McLuhan and by a Zeitgeist concerned with social change. 11 In their view, with its abundant channel capacity, cable could become the savior of American television, which had become a "vast wasteland" in the hands of greedy capitalists. 12 In "wired cities," citizens could produce their own programming and distribute it on channels that cable operators would provide to municipalities free of charge, as a condition of franchise approval. "Narrowcasting" would supplement broadcasting with an array of arts and educational programming. Jeffersonian democracy would bloom as cable subscribers used "two-way," interactive cable technology to cast votes in public referenda. 13
By the early 1970s, with organizations like the RAND Corporation, The Brookings Institution, and the Sloan Commission all calling for more supportive regulation of cable, pressure for change was building. 14 The Nixon Administration, beleaguered by the broadcast networks, encouraged cable's growth, under the theory that "the enemy of my enemy is my friend." FCC Chairman Nicholas Johnson, an ardent supporter of the wired cities concept, championed a series of FCC actions helpful to the cable industry. 15 For example, the Commission sought to rescind its restrictions on the carriage of distant signals into the top 100 markets. After much debate, in 1972 the FCC issued standards for the number of broadcast station signals that should be available in a community. Cable operators were allowed to import distant signals up to the point where the standards were met. In 1972, the FCC also limited the franchise fees that municipalities could charge cable operators to three percent of revenue, and fixed the length of franchise agreements at fifteen years, reducing uncertainty for cable operators when bidding for new franchises or renegotiating the renewal of existing franchises. 16
With new rules in place improving their access to programming and capping franchise fees, cable operators rushed to develop urban markets. They encountered a chaotic and sometimes corrupt process as they negotiated for franchises. 17 In addition to the aggressive demands of city officials, cable operators encountered higher than expected construction costs as they entered urban markets. It proved difficult to lay cable under busy city streets while avoiding disruption to existing power, phone, water and sewer lines. 18 Penetration also developed more slowly than expected, because city dwellers tended to have access to more over-the-air broadcast signals than subscribers in rural areas; reception of these over-the-air signals usually was good; and the urban population was more transient, which implied higher subscriber attrition rates and thus increased marketing and field service expenses.
With low penetration and high capital and operating expenses, cable operators experienced significant losses in most urban systems. Hence, in 1975, the industry was not very profitable. Based on financial data for seven public companies predominantly engaged in operating cable systems, the sample companies' weighted average pretax income was only 3.1 percent of revenues. 19 This low profit margin reflected the interest expense associated with an average debt-to-equity ratio for the sample companies in excess of 2-to-1. The two largest cable companies, TelePrompTer and TCI, nearly went bankrupt during the early 1970s due to excessive debt leverage. 20
The cash drain from building and operating cable franchises encouraged industry consolidation. Despite the fact that over three thousand separate franchises had been awarded by cities and towns across the United States, by 1975, the 50 largest multiple systems operators (MSOs) served 72 percent of the industry's total subscribers. 21 Of the 7.1 million subscribers in systems operated by the top 50 MSOs, 25.7 percent were customers of seventeen owner-managed focused firms; 24.3 percent were customers of seventeen owner-managed diversified companies; 11.5 percent were customers of three agent-led focused firms; and 38.5 percent were customers of thirteen agent-led diversified companies. 22
Through the 1970s, both owner-managed and agent-led focused firms typically were still run by their founders. 23 However, in the case of the agent-led focused firms, the entrepreneurs' ownership stakes had been diluted by issuing new equity to fund expansion. Owner-managed focused firms also financed their growth by issuing additional stock, but in many of these firms the founder preserved control of a majority of shareholder votes by creating a separate class of equity with superior voting rights. Also, in owner-managed focused firms, the founders frequently avoided dilution of their ownership stake by relying more heavily on debt to fund expansion than their counterparts in agent-led focused firms.
