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.
by Thomas R. Eisenmann

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

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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.