ARCHIVED - Public Notice CRTC 1990-53
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Ottawa, 15 May 1990
Public Notice CRTC 1990-53
CABLE TELEVISION REGULATIONS, 1986 - CHANGES TO THE REGULATION OF SUBSCRIBER FEES AND RELATED MATTERS
RELATED DOCUMENTS: Public Notices CRTC 1986-182 dated 1 August 1986, CRTC 1987-27 dated 30 January 1987, CRTC 1987-123 dated 4 May 1987, CRTC 1987-177 dated 28 July 1987, CRTC 1988-57 dated 13 April 1988, CRTC 1988-72 dated 29 April 1988 and CRTC 1988-185 dated 10 November 1988; Circulars No. 347 dated 22 July 1988 and No. 354 dated 29 November 1988; CRTC Notice of Public Hearing 1989-14 dated 18 October 1989.
At a public hearing commencing 5 February 1990 in Hull, Quebec, the Commission considered a number of proposals to change the regulation of cable television subscriber fees, as well as various related matters. These proposed changes and other issues had been set out for public comment in CRTC Notice of Public Hearing 1989-14 (the October notice) dated 18 October 1989.
The Commission received 282 written submissions in response to the October notice, including a large number from individual cable subscribers. Submissions were also received from cable licensees and associations, provincial governments, public interest and consumer groups, telephone companies, pay television and specialty service licensees, broadcasters and others. A total of 49 parties appeared at the public hearing to expand upon their written submissions.
The Commission wishes to thank all those who took part in this proceeding. Their contributions have greatly assisted the Commission in reaching its conclusions on the matters under consideration.
The existing provisions for the regulation of monthly basic cable service fees are contained in section 18 of the Cable Television Regulations, 1986 (the regulations), which were enacted on 1 August 1986. In Public Notice CRTC 1986-182 accompanying the regulations, the Commission stated that the impact of the rate setting provisions for Class 1 and Class 2 systems would be reviewed in two years.
In the October notice, the Commission stated:
In light of the Commission's promise to review its approach to cable rate regulation in Public Notice CRTC 1986-182, and in recognition of the changes that have occurred in the broadcasting environment since 1986, in clouding the increase in cable industry profitability (as measured by the return on net fixed assets), the Commission has reviewed the impact of the rate setting provisions of the regulations on subscribers, service suppliers and the cable industry. As a result of this review, the Commission proposed in the October notice certain revisions to the fee increase mechanisms contained in section 18 of the regulations. These proposed revisions were the primary focus of the hearing.
The proposed revisions reflected the Commission's attempt to address concerns related to cable industry profitability as well as the affordability of basic cable service. Both of these issues were the subject of considerable discussion at the hearing.
With regard to the issue of profitability, the Commission has made the following assessments.
First of all, the Commission is of the view that industry profitability should be examined over an eight year business cycle rather than for just a single year. In this regard, the Commission notes that the earned return before interest and income taxes on net fixed assets for the most recent eight year period for which data are available (1981-1988) was 24.2%. This is haded on information reported to Statistics Canada by individual licensees and adjusted by the Commission to reflect standardised rates of depreciation.
Secondly, in terms of the profitability benchmark against which to assess this industry return, the Commission has concluded, on the basis of the evidence submitted at the hearing, that its current benchmark of 24% is too high. This benchmark was derived from the earned return on net fixed assets for the industry as a whole, measured over the period 1973 to 1979.
The Commission considers that the profitability benchmark should no longer be haded only on historical averages, but rather on an appropriate rate of return for basic cable service determined by means of an independent assessment. In this regard, the Commission notes that the Price Waterhouse study submitted by the Canadian Cable Television Association (CCTA) provided the only independent assessment of the rate of return for basic service. For reasons discussed more fully in a later section of this notice, the Commission has concluded that the Price Waterhouse study, which estimated the expected return for the cable industry to be between 22.8% and 25.6%, is flawed in several ways and overstates a reasonable return by at least two percentage points.
At the same time, the evidence in this proceeding is insufficient to allow the Commission to reach a final conclusion as to the specific profitability benchmark it should use. Accordingly, the Commission has decided to retain a consultant to conduct an independent analysis of the appropriate measures of cable industry profitability and to propose a benchmark rate of return. The consultant's report will be made available for public comment prior to the Commission making a final determination.
