THE OLD ADAGE ABOUT INNOVATION STILL HOLDS TRUE: "You can tell the pioneers by the arrows in their backs." More than 70 municipal utilities have either built or plan to build telecommunications systems with fiber-optic and coaxial cable to compete against local cable television, data communications or telephony providers. Profitability for these ventures has been abysmal, but their customers and regulators are happy. Now large, investor-owned electric utilities are stumbling down the same trail marked with cast-off bandages of these early pioneers. Moreover, the recent merger of AT&T and TCI will bring an unprecedented level of competition to the cable business, making such ventures even more risky.
Losses tracked by the Cable Telecommunications Association (CATA), the cable television trade group, have been horrendous. Glasgow, Ky., one of the first munis to build a competing telecommunications system, has lost more than $1.4 million since 1989 on the effort - subsidized by ratepayers, Glasgow electric officials and the Tennessee Valley Authority, according to CATA. Paragould (Arkansas) Light & Water built its system in 1990 at a cost of $3.2 million, and two years later began raising taxes to cover losses.
Similar horror stories can be found in Cedar Falls, Harlan and Waverly, Iowa; Morgantown, N.C.; Elbow Lake, Minn.; Daleville, Ala.; and Coldwater, Mich. Municipal utilities in these towns built CATV systems even though a private company already provided cable TV service. (CATV, which first appeared as an acronym for Community Antenna Television, is used here to describe a traditional, coaxial cable TV system.)
Jim Paxton, editor of the Paducah Sun, which covers Glasgow, framed the issues in an editorial: "But what are the ethics of cities such as these awarding cable franchises to private companies in a competitive bidding process, collecting large annual franchise fees from the operators who also invest tens of millions to build a system and a market, and then destroying their business by building a city-owned system with artificially low rates?" Paxton questions the ethics of forcing utility customers without cable TV to subsidize those who do via higher electric rates. Paxton asks: "Beyond the question of pure ethics, there is also this issue: What is the proper role of government?"
In this debate, the government's role is the largest issue to resolve. Why did regulators approve such expensive ventures fraught with risk to taxpayer and ratepayer funds? As costs continued to escalate, what sort of oversight and control did regulators exercise? How will regulators respond as the larger, investor-owned utilities do battle with CATV systems, as seen in today's fight between Boston Edison Co. and Cablevision System Corp.?
Regulators and elected officials say they approved these public sector CATV ventures for a simple reason: to improve service.
In any small town or mid-size city, ask the mayor, the city council members, or even a university economics professor appointed to a regulatory board why they approved municipal CATV operation. Invariably, they will cite the disregard for the community shown by the incumbent operator as a major factor. They will plead exhaustion from citizen complaints about the cable operator. The regulators interviewed say they intended to bring higher-quality, lower-cost CATV service to their citizens even if it meant subsidization of nonessential entertainment through essential electric service.
Glasgow: Arrows in the Wallet?
Glasgow was one of the first munis to enter the CATV business. Its superintendent has gained national attention even as the cable industry criticizes the Glasgow system's poor financial performance. Nevertheless, its regulators, customers and the 14,000 citizens of the municipality have continued to expand its funding, allowing it to grow. Glasgow even has begun experiments in telephony.
During the late 1980s, the Glasgow Electric Power Board approved installation of 120 miles of broadband cable for management and control of the electrical system. At that time, William "Billy" Ray, board superintendent, advocated using the broadband network to provide cable TV service as well. He had no trouble gaining approval from the Glasgow board of directors, the mayor or the city council. The city attorney found no legal prohibitions and gave the go-ahead.
"The prior system was high-cost, poor in quality and deaf to our complaints," says Charles Honeycutt, Glasgow mayor. According to Allie Morgan, a telecommunications consultant in nearby Paducah, Ky., animosity against the cable system dated back to 1981, when technical problems with outdated equipment forced the cable company to change programming. It took University of Kentucky basketball games off the air, and the public outcry was deafening.
To offer competing service, however, the Glasgow EPB needed approval from TVA, wholesaler of power to the town. TVA wanted to ensure that electric ratepayers would not subsidize municipal CATV service. Allocating costs of the system became an issue. Ray wanted to allocate four-sixths of the cost to electrical operations. "But TVA says no," according to Ray. "The utility could only charge electric operations [with] two-sixths of the cost, as that is all the bandwidth electric operations use."
A price war ensued, forcing the city to drop its CATV base rate to about $6 a month. Federal and state suits and countersuits followed. Did the city have authority to enter the cable business? Had it used ratepayer assets to compete against a private business? Did it breach its franchise agreement? Would CATV service violate the Sherman Antitrust Act? Eventually, the parties settled. The city's base rate for cable recovered to $14.95, but the financial damage was done.