In 1975, thirty of the fifty largest MSOs were subsidiaries of diversified companies. Seventeen of these thirty diversified companies were led by owner-managers—usually the firm's founder, but sometimes a second-or third-generation family member, as with Cox Communications and the Providence Journal. Most of the thirteen agent-led diversified firms had widely dispersed equity ownership; however, in a few companies, like Times Mirror and King Broadcasting, members of firms' founding families owned the majority of shares. Among these thirty MSOs owned by diversified corporations, eight, including Cox, Times Mirror, and Newhouse, had corporate parents that owned both newspapers and broadcasting properties. Another thirteen were owned by parents that owned TV and/or radio stations, but no newspapers. This group included many smaller companies, like Gill Industries, which owned a TV station in San Jose, along with giants like General Electric, Westinghouse, and General Tire. 24
Expanding into cable TV—either by applying for franchises or by acquiring established cable companies—was a natural strategy for broadcasters and newspaper companies for three reasons. 25 First, in securing cable franchises, media company managers could leverage their knowledge of local communities and their political processes. However, some companies avoided franchising: their executives worried that the need to influence city officials might put the company's reputation at risk. Second, managers in many diversified media companies viewed entry into cable as a hedge: they believed that their newspaper readership and broadcasting audiences might decline over time due to competition with cable, and wanted to reduce their dependence on advertising revenues, which fluctuated with growth in the economy and thus engendered earnings volatility.
Finally, cable provided an outlet for cash flow generated by diversified media companies. During the 1960s, television broadcasting had grown into a very profitable business. 26 At the same time, margins were rising in the newspaper business as publishers converted from hot-to cold-type printing technologies, and captured the labor cost savings afforded by new techniques. Nieva de Figueiredo, in her study of the post-war U.S. newspaper industry, explains that the demands of managing technological change and labor strife had proved overwhelming for many newspaper companies still run by second-and third-generation family members, so they turned to professional management. 27 According to Nieva de Figueiredo, these agent CEOs realized they had only modest opportunities for wealth accumulation in private companies. They encouraged owners to take their companies public, and to grant stock options to management. Once public, stock valuations depended on Wall Street's perceptions that the company would sustain strong growth. At first, newspaper chains met growth targets by acquiring independent, family-owned newspapers. Eventually, the pool of such properties was exhausted, so the chains turned their attention to broadcasting and cable during the 1960s and 1970s.
1. On the Cable: The Television of Abundance (New York, 1971) was the title of the report prepared by the Sloan Foundation's Commission on Cable Communications. The Commission was chaired by Edward Mason, the Dean Emeritus of Harvard's Graduate School of Public Administration. Among its other members were the former mayors of Atlanta and Boston; IBM's chief scientist; Professor James Q. Wilson of Harvard; and the presidents of The Brookings Institution, The Urban Institute, The University of Chicago, The Rockefeller University, MIT, and the RAND Corporation. After reviewing the technological potential and social implications of cable television, the Commission concluded that federal regulation should be changed to encourage the industry's growth.
2. This account is drawn from the first installment of a three-part series on the cable TV business, published by Thomas Whiteside in the New Yorker (20 May, 27 May, and 3 June 1985). Simon Applebaum, "The Great Cable Controversy: Who Launched First?" Cablevision, 4 May 1998, 16, described an ongoing dispute over which of four entrepreneurs (including Walson) actually launched the first cable system. Additional information on the early history of the U.S. cable industry is available in "Cable Television: The First Fifty Years," a series of monthly supplements to the 1998 editions of Cable World, and from a website (www.cablecenter.org/) maintained by the National Cable Television Center and Museum (NCTC&M).
3. Although RCA's National Broadcasting Company (NBC) began broadcasting television signals in New York in 1939, diversion of electronic components for military use limited the industry's growth until after World War II. See Sally Bedell Smith, In All His Glory: The Life of William S. Paley (New York, 1990), Ch. 17, and Erik Barnouw, A History of Broadcasting in the United States, published in three volumes (New York, 1966, 1968 and 1970).
4. Cable channels originate from a "headend," where over-the-air signals are captured by antennas, then modulated (assigned a channel number) onto coaxial copper lines. The basic principles of cable TV technology are described in Walter S. Ciciora, An Overview of Cable Television in the United States (Boulder, Colorado, 1990), published by CableLabs, the cable industry's research and development consortium.