Finally, the Commission notes that industry profitability, measured in terms of the annual return on net fixed assets, has been increasing steadily since the early 1980s, reaching a high of 28.1% in 1988. After consideration of the evidence filed in this proceeding, the Commission is not convinced that profit levels will decline significantly in the absence of regulatory intervention. Accordingly, the Commission is proposing amendments to the section 18 fee increase mechanisms which would have the effect of lowering the rate of return for the industry, thereby addressing the Commission's concerns with respect to profitability for the industry as a whole.
The Commission will continue the current supervisory approach to the regulation of cable fees. The proposed amendments to section 18 of the regulations would ensure that allowable fee increases compensate only for increased costs, without increasing the profitability of individual licensees. The Commission recognizes that not replacing this section with some form of rate-of-return regulation might allow more efficient licensees to earn or,continue to earn a rate of return in excess of the Commission's profitability benchmark. Therefore, the Commission intends to monitor profitability levels closely over the next several years to determine whether further regulatory action may be necessary or appropriate.
The Commission will soon issue proposed amendments to the regulations to reflect the specific conclusions set out in the following sections of this notice. Until the amendments are enacted, the current provisions of the regulations will remain in effect.
With regard to the affordability of cable service, it is clear that subscribers are concerned about the rapid increases in fees over the last few years. The changes proposed to the section 18 fee increase mechanisms would reduce the magnitude of basic cable service fee increases in the future, while still allowing cable operators to earn a fair rate of return.
However, the Commission recognises that there are other issues affecting the affordability of basic cable service, and these are related to the structure of the basic service. Some of the discussion at the hearing focused on the possible restructuring of the basic service as a means of allowing subscribers greater ability to choose which services they want to receive and then to pay only for those services.
Other issues discussed at the hearing having implications for the cost and structure of the basic service include the cable industry's evolution to addressable technology and concomitant new service options.
In light of these broader issues, the Commission has decided to undertake a review of the structure and cost of cable service, including tiering and linage policies, and has tentatively scheduled a public hearing on these matters for mid-1991.
This time frame will allow the Commission to develop specific proposals with regard to the possible restructuring of basic service and consequent tiering and linkage rules. It will also give the cable industry more time to develop strategies with respect to the issue of addressable technology.
II. SUBSCRIBER FEE REGULATION
1. Connection Fees (section 17)
Subparagraph 17(b)(i) of the regulations limits the charge for the installation or reconnection of a subscriber drop to an amount not exceeding the non-recurring costs to he reasonably incurred in mailing the installation or reconnection.
The Commission clarified this provision in Circular No. 354, dated 29 November 1988, which required licensees to establish separate charges for three categories of connections: new installations, "hot reconnects" and "cold reconnects".
The Commission allowed costs to be averaged within each category to establish a single charge per type of connection. The total revenue collected for each category may not exceed the actual non-recurring costs for that category.
In the October notice, the Commission confirmed its intention to amend section 17 of the regulations to incorporate the requirements of Circular No. 354, taking into account both the need for cost-related charges and the need for administrative simplicity and practicality.
At the hearing, a large number of cable operators expressed support for the approach set out in the circular. Others, however, proposed that they he allowed to subsidize the cost of new installations with revenues from "hot" and "cold" reconnects by increasing the charge for these latter connections beyond their non-recurring costs.
The Commission is of the view that the cost-related framework for connections set out in Circular No. 354 ensures an appropriate balance between the interests of licensees and subscribers in determining the maximum fee for installations. More specifically, the connection policy enunciated in Circular No. 354 allows operators to average the costs of new installations between underground installations and lower cost aerial installations. At the same time, this Circular does not preclude licensees from charging less than the non-recurring costs for a new installation on a regular or a promotional basis. It simply ensures that subscribers are not required to pay more than the nonrecurring costs incurred in reconnecting an existing installation for the purpose of cross-subsidizing new installations or for any other purpose. Accordingly, the Commission intends to amend section 17 of the regulations to incorporate the framework set out in Circular No. 354.
In response to concerns expressed at the hearing about the difficulty of ensuring that technical standards are maintained when offering "hot reconnects" , the Commission wishes to clarify that Circular No. 354 does not require licensees to establish this category of connection. However, those licensees that choose to offer this category must adhere to the requirements outlined in the circular.
The October notice also invited comments as to bow to ensure that a subscriber is not charged more for an installation or reconnection than that permitted in Circular No. 354. Some parties at the hearing proposed that the Commission require licensees to file documentation pertaining to the non-recurring costs for installations and reconnections.