In 1995, Glasgow began offering telephone and Internet services. In 1996, BellSouth lobbied for a bill in the Kentucky legislature to prohibit municipal utilities from competing against private telecommunications providers. "We asked for a bill to do two things: To account for the cost of telecommunications to the ratepayers and to price services either at or above cost," says Dave Weller, BellSouth regional director in Frankfort, Ky. "We don't want to stop them, we only want to put the service on a baseline for comparison." But the bill died.
According to CATA, Glasgow has had to issue three revenue bonds to finance the CATV operations. CATA estimates that the cable operation has lost from $1.4 million to $1.6 million, despite electric ratepayer subsidies of more than $1.6 million. TVA's 1995 and 1996 audits forced the cable operations to repay electric operations nearly $200,000 each year for expenses shifted from cable to electric without justification. "I've never had a ratepayer complain," Ray says.
Despite the losses, Ray and Honeycutt point to the greater benefit to the community and overall savings as justification: $175,000 a year from the SCADA system (System Control and Data Acquisition), plus $1.2 million a year in cumulative savings to cable subscribers in CATV rates. "Our citizens have benefited," claims Honeycutt. After the city started providing service, "the quality of the other company improved immediately and their prices went down." The EPB's Web site (www.glasgow-ky.com) includes Ray's philosophy on competition. "The GEPB used its existing poles, trucks, billing system and expertise to expand on the affirmative government philosophy which created it," he writes. "Using that philosophy, they have been able to also take broadband telecommunications out of the luxuries of life, only to be used by the wealthy, and place it within the reach of the humblest of citizens."
Given the results, TVA has no problems with Glasgow's CATV operation, according to Mark Medford, TVA executive vice president. "Billy Ray's local rates are quite reasonable, and the cable rates and reliability are also good," Medford says. He also acknowledges political reality: "I know about the importance of basketball in Kentucky."
Tacoma: A Ballooning Budget?
Tacoma Power provides a larger perspective with the same theme: Dissatisfaction with the cable operator influenced the decision to create municipal competition with private enterprise. Tacoma, Washington has a population of about 185,000. Tacoma Power is one of the 14 largest public utilities in the U.S. According to Steve Klein, superintendent of the utility, Tacoma Power first considered the obvious, least-cost route and approached the local exchange telephone carrier U S West? and the cable operator, Telecommunications Inc., about leasing bandwidth on their networks for SCADA. Neither the local telco nor TCI had sufficient capacity on their systems, nor were they interested in the proposal, Klein says.
Tacoma Power hired SRI International of Menlo Park, Calif., to prepare cost estimates for the SCADA system. SRI recommended that the city use the hybrid fiber-coaxial system to also provide CATV, data and telephone communications. The proposed system would cost $69.4 million, paid for out of profits the utility had made in the wholesale power business. "If we hadn't had a surplus from wholesale power sales, it would have been more difficult to do," Klein says. "We might have done only the SCADA."
The public utilities board hired a major accounting firm (which revised the cost estimate to $100 million) and gave its approval. "We felt it was a doable, sound plan and the risks were acceptable," says Ross Singleton, a professor of economics at the University of Puget Sound and then public utilities board president.
The plan went to the city council for approval in October 1997. But Leo J. Hindery Jr., TCI president, went to Tacoma to negotiate an alternative. He offered to build the network for the city for about $30 million. The city rejected TCI's offer. "He came back to talk us out of it," says Councilman Steve Kirby. "He didn't have anything to put on the table. "
Councilwoman Dolores Silas represents one of the economically disadvantaged parts of town. "TCI was not giving us the best service," she says. "Seattle was getting 60 channels versus our 20 channels." Silas did not appear concerned about philosophical questions related to public-private competition, nor the role of regulation and taxation. Nor did she mention the risk of electric ratepayers subsidizing CATV. "The citizens will get better service," she says. "Now, TCI is putting in additional services. I see them everywhere in my part of town now, and we never saw them down here before."
Steve Kipp, a TCI spokesman, acknowledged that TCI is now investing "tens of millions of dollars" in its local cable system. The Seattle/Tacoma area is one of two areas in the U.S. where TCI is testing its @Home Network telecommunications products. The other is the San Francisco Bay area, where TCI is confronting municipal plans to enter CATV.
"TCI is going to get better; Tacoma Public Utilities is going to get better," says Councilman Kirby. "We're all going to benefit." Unless, of course, AT&T Communications Services - the combined AT&T/TCI telecommunications provider envisioned under the proposed merger of the two giants - should gain enough market share to defeat the municipal cable system.