5. John R. Barrington, "Pay Cable-An Old Idea Whose Time Has Come," in The Cable Communications Book: 1977-1978, ed. Mary L. Hollowell, (Washington, D.C., 1977) described these early efforts. Whiteside (I, 48-58) also related an account of the most ambitious project, Subscription Television Inc., which launched a cable-delivered pay TV service in California in 1964. The venture, backed by Dun & Bradstreet and by the electronics firm Lear Siegler, obtained broadcast rights for the Los Angeles Dodgers and San Francisco Giants baseball games. However, the service had problems contracting for Hollywood films, and theater owners in California sponsored a successful referendum banning pay TV in that state. Subscription Television Inc. went bankrupt after five months of operation.
6. This section draws on George H. Shapiro, "Federal Regulation of Cable TV-History and Outlook," in Hollowell. Other sources offering summaries of cable TV's regulatory history include Willis Emmons and David Grossman, Note on Cable Television Regulation, Harvard Business School case 9-391-022, 1993; Whiteside, I, 46-60; Paul W. MacAvoy, ed., Deregulation of Cable Television (Washington, D.C., 1977), 5-9 and 25-33; and Kas Kalba, Cable Meets the City: A Case Study in Technological Innovation and Community Decision-Making (Cambridge, Mass., 1975), 52-57.
7. The FCC had long considered localism and diversity of programming to be priorities when shaping broadcast regulation. The Commission was particularly concerned about network domination of TV broadcasting. To check the networks' power, the FCC authorized a large number of new television stations, mostly in the UHF band (channels 14-83), which is more prone to interference than the VHF band (channels 2-13). Congress passed FCC-sponsored legislation in 1962 requiring TV set manufacturers to add UHF tuners to new sets. Having invested political capital in an integrated set of policies to promote local broadcasting (see Barnouw, II), the Commission was sympathetic to protests about the impact of cable TV.
9. Roger G. Noll, Merton J. Peck, and John J. McGowan, Economic Aspects of Television Regulation (Washington, D.C., 1973), 158-159. According to these Brookings Institution researchers, investment in cable plant was largely fixed, so profits were sensitive to penetration rates. Penetration was defined as the number of homes subscribing to the basic tier of cable service divided by the total number of homes "passed" by cable lines on their street. Penetration rates were determined by the quality of off-air reception (which was related to distance from station transmitters, transmitter strength, and interference from hills or large buildings); the number of over-the-air broadcast signals available locally; the number of distant signals imported; pricing; the quality of the cable operator's marketing and service efforts; and community demographics. At 75 percent penetration-a typical figure outside of the top 100 markets-a system could earn a 46 percent pretax return on the average book value of its assets. Given the fixed nature of cable plant investment, an otherwise identical system with 45 percent penetration would earn returns in the low 20 percent range.
10. The terms "wired cities" and "wired nation" were used beginning in the late 1960s to describe a vision of communities interconnected through two-way broadband ("broad bandwidth") communications networks. See for example an article by Ralph L. Smith, "The Wired Nation," in The Nation, 18 May 1970, 582-606, later expanded into a book with the same title (New York, 1972).
11. Stuart M. DeLuca, Television's Transformation: The Next 25 Years (San Diego, 1980), 191-193, offered a brief history of the ideas that influenced a group he called the "media freaks," and chronicled their rising power within the FCC and the broader policy arena during the early 1970s. McLuhan was famous for observing that "the medium is the message," and speculating that electronic media would transform human societies into a "global village" in which computer technology would someday render human language obsolete. See Gary Wolf, "The Wisdom of Saint Marshall, the Holy Fool," Wired, Jan. 1996.
12. According to the NCTC&M website, several technological developments boosted the channel capacity of cable systems in the 1960s, including the use of solid state electronics in amplifiers and the introduction of set-top converters that processed signals in frequencies above the 12 channel VHF band. By the early 1970s, 35-channel systems were the industry standard, and 100-channel systems seemed feasible. Data on changes in cable system channel capacity are provided in Walter S. Baer, "Telephone and Cable Companies: Rivals or Partners in Video Distribution?" in Video Media Competition, ed. Eli Noam (New York, 1984). "The Vast Wasteland" was the title of a speech delivered by FCC Commissioner Newton Minow to the National Association of Broadcasters on 9 May 1961. Minow said, "There are many people in this country, and you must serve all of us. You will get no argument from me if you say that, given a choice between a Western and a symphony, more people will watch the Western. I like Westerns and private eyes too-but a steady diet for the whole country is obviously not in the public interest." Cited in Noll, Peck, and McGowan, 2.
