Consumers and their satellite dishes

How strong is the bond?

Sep 01, 2002

Sections Economics

A new study shows that cable companies have a greater degree of market power than satellite companies.

Home satellite systems provide the only alternative to local cable television companies for most Americans. The number of satellite customers has grown from 400,000 in 1994 to 10 million in 1999, making satellite dishes one of the fastest adopted consumer products in U.S. history. Despite the popularity of this new product, just how much competition is there between cable and satellite?

During the last two decades, economists have devoted increasing attention to the importance of new goods and their role in enhancing competition. In a new study, "The Consumer Gains from Direct Broadcast Satellites and the Competition with Cable TV," two University of Chicago Graduate School of Business professors, Austan D. Goolsbee and Amil K. Petrin, examine Direct Broadcast Satellites (DBS) as an alternative to cable television, and the subsequent impact this new product has had on consumers.

In a market with very few players, DBS is cable's only serious competitor, currently holding a 15 percent market share, 5 percent higher than in 1999, when data for the study was collected.

The degree of competition between cable and satellite is a central issue in debates over the regulation of cable prices. The study is also relevant to two of the biggest proposed telecommunications mergers in history, which are currently awaiting Federal Communications Commission and Department of Justice approval: the merger of the two biggest satellite providers, EchoStar and DirecTV, and the sale of AT&T Cable to Comcast, which would create the largest cable company in the world.

Using detailed data on the television choices of 45,000 people, Goolsbee and Petrin measured consumer demand for four television options: satellite, basic cable, premium cable, and local antenna only. The study focuses on how sensitive consumers are to changes in price, as shown by changes in demand. A key question the study tries to answer is how much of a check on DBS prices does cable provide, and vice versa.

"Consumer sensitivity to changes in price reflects how much competition there is in the market," says Petrin. "If consumers view cable and satellite as being close substitutes to each other, a small change in the price of one will cause consumers to switch to the other. That puts a check on what competitors can do in terms of charging higher prices."

Contrary to popular assumptions that cable and satellite are very similar products, the study shows that satellite dishes are not easily substituted for cable, despite satellite's growing popularity with consumers.

"We find that if you raise the price of cable, not that many people switch to satellite," says Goolsbee. "This suggests that cable is not very price sensitive and therefore has a fair degree of market power. Satellite, on the other hand, is extremely price sensitive, and looks like a pretty tough business to be in at the moment."

A Love Affair with Television

In 1999, 97 percent of U.S. households had a television and almost 75 percent had cable or a satellite dish. That same year, the average household watched more than seven hours of TV per day, making it the nation's top leisure activity. Total TV advertising in 1999 exceeded $45 billion and consumers spent $37 billion on cable subscriptions.

"There are a lot of businesses that want answers to important questions about cable and satellite," says Goolsbee. "People in the media business and advertisers want to know what consumers think, how much they watch DBS, and what happens if cable prices go up."

Cable TV rose to prominence over the past three decades, beginning with rural consumers, and became a major alternative source of programming by the 1980s. Since it is very costly to lay cable, regulators at first treated cable companies as a natural monopoly in each local market.

In 1984, the government began deregulating cable prices. Over the next seven years, the average price of cable rose two to three times faster than the overall rate of inflation, though it is not certain whether the price increases were due to quality improvements or increased markups, the authors note.

Public outcry over rising prices led the government to re-regulate cable in 1992. However, dissatisfaction with this solution resulted in government deregulation in the Telecommunications Act of 1996, which encouraged direct competition as an alternative check on prices. This effort has largely failed. Currently, consumer advocates are calling on Congress to regulate cable prices again, until there is viable competition. However, the National Cable Television Association has argued that the rapidly growing market for DBS provides enough competition, so the cable industry does not warrant additional regulation.

Like cable, home satellite systems first began with rural TV viewers who could purchase nine-foot C-band satellite receivers for a few thousand dollars in the 1970s and 1980s. By the mid-1990s, improvements in satellite receiver and digital compression technology set the stage for the next generation of home satellite systems.