After construction started in Tacoma, costs ballooned to $100 million as the accounting firm predicted. The municipal cable operation is now negotiating a cable franchise with the city, according to Klein. "The city is making efforts to maintain parity between TCI and Tacoma Public Utilities," Klein says. "What we all want is a healthy, competitive marketplace without cross-subsidization."
Singleton, former utility board president, says that competition is the important issue. "It will provide additional competition in a previously stagnant market," he says. "TCI's record of service was generally not good in this market." The board will monitor the project to assure cross-subsidization doesn't take place, and as a fall-back position, the city can always sell the broadband network if projected profits do not materialize.
Alameda: Sinking In Costs?
Alameda, Calif., bills itself as the Island City. It prides itself on having "an island consciousness." In 1887, the city bought the Jenny Electric Co., becoming the first municipal electric utility in California. Now, the Bureau of Electricity is speeding onto the information highway, laying fiber-optic cable despite city charter provisions prohibiting it from entering businesses other than electric service.
Like the other munis, Alameda says it needs the fiber network for SCADA and might as well make use of unused bandwidth. "We had to put in fiber for command and control of our utility system, and the business plan grew out of that," says Matt McCabe, the utility's public information officer. The bureau installed four miles of fiber cable in one high-tech business park, one mile in another, and began leasing bandwidth on the network despite the city charter prohibition. The project came to the city council's attention, which asked the bureau for a business plan in 1996.
The appointed public utility board hired consultants to develop a plan to appease the city council. Unlike Tacoma, Alameda did not investigate alternatives first. Ken Hansen, president of the PUB, says the bureau did not consider alternatives such as leasing bandwidth from Pacific Bell or TCI due to past reliability problems with a network leased from the telco. "Also, our citizens are very disappointed with TCI," Hansen says. Working with sample business plans in the American Public Power Association's Utilities Telecommunications Guidebook, the consultants produced a 10-year, $8-million operational plan. The city council approved the plan in August 1997.
Bill McCall Sr., a former mayor and member of the PUB, brought the city charter prohibition to the attention of the city council. City Attorney Carole Korade issued a ruling that the Telecommunications Act of 1996 preempts all local prohibitions of entry into telecommunications for any entity - the APPA holds the same position - and gave the bureau the green light to continue installing cable. The issue awaits a hearing in the Alameda Superior Court next year.
Nevertheless in 1997, the Federal Communications Commission refused to strike down a Texas statute that bars local governments from providing telecommunications services. "The Texas prohibition is an exercise of the Texas legislature's power to define the contours of the authority delegated to the state's political subdivision," the FCC ruled. (FCC 97-346, released Oct. 1, 1997. An appeal was pending at press time, however, with oral argument set for Nov. 2. See, City of Abilene v. FCC, D.C. Cir. Nos. 97-1633, 97-1634.)
In Alameda, the city electric bureau is also taking a political tack. A charter amendment allowing it to enter into this and other ventures unrelated to electric service goes before the voters in November. Meanwhile, the bureau continues to lay fiber cable and sign telecommunications leases.
Unlike Tacoma, no independent party has been hired to review the business plan. What the plan says, and what the bureau doesn't mention to city council or voters, is that the $8-million capital investment only covers start-up costs for the first three years of CATV operation for 7,500 customers. The plan projects a system serving more than 10,000 CATV customers by year 10 - but doesn't provide cost estimates above the initial 7,500. The $8 million won't cover the utility's own SCADA system, nor the investment necessary for technology for data communications or telephony. All told, the bureau promises a system with costs that could run from $15 million to $20 million, according to Carol Mann, director of cable and satellite operations at The Strategis Group, a Washington, D.C., telecommunications consulting firm.
Hansen claims that the question of total required capital investment is presumptuous - that it's proper for the utility to diversify into other fields. "I believe it is right and proper for the PUB to examine and make recommendations to go forward when the window of opportunity is open," he says. The plan offers no contingency for dramatic cost overruns, with no back door to salvage part of the investment if marketing fails.
Moreover, the plan allows electric operations to subsidize the CATV business - providing use of bureau vehicles, facilities and data processing equipment at an artificially low or zero cost - and with the PUB's approval. "There will be some economies," Hansen says. "You don't have to keep everything separate. You can look at it as a subsidy, but on the other hand, you can look at it as a cost saving. I see it as proper use of resources."
"We are bringing competition to TCI in the best tradition of American business," Hansen says. "That is the best way to benefit the consuming public." The question is whether the consuming public will agree if costs rise to $15 million, AT&T Communications Services offers better service at lower costs, and subscribers refuse to switch, stranding the taxpayer's and ratepayers investment in the municipal cable system.