13. Two-way cable allowed customers to push a button on a hand-held remote control, sending an electronic signal back to the cable system headend. With two-way technology, customers could register a preference in a referendum; authorize delivery of "pay-per-view" programming; or purchase merchandise from home shopping services. "On-demand" services were envisioned as an extension of two-way technology: such services would deliver unique information and entertainment programming to individual households upon request, operating much as the Internet does today. James D. Scott, Bringing Premium Entertainment into the Home via Pay Cable TV, Michigan Business Reports #61 (University of Michigan Graduate School of Business Administration, 1977), 5, noted that as of June 1972, 16 cable systems had tests of two-way services underway.
14. The RAND Corporation prepared two reports on cable TV in 1970: The Future of Cable Television: Some Problems of Federal Regulation, RM-6199-FF, Jan. 1970; and Richard A. Posner, Cable Television: The Problem of Local Monopoly, RM-6309-FF, May 1970.
15. DeLuca, 193. During this period, Nixon's Justice Department also prohibited equity participation by ABC, CBS, and NBC in the production of primetime entertainment programs. Shapiro, 9-14 documented the FCC actions described in the balance of this paragraph.
16. Prior to the FCC's 1972 action, franchise fees typically ranged between 1 to 6 percent of the cable operator's revenue, according to Shapiro, 10. Leonard Tow, CEO of Century Communications, said that cities and towns sometimes negotiated franchise fees as high as 35 percent, leaving the cable operator little or no profit margin (personal conversation, 25 Aug. 1995). The terms of franchise agreements tended to range between 10 and 35 years, according to Posner, 6.
17. Whiteside, II, gave an account of the franchising process in Milwaukee, where several cable companies offered unseemly investment opportunities to prominent citizens to secure their support. Kalba presented a case study of the franchising process in Cincinnati, Ohio, which began in 1972. He described how conflicting community interests led to shifting priorities and indecision. At the end of 1974, when Kalba finished his study, it still was unclear when Cincinnati would award its cable franchise. In the appendix to "Franchise Bidding for a Natural Monopoly," Ch. 13 of The Economic Institutions of Capitalism (New York, 1985), Oliver E. Williamson described how the terms of the Oakland franchise had to be renegotiated during the early 1970s to resolve the franchisee's economic problems. Williamson's objective was to refute proposals made by University of Chicago economists, who had suggested that with a natural monopoly like cable TV, franchises should be awarded to the party offering the largest lump sum or the lowest price to consumers. Using the Oakland case study, Williamson showed that in a turbulent environment, it was difficult to draft complete contracts that specified each party's rights and obligations under all possible contingencies. Williamson concluded that regulation, while problematic, was superior to rigid franchise bidding.
18. According to Scott, 4, in rural areas, the cost per mile for aerial construction of cable plant (i.e., attachment to telephone poles) was about $3,500. In urban areas, where congested city streets slowed construction, aerial construction averaged $10,000 per mile. Underground construction, frequently required in urban areas where utility lines were buried in conduits, could cost $75,000 per mile.
22. In owner-managed firms, the CEO's shareholdings are large enough to: one, align his or her personal financial interests with those of other shareholders; and two, ensure the selection of supportive directors, allowing the CEO to sponsor strategies free from concern that he or she could be terminated if the strategies were to fail. Following Randall Morck, Andrei Schleifer, and Robert W. Vishny, "Management Ownership and Market Valuation," Journal of Financial Economics 20 (1988): 293-315, who asserted that control of 20 to 30 percent of a firm's equity typically is sufficient to thwart a hostile takeover bid, CEOs were defined in this study as owner-managers when they owned 20 percent or more of the equity in a firm with a single class of stock. In firms with a "B" class of stock with superior voting rights, CEOs were defined as owner-managers when their shareholdings entitled them to at least five percent of dividends and to elect a majority of directors. Finally, the CEOs of limited partnerships were defined as owner-managers, because they typically had a "carried interest" that entitled them to a share-often 20 percent-of any distributions paid by the partnership, and could only be removed by a majority vote of the limited partners. In firms separating the positions of Chairman and CEO, a Chairman's equity was added to the CEO's in determining whether the firm was owner-managed, provided the Chairman's job represented his or her principal occupation. Equivalent to "dominant" firms in Rumelt's classification (Strategy, Structure and Economic Performance, [Boston, 1974]), "focused firms" were defined in this study as earning at least 70 percent of their revenues from cable system operations and cable programming services.