The Commission has concluded that it is not necessary to require licensees to file such data on a regular basis. Instead, the Commission will require licensees, upon request by a subscriber or the Commission, to provide details as to how the total installation or reconnection charge equivalent to the total non-recurring costs of the installation was derived.
2. Monthly Fees
2.1 Partial Indexing Increases (subsection 18(2))
In the October notice, the Commission proposed to retain the partial indexing method of obtaining fee increases (subsection 18(2) of the regulations), whereby licensees may increase the base portion of the basic monthly fee, on or after 1 September of each year, by up to 80% of the percentage increase in the Consumer Price Index (CPI). The "base portion" means the basic monthly fee exclusive of the pass-through portion (subsection 18(3)) and the capital expenditure portion (subsection 18(6)).
The Commission proposes to retain a partial indexing fee increase method to compensate for a portion of inflationary cost increases. The Commission considers that this fee increase mechanism continues to meet its original objective of helping to streamline the regulatory process and decrease regulatory lag, the costs of which are ultimately borne by subscribers. It is also in keeping with the Commission's more supervisory approach to regulation.
Further, the Commission considers that the CPI continues to be the most appropriate cost increase index for the purposes of subsection 18(2) for a number of reasons. First, there is some correlation between the CPI and the cost increases faced by the cable industry in that labour costs, which generally increase at the rate of inflation, typically represent between 30 and 50% of a cable licensee's operating costs. Secondly, this index is well known to subscribers and is convenient to apply. Finally, the Commission considers that alternative indices more relevant to the specific cost structure of the cable industry would be difficult to develop, would offer no substantial advantages compared to the CPI, and could add significantly to the cost of regulation.
At the hearing, the Commission discussed with some parties the nature and level of the productivity offset that should be used in the partial indexing formula. This refers to the amount by which the increase in the CPI is discounted in order to reflect and encourage gains in efficiency.
The current method of calculating the partial indexing fee increase results in a productivity offset that varies with the level of inflation, namely 20% of the increase in the CPI. For example, an inflation rate of 5% yields a productivity offset of 1%, whereas a 10% rate of inflation yields an offset of 2%. Thus, the lower the inflation rate, the lower the productivity offset, while a higher inflation rate results in a higher productivity offset.
The Commission is of the view that the ability of a licensee to achieve productivity gains should not vary with the rate of inflation. Therefore, in keeping with the recommendation of the National Anti-Poverty Organisation, the Commission proposes to amend subsection 18(2) to incorporate a constant productivity offset of two percentage points less than the increase in the CPI. For example, if the CPI increases by 5% in a given year, a cable licensee would he able to increase its base portion by 3%.
In addition, the Commission intends to place a limit on subsection 18(2) fee increases to ensure that the increase in a given year does not exceed an amount equivalent to 80% of the increase in the CPI. This cap would have an effect only when the rate of inflation exceeds 10%.
Given the time required to make the necessary changes to the regulations, this new partial indexing recovery mechanism would take effect commencing with the 1991/1992 fiscal year. The Commission's conclusions with respect to the timing of partial indexing increases and subscriber notification requirements are discussed in a subsequent section of this public notice.
2.2 Pass-Through Increases and Copyright Payments (subsection 18(3))
In the October notice, the Commission proposed to narrow the definition of "pass-through portion" in subsection 18(3) to encompass only CRTC-authorized wholesale fees for programming services. As a result of this change, other types of charges, such as pole attachment fees and microwave charges, would no longer he treated as pass-through but rather as normal expense items.
At the public hearing, the CCTA argued that the definition should be expanded to include fees approved by bodies other than federal or provincial telephone authorities, on the basis that any charge that has been scrutinized by an independent body other than the Commission should become an eligible pass-through. This position was also held by Cogeco Télécom Inc. and Cablenet Limited.
The CCTA, the Ontario Cable Telecommunications Association and some cable companies further suggested that, for amounts payable to third parties for pole attachment and microwave fees, the pass-through portion should be limited to the amount of the increase in excess of 80% of inflation.