Starting in 1994, Americans could purchase a small satellite dish for their home, pay a monthly subscription fee, and receive multichannel video programming without having to subscribe to cable. The new dishes are as small as 18 inches in diameter, and much cheaper than the C-band dishes. Popular systems at the time of the survey were DirecTV, the DISH Network (currently a division of EchoStar), and Primestar (later bought by DirecTV).

These DBS systems offer hundreds of channels, more extensive sports, movies, and pay-per-view options, and typically superior digital video and sound when compared with most cable. Despite the high installation costs (on average $232 in 1999, including equipment), and slightly more expensive programming packages, consumers embraced the product.

At the time of the survey, regulatory restrictions prevented DBS systems from broadcasting local network content to anyone who could get these channels with a regular TV antenna, a restriction that was later lifted. Other restrictions included the 1996 Satellite Home Viewer Act, still in effect, which allows homeowners to put up satellite dishes but does not give renters clear rights to do the same.

The most notable problem with DBS systems is that a user must have a clear line of sight to a broadcast satellite's location in the sky. Buildings, geography, and even trees can interfere with the signal, so the quality of the satellite product varies depending on the user's location. Goolsbee and Petrin's calculations take into account these differences in the physical properties of DBS systems.

Television Choices

Goolsbee and Petrin obtained detailed information on consumer behavior from the Technographics 1999 survey conducted by Forrester, a leading market research company focusing on the information economy. The survey provided demographic information on household size, gender, family income, marital status, education, living accommodations, geographic state, and television market. Households reported whether they had cable or satellite, the amount they spent on premium television, and whether or not their local cable company was owned by one of the seven largest national cable companies: AT&T/TCI, Adelphia, Americast, Cablevision, Cox Communications, Media One, and Time Warner.

The authors matched information on the cable system prices and characteristics of each household with household data on consumer choices, using cable system data from Warren Publishing's 1999 Television and Cable Factbook.

To calculate demand for satellite, expanded basic cable, premium cable, and local antenna, the authors used statistical models for demand, accounting for variations in price, product characteristics, and household demographics. Their calculations also accounted for product quality and differences in taste. Demand estimates are identified by comparing how the likelihood of purchase by people with the same characteristics changes as prices and characteristics of products change.

In economic terms, "elasticity" refers to the percentage change in quantity demanded as a result of a 1 percent change in price. For expanded basic and premium cable, Goolsbee and Petrin find an elasticity of -1, which means that a 1 percent increase in cable price leads to a 1 percent decrease in demand. Satellite has a higher elasticity of -4 or -5, indicating that a 1 percent increase in satellite price leads to a 4 or 5 percent decrease in demand.

"Elasticity is important for sellers to consider," says Petrin. "A high elasticity means there are close substitutes for your product, and therefore you risk losing many customers if you increase your price."

Picture quality and ease of installation appear to be important factors for DBS selection. Satellite ownership is much greater for people with higher dish angles (living in higher latitudes), for homeowners rather than renters, and for people living in single-unit dwellings. The authors find that when people shift away from DBS, fewer than 5 percent switch to local antenna only, while 95 percent switch to basic or premium cable.

Welfare Gains

In addition to calculating demand, Goolsbee and Petrin also measured consumers' "welfare gains" from adopting DBS systems. Welfare gains indicate the highest prices consumers would be willing to pay before demand drops to zero. The authors calculated how much money a consumer would need to be given to make them indifferent to losing their satellite. Some consumers value their satellites at a hundred times the satellite's dollar value, while others value it at little more than the price they paid for it.

"Essentially what economists call the 'welfare gain' is just how much people like something, in dollar terms, over and above what they paid for it," says Goolsbee.

Goolsbee and Petrin find that the average welfare gain for consumers is $100 per year (in excess of the price they paid for satellite), an aggregate of about $1 billion for 10 million households with satellite dishes.

"While the welfare gains for satellite buyers are tangible, the gain is smaller than we expected," says Goolsbee. "It appears that satellites are not an especially valuable improvement over cable except for a relatively small group of people."

Austan D. Goolsbee is professor of economics at the University of Chicago Graduate School of Business. Amil K. Petrin is associate professor of economics and statistics at the University of Chicago Graduate School of Business.