23.This paragraph is based largely on face-to-face conversations with eight senior executives of seven owner-managed focused firms, and two attorneys who both had specialized in cable transactions since the 1970s. Interviewees included Leonard Baxt, a senior partner at the law firm Dow, Lohnes & Albertson (23 Apr. 1997 and 3 June 1997); Julian Brodsky, Vice-Chairman of Comcast (10 Oct. 1997); Amos Hostetter, CEO of Continental Cablevision (3 May, 1995 and 14 Feb. 1997); Glenn Jones, CEO of Jones Intercable (18 Feb. 1997); Jerry Kern, a senior attorney at the law firm Baker & Botts, and a Director of TCI (18 Feb. 1996 and 4 June 1996); Gerry Lenfest, CEO of Lenfest Group (25 Sept. 1996); John Malone, CEO of TCI (25 Sept. 1996 and 18 Feb. 1997); Fred Nichols, President and COO of TCA Cable (24 Sept. 1996); Brian Roberts, President of Comcast (13 Feb. 1997); and Leonard Tow, CEO of Century Communications (25 Aug. 1995). The NCTC&M website also provides information on the motives and methods of early cable entrepreneurs (see "Oral Histories" within the "Library" section, and "Hall of Fame," "Legends," and "Pioneers" within the "Museum" section).
24. Two of the MSOs on the top 50 list were owned by small newspaper companies that held no broadcasting interests. Five of the remaining seven diversified firms, including Time Inc. and Warner Communications, owned other types of media properties.
25. In addition to the Nieva de Figueiredo study cited below, this section is based on personal conversations (face-to-face unless noted) with fourteen senior executives of eight diversified companies that owned cable systems and with Leonard Baxt (cited above). Interviewees included Frank Batten, Chairman of Landmark Communications and TeleCable (telephone conversation 26 June 1997); Glenn Britt, EVP of Time Warner Cable (telephone conversation 5 Aug. 1997); William Burleigh, CEO of E. W. Scripps (12 Aug. 1996); Daniel Castellini, CFO of E. W. Scripps (12 Aug. 1996); Jack Fontaine, President and COO of Knight-Ridder (23 Jan. 1997); Stephen Hamblett, CEO of Providence Journal (18 Dec. 1996 and 3 Oct. 1997); Gerald Levin, CEO of Time Warner (9 Jan. 1997); Robert Miron, CEO of Newhouse Broadcasting (telephone conversation 13 Nov. 1996); Trygve Myhren, President and COO of Providence Journal, and formerly CEO of ATC, Time Inc.'s cable subsidiary (17 Feb. 1997); Anthony Ridder, CEO of Knight-Ridder (23 Jan. 1997); James Whitson, EVP and COO of Sammons Enterprises (25 Feb. 1997); Al Ritter, CFO of TeleCable (12 Dec. 1996); Dick Roberts, CEO of TeleCable (12 Dec. 1996); Alan Spoon, President and COO of Washington Post (27 Jan. 1997). Also, Whiteside, "Cable - I," 60-69, offered an account of Time Inc.'s early vacillations in the cable business, and Connie Bruck, Master of the Game: Steve Ross and the Creation of Time Warner (New York, 1994), 67-69, described factors that motivated Warner Communication's entry into cable.
26. In 1969, the television broadcasting industry, in aggregate, earned a 20 percent pretax operating return on revenues, and had a pretax return on tangible book value of 73 percent, according to Noll, Peck, and McGowan, 16.
Excerpted from the article "The U.S. Cable Television Industry, 1948-1995" in Business History Review, Spring 2000.
For more about Business History Review, click here.