A Boston TCI Party
RCN Data Corp. recently teamed up with Boston Edison to provide broadband communications in the Boston area. BECo, the holding company for Edison, had received a 49-percent interest for a $300-million investment in RCN/Massachusetts, and had conveyed about 200 miles of fiber cabling and rights of way in Boston and 40 local communities to the joint venture, according to Mike Monahan, Boston Edison spokesman. The local CATV operator, Cablevision Services Corp. (25-percent owned by TCI), filed for intervenor status with the Massachusetts Department of Energy and Transportation and was turned down. However, Janet Besser, DTE chairman, told Public Utilities Fortnightly in late July that Cablevision Services Corp. indeed was a party to the case (DTE Docket No. 97-95). She explained that the case was opened on the commission's own motion, to investigate whether Boston Edison's investment in its RCN subsidiary might violate a prior commission order.
Previously, the DTE had agreed to allow BECo to invest as much as $45 million in energy-related, unregulated subsidiaries provided that BECo would return to the DTE for approval of specific activities. "Lo and behold, without going back to the DTE, they agreed to invest $150 million in RCN and provided cable and rights of way valued at $60 million to $80 million," says Lisa Rosenblum, Cablevision senior vice president. "The electric utility is moving assets built up over the years to the subsidiary without sufficient compensation to the ratepayers."
Monahan says the joint venture will lease space on BECo's rights of ways on the same terms as any other CATV company. The shareholders, not the ratepayers, paid for the fiber cable transferred to the joint venture, Monahan insists. But Rosenblum, who recently served on New York's Public Service Commission, counters that the joint venture provides a double risk to the ratepayers: Not only are they subsidizing BECo's entry into competition with Cablevision, she alleges, but BECo ratepayers will not share in whatever gains the joint venture may realize.
"Customers will have to pay the full stranded costs of Boston Edison," she says. "The utilities agreed to mitigate these costs when they involved ratepayer-funded assets, and the ratepayers are entitled to the benefits of these assets."
George Dean, assistant attorney general in the Massachusetts Attorney General's Office, says his office may file a separate action concerning cross-subsidization of the cable venture with utility rates. "It's a matter of what's the best thing for the consumer," Dean says. "RCN didn't go looking for Boston Edison for its managerial expertise. It needed their rights of way, line crews and other assets. Along with the transfer pricing question, Boston Edison will collect more than $1 billion in stranded costs."
Monahan says the issue is not cross-subsidization or stranded costs, but competition. "Cable TV has never had any competition," he says. "Where is the incentive for cable companies to beef up their systems, control rates, and provide better service? Look at how Cablevision is now investing hundreds of millions of dollars here right now because suddenly there's competition."
"Competition is welcome," Rosenblum says. "But you can't have competition subsidized by captive electric customers. Predatory pricing will preempt the market."
From Here to AT&T
Jim Ewalt, CATA executive vice president, summarizes many of the issues. For one, the cable industry has been hamstrung by the high capital investment necessary to continually upgrade networks with the latest technology. "When cities enter into these risky business ventures, they are trading off the CATV operator's ability to make a long-range investment in upgrading the system in exchange for income to the utility and short-term, low cable rates," he says. "The longer the community maintains the cable-rate savings illusion, the greater the probability that the community will be bypassed by the next stage of technological innovation. Why not offer an economic inducement to the cable operator to lower cable rates, such as reduced franchise fees?"
Many electric utilities, including municipal systems, may now decide to rethink any plans to diversify into telecommunications, after the June 24 announcement that TCI will merge with AT&T to form AT&T Consumer Services. For one, AT&T brings aggressive marketing and deep pockets to this capital-intensive business. TCI brings wholly owned and affiliated cable systems that pass 33 million homes. The merger will not only increase competition for any utility in the CATV business, but it also means that consumers will finally benefit from true competition in the local telephone arena, AT&T's major benefit from the merger.
The AT&T/TCI merger also will bring new issues to the regulatory arena. Without regulation of cable rates, price wars can create a new class of stranded assets in CATV networks lacking enough subscribers to cover costs. The real question is: Will ratepayers and taxpayers have to bail out utilities when they suddenly discover they're unable to compete in this capital-intensive, highly competitive industry?
Len Grzanka is an Alameda, Calif. freelance writer. After filing this article in July, he urged the Alameda city council to submit its cable TV business plan to an accounting firm's independent analysis. Subsequently, he signed a voter information pamphlet against the ballot to authorize the city's bureau of electricity to enter the cable TV business.
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