The Commission has not found sufficient merit in either of these suggestions to warrant any modification to the proposal outlined in the notice. Accordingly, the Commission intends to amend the definition of "pass-through portion" to include only CRTC-authorised wholesale fees for programming services, and to exclude pole attachment fees and microwave charges. Meanwhile, pass-through charges previously authorized pursuant to subsection 18(3), with respect to pole attachment fees and microwave charges, will remain part of the basic monthly fee but will not he included in the base portion for the purpose of calculating fee increases pursuant to subsection 18(2).
The October notice also requested comments as to whether copyright royalties for the retransmissions of distant signals should be treated as pass-through charges under subsection 18(3). At the hearing, the CCTA argued that copyright fees should be considered as eligible pass-through charges on the grounds that they meet the objectives originally established for pass-through charges outlined in Public Notice CRTC 1986-182. The CCTA maintained that copyright fees for the retransmissions of distant signals should he treated in the same manner as wholesale fees for specialty services.
The Provinces of Nova Scotia and Ontario suggested that copyright fees should he considered a "one-time-only" pass-through.
After considering the evidence presented at the hearing, the Commission has decided that copyright fees should not become an eligible pass-through charge.
In reaching this decision, the Commission recognizes that copyright royalties are similar to the wholesale fees for specialty services in that they represent charges for programming services and are approved by a federal authority. The Commission notes, however, that the criteria used by the Copyright Board to assess the appropriate level of royalties for the retransmissions of distant signals necessarily reflect the legislative framework of the Copyright Act, and not the broadcasting policy set out in the Broadcasting Act.
The Commission considers it appropriate to limit pass-through charges to fees that the Commission itself has scrutinized and authorized in accordance with its mandate under the Broadcasting Act. Only in this manner can the Commission be satisfied as to the reasonableness of the charges and ensure that the issue of affordable rates is adequately addressed. Accordingly, the Commission considers that copyright fees can be distinguished from the wholesale fees for specialty services and should be treated as a normal expense item rather than a pass-through charge.
Although the Commission has decided not to allow copyright fees as a direct pass-through to subscribers, it recognizes that this additional expense may impose economic hardship on some licensees. In this context, the Commission notes that the subsection 18(8) fee increase mechanism continues to be available to those licensees that can demonstrate economic need.
Public Notice CRTC 1990-53 (Continued)
2.3 Capital Expenditure Increases (subsection 18(6))
In the October notice, the Commission proposed to discontinue the capital expenditure method of obtaining rate increases for Class 1 systems. In mailing this proposal, the Commission noted that "in order to ensure an appropriate balance between the interests of subscribers and the needs of licensees, fee increase proposals made by Class 1 licensees based on further capital expenditure requirements should be subject to the more detailed regulatory scrutiny provided for by the subsection 18(8) fee increase method".
At the hearing, representatives of the cable industry argued strongly that the capital expenditure fee increase method should be retained for Class 1 systems. They emphasised the capital-intensive nature of the industry and the fact that ongoing upgrades are necessary in order to improve technical quality and reliability, and to expand channel capacity. They also suggested that removal of the capital expenditure fee increase method would introduce an element of uncertainty into the revenue projections of Class 1 licensees, thereby impairing their ability to attract investment capital and engage in long-term planning.
It was also argued that termination of the capital expenditure mechanism would be unfair to those licensees that have deferred upgrading while they pursued other worthy objectives, such as extension of service.
The Commission's proposal to introduce a five-year "sunset" provision, which would apply to all previous capital expenditure increases taken by both Class 1 and Class 2 licensees, and to all such increases taken by Class 2 licensees in the future, was also strongly opposed by the cable industry.
With regard to past increases, licensees argued that a sunset provision would be a retroactive change to established rules, and hence unfair since there would have been no warning given to the industry. They submitted that, had there been a sunset provision in place from the beginning, many would have opted for subsection 18(8) fee increases which are permanently embedded in the base portion. Furthermore, they argued that the proposed sunset provision could jeopardize long-term financing arrangements.
With regard to future capital expenditure increases, most licensees opposed the introduction of a five year sunset provision on the grounds that recovery of 10% of capital expenditures for each of five years is insufficient. In their view, the sunset provision would preclude recovery of even 50% of their capital expenditures since subsection 18(6) excludes the interest cost of new investments. Some licensees argued that the capital expenditure mechanism is insufficient to cover even the interest costs on these expenditures, let alone paying down the original capital.
During the hearing, the Commission questioned a number of cable industry representatives about the feasibility of limiting the application and scope of the capital expenditure mechanism, in the event that the Commission did not eliminate it entirely for Class 1 systems.
The cable industry generally opposed the alternatives put forward for discussion by the Commission, with the exception of a limit on the amount of any given capital expenditure increase. There appeared to be a consensus among cable industry participants that, in order to address affordability concerns, and to ensure that very extensive capital expenditure programs are subject to the more detailed scrutiny of subsection 18(8), it would be acceptable to limit the amount that could be claimed by a cable licensee each year. The CCTA suggested that an annual limit of 4% of the basic monthly fee would be appropriate, and most licensees agreed. A few licensees suggested a $0.50 limit.
Cable licensees appearing at the hearing also reached a consensus that, if the Commission decided to retain the capital expenditure mechanism for Class 1 systems, it would be appropriate that these increases he taken only after eligible capital expenditures have been completed. Such an approach would eliminate the administrative complexities associated with subsequent adjustments for any overspending or underspending during the year, and could be more acceptable to subscribers since they would not have to start paying for improvements until they were completed.
It was acknowledged that, if the Commission were to adopt this ex post facto recovery of eligible capital expenditures, the nest round of fee increases would occur in January 1992 at the earliest, for the fiscal year commencing 1 September 1990.
The Commission also discussed with some licensees other issues related to the capital expenditure fee increase method, such as the specific items that should be included in the definition of eligible capital expenditures, and the special problems associated with systems having very high subscriber growth rates.
The Commission appreciates the many constructive suggestions presented at the hearing concerning the capital expenditure fee increase method. They have been instrumental in persuading the Commission to modify the proposed changes to subsection 18(6) contained in the October notice.
The Commission proposes to retain the capital expenditure fee increase method for both Class 1 and Class 2 licensees, but with certain changes. The Commission intends to amend the regulations to introduce an upper limit to the total amount of each licensee's annual capital expenditure increase. This upper limit would be equivalent to 3% of the base portion of the authorized basic monthly fee at the end of the previous fiscal year. Although the cable industry had suggested a limit equal to 4% of the basic monthly fee, the Commission has reviewed the increases taken by the industry since the introduction of the capital expenditure method and considers that the lower limit of 3%, taken on the base portion only, would be sufficient to yield potential fee increases, based on eligible expenditures, consistent with the requirements of most licensees.
Such a limit would enable licensees to continue to plan rebuilds on an evenly-paced, long-term basis. Proposed fee increases related to higher levels of capital investment in any given year will have to be justified under the more detailed process provided for under subsection 18(8).
The Commission also proposes to amend the regulations by adding sunset provisions applicable both to subsection 18(6) increases implemented prior to the date of this public notice, and to future capital expenditure increases. In recognition of concerns expressed at the hearing by many cable operators with regard to a sunset provision on previous subsection 18(6) increases, the Commission proposes to allow these increases to remain in effect until 1 January 1995. All future capital expenditure increases would be terminated five years after the date they go into effect.
This approach is consistent with the Commission's view that the capital expenditure fee increase method is intended only to provide an incentive to licensees for certain types of desirable projects and was never intended to provide for full recovery of eligible expenditures.
With regard to the definition of eligible capital expenditures, the Commission intends to make two changes. First, the definition would be clarified to ensure that eligible capital expenditures include only those expenditures that would not have been incurred if the project in question had not been undertaken. Accordingly, expenses such as overhead, that cannot be related to a specific capital project and would have been incurred whether or not the project had been undertaken, would no longer be considered eligible.
Secondly, as proposed in the October notice, new plant construction would no longer be considered an eligible expenditure. The Commission notes that a large part of such construction relates to the servicing of new subdivisions in urban areas and is therefore required by regulation. Accordingly, the Commission considers that it is inconsistent with the incentive-based objective of the capital expenditure fee increase method to have subsection 18(6) apply in these circumstances. Furthermore, the Commission notes that it does not favour the use of the capital expenditure method as an incentive to make expenditures that generate an additional revenue stream.
In recognition of the fact that the above change could affect a licensee's ability or willingness to extend cable service into uneconomic low-density areas, the Commission wishes to emphasize that such initiatives will be given favourable consideration in the context of subsection 18(8) fee increase proposals, to the extent that economic need can be demonstrated. In the future, eligible capital expenditures would include head end equipment for the reception and processing of programming services distributed on the basic service, community programming equipment, and direct costs associated with the upgrading and rebuilding of distribution plant and existing subscriber drops. However, only that portion of the costs of the distribution plant and subscriber drops allocated to the basic service, in accordance with the method of cost separation and recovery outlined in a subsequent section of this notice, would be considered eligible for a corresponding fee increase using the capital expenditure method.
With regard to the procedural aspects of the capital expenditure method, the Commission finds considerable merit in the proposal put forward by several cable industry participants that future fee increases be based on eligible expenditures incurred during the previous fiscal year. The Commission therefore intends to amend the regulations to this effect.
As a result of this change, capital expenditure fee increases for eligible capital expenditures incurred during any fiscal year commencing 1 September would be implemented no earlier than the first day of January following the end of the fiscal year. For example, capital expenditure fee increases for eligible expenditures incurred during the fiscal year commencing 1 September 1990 would he implemented no earlier than 1 January 1992. As part of the documentation to he submitted in support of such increases, licensees would be required to file a schedule showing eligible expenditures actually incurred during the previous fiscal year. The amounts indicated would have to reconcile with information contained in the Statistics Canada Annual Return - Cable Television for that year, which would also be filed with the supporting documentation.
Until the current regulatory provisions with respect to the capital expenditure fee increase mechanism are amended, the Commission will not be favourably disposed towards filings for implementation during the fiscal year commencing 1 September 1990, haded on new spending. However, the Commission will be favourably disposed towards filings with respect to eligible spending during the current fiscal year ending 31 August 1990, and for which subsection 18(6) increases have not already been implemented, provided they meet the existing requirements of the capital expenditure fee increase method.
With regard to any underspending during the current fiscal year, related to subsection 18(6) increases that have previously been implemented, the Commission will take this into account when assessing future capital expenditure fee increase proposals.
Cable subscribers should benefit from the revised capital expenditure provisions in a number of ways. Specific system improvements would be carried out before the associated fee increase goes into effect. Concerns about the continued affordability of monthly fees would be addressed by means of the annual limit and the five-year sunset provision. Further, the Commission notes that, after five years, the capital expenditure component of the basic monthly fee would in fact decrease unless a licensee continues capital spending on system improvements at close to historic levels.
For cable licensees and the Commission, this revised mechanism would continue to provide a streamlined process for obtaining modest fee increases, without the paper burden and regulatory lag associated with subsection 18(8). It should also provide an incentive for licensees to carry out the planning of upgrades on a steady, long-term basis.
2.4 Economic Need Increases (subsection 18(8))
In the October notice, the Commission proposed that, rather than continue to assess subsection 18(8) submissions under the six criteria set out in the public announcement dated 18 September 1974, it would assess all future subsection 18(8) submissions on the single criterion of economic need, using well-defined profitability measures and associated benchmarks. In assessing economic need, the Commission proposed to take into account the revenues and expenses associated with "extended basic' discretionary tiers offering Canadian specialty services.
The Commission currently measures the profitability of basic cable service on the basis of rate of return on net fixed assets before interest and taxes. In the October notice, the Commission invited interested parties to propose alternative methods for measuring industry profitability and to suggest appropriate benchmarks for use in connection with the current or proposed methods of establishing profitability levels.
Both in the written submissions and at the hearing, there was considerable discussion of the proposal to assess subsection 18(8) filings on the basis of the single criterion of economic need. Views expressed ranged from those advocating the maintenance of the current criteria to those arguing that the criteria should be replaced by strict rate-of-return regulation. However, the majority of those that addressed this issue favoured the Commission's proposal.
After considering all the evidence, the Commission has decided to adopt economic need as the sole criterion for assessing subsection 18(8) fee increase proposals. Further, in assessing economic need the Commission will take into account the total revenues and expenses associated with "extended basic discretionary tiers where such tiers contain one or more Canadian specialty services authorized for distribution on the basic service.
As part of the supporting documentation, a licensee will be required to submit a copy of the Statistics Canada Annual Return Cable Television for the most recently completed fiscal year. The Commission recognizes that subsection 18(8) filings will no longer be assessed on the basis of criteria such as quality of service and proposed additions to service, including improvements to community programming. At the same time, licensees should continue to address subscriber complaints with respect to quality of service and fulfil their community programming obligations.
Furthermore, as discussed in a later section of this public notice, once an industry code of service standards is developed, the Commission will take into account the expenses reasonably incurred by a licensee to achieve the prescribed levels of service, in assessing subsection 18(8) fee increase proposals.
With regard to appropriate benchmarks for use in connection with current or proposed methods of establishing profitability levels, three parties made submissions and commented at the hearing: the CCTA, the Consumers' Association of Canada (CAC), and Bell Canada (Bell).
The CCTA commissioned Price Waterhouse (PW) to determine, among other things, the appropriate rate of return for the cable television industry. PW determined that the expected rate of return on net fixed assets for the industry during the period 1981 to 1988 was between 22.8% and 35.6%.
To arrive at the expected return, PW assigned a risk factor to the cable industry based on a comparative assessment among several publicly traded cable licensees and five other selected industries. This risk assessment was then used by PW to estimate the cost of equity for the cable industry using the Capital Asset Pricing Model (CAPM). In turn, the estimated cost of equity was converted to a rate of return on net fixed assets for the industry.
Based on its detailed assessment of the PW submission and its questioning of the PW representatives at the hearing, the Commission has concluded that the PW study contains a number of flaws. The Commission considers that the PW estimate overstates the appropriate rate of return by at least two percentage points haded, among other things, on the fact that the PW representatives admitted at the hearing that a better estimate of the market risk premium would he 8% rather than the 10% figure used in the written submission. Furthermore, PW analyzed the riels specific to the cable industry using data for publicly traded companies that are involved in both basic cable service and
The CAC's assessment of the appropriate benchmark was derived by averaging the cost of equity for Bell and the British Columbia Telephone Company (B.C. Tel) allowed by the CRTC. CAC concluded that the fair return on net fixed assets applicable to basic, discretionary and non-programming services for the cable industry should be 15.8%.
In its submission, CAC stated that, if the Commission considers cable licensees to be riskier than Bell and B.C. Tel, a premium can be added to the average cost of equity for these two companies to reflect this additional risk. CAC considered that the maximum risk premium, in terms of the cost of equity, would be 4%, which translates into an increase in the rate of return on net fixed assets from 15.8% to 19.3%.
Bell did not carry out a study to estimate the appropriate rate of return for the cable industry. Bell considered that the benchmark rate of return for the cable and telephone industries should be similar on the basis that the two industries face comparable risks. Further, Bell recommended that the Commission establish the rate of return within a range, based on reasonable upper and lower limits. Bell considered that an appropriate rate of return on net fixed assets for the cable industry would be approximately 16% to 18%.
In assessing these submissions, the Commission notes that neither CAC nor Bell undertook an independent study to arrive at their recommended benchmarks. The Commission considers that the establishment of a profitability benchmark for basic cable service should not simply be derived from the approved rates of return and capital structures for Bell and B.C. Tel.
After detailed examination of these three submissions, the Commission has concluded that there is insufficient evidence to make a final determination as to the appropriate benchmark to use for assessing the profitability of basic cable service.
Accordingly, the Commission intends to retain a consultant to carry out a detailed independent study to: (i) propose and assess various methods that could be used to measure cable industry profitability, including rate of return on net fixed assets, and any alternative measures which might he appropriate; (ii) propose appropriate benchmarks for use in connection with current or proposed methods of establishing profitability levels; and (iii) assess the feasibility of establishing an appropriate profitability benchmark within a range, rather than as a single, fixed number. With respect to the latter, the consultant would examine the basis on which a licensee's allowed return would be established within the range.
The consultant's report will be made available for public comment prior to the Commission making a final determination. In the interim, the Commission will continue to measure profitability primarily on the basis of the rate of return on average net fixed assets, measured over an historical period of 8 years, and will maintain the benchmark at its current level of 24%.
3. Subscriber Notification and Administrative Procedures
In the October notice, the Commission proposed to lengthen the period that must elapse between the date on which a licensee provides notice to subscribers and the Commission regarding a proposed increase in its basic monthly fee and the date on which the increase is implemented. It proposed to change the notification period from 40 days to 90 days for increases pursuant to subsections 18(2), 18(3) and 18(6). In addition, the Commission proposed that subscribers be provided with 30 days to submit comments regarding subsection 18(6) increases, rather than the current 20 day period. This would make the comment period for subsection 18(6) increases the same as that for subsection 18(8) increases.
At the hearing a number of cable industry representatives and the Government of Nova Scotia suggested that the notification period should be extended to 60 days rather than 90 days as proposed in the notice. Generally, these parties were concerned that, with a 90 day notification period, some subscribers will have forgotten the notice by the time the fee increase goes into effect.
The Commission acknowledges this concern and therefore proposes to implement a 60 day notification period for subsection 18(2), 18(3) and 18(6) fee increases. The Commission also proposes to implement the 30 day subscriber response period for subsection 18(6) increases.
Furthermore, as indicated in the October notice, the Commission intends to modify its practice with respect to the suspension or disallowance of a proposed capital expenditure fee increase so that any such action would be taken no later than 60 days after the Commission has received notification from the licensee.
The Commission considers that these changes would improve notification to subscribers, simplify and standardise rules for notifications, and give the Commission more time to process submissions and take subscriber comments into account.
In a earlier section of this public notice, the Commission decided that subsection 18(6) fee increases should he haded on eligible expenditures made during the previous fiscal year. As a result of this change, capital expenditure fee increases for the fiscal year ending 31 August will be implemented no earlier than 1 January of the following year. Given these changes, the Commission considers it appropriate that 1 January also be used for subsection 18(2) increases. This change would take effect on 1 January 1992. The current partial indexing formula would remain in effect for increases to take effect on 1 September 1990.
With regard to the CPI reference date used to calculate allowable partial indexing increases commencing 1 January 1992, the Commission proposes to use the percentage increase in the CPI for the twelvemonth period ending the previous 31 July.
The Commission's internal procedures for processing fee increase applications currently involve the verification by the Commission of the completeness and accuracy of the calculations prior to the implementation of the fee increase by licensees. At the hearing, the Commission proposed an alternative procedure whereby the onus of ensuring the correctness of the calculations for rate increases would be placed on licensees. Fee increases would be implemented by licensees provided they had complied with the appropriate notification period. At the same time, if a subsequent audit revealed that an incorrect increase had been implemented, the Commission would require a reduction of the rate and a refund to subscribers.
The CCTA agreed in principle to this proposal, but was concerned about the possibility of licensees having to provide a refund to subscribers. Instead, the CCTA recommended a roll-back of any improper fee increase and a credit to subscribers on subsequent bills.
In light of the discussion at the hearing, the Commission proposes to adopt this alternative procedure, including the implementation of a roll-back and credit system to deal with any inaccuracies in rate increase filings submitted by licensees, and intends to amend the regulations to this effect.
The Commission will ensure the accuracy of fee increase notifications through subsequent monitoring and in response to subscriber complaints.
III RELATED ISSUES
1. Cost Separation and Recovery
The original CCTA proposal with respect to cost separation, as described in its December 1986 document entitled "Recommendations on Accounting for Non-Rate-Regulated Services" , was based on the principle of "incremental recording" to govern the recording of revenues, operating expenses, and capital expenditures associated with non-programming services and discretionary programming services.
The CCTA subsequently modified its recommendations in a letter dated 15 June 1989, by proposing an extension to the incremental costing approach to include an allocation to non-programming services of a portion of the common facilities operating costs and annual capital expenditures, using a formula based on net revenues.
While acknowledging the merit of the general thrust of the revised proposal, the Commission had concerns with respect to certain details contained in the 15 June letter. In the October notice it proposed to adopt the CCTA's cost separation methodology, but with three amendments.
First of all, the Commission considered that the CCTA's proposal should be expanded to include an allocation of the total historical cost of distribution plant and subscriber drops in use at the end of a given fiscal year, in addition to common facilities operating costs and annual capital expenditures.
Secondly, the Commission indicated that gross revenues, rather than net revenues, should he used to calculate the percentage allocation of these costs to non-programming services.
Finally, whereas the CCTA had recommended that Class 2 licensees not be required to allocate these costs to non-programming services, the Commission proposed to treat Class 1 and Class 2 licensees alike.
In written submissions and at the hearing, interested parties commented on the CCTA's cost separation procedures, as amended by the Commission, and suggested alternative cost separation methodologies. These alternatives ranged from eliminating the need for cost separation, by using the combined rate of return from all services carried by a licensee when assessing fee increase requests for the basic service, to adopting a measure of relative use such as bandwidth to determine the allocation of common costs.
Based on the discussion at the hearing and after considering all the evidence, the Commission has reached a number of conclusions. First, the Commission considers that the common facilities operating costs as well as the annual and historic capital expenditures on distribution plant and subscriber drops are not causal to basic service. Rather, the Commission is of the view that these costs are incurred in common for the provision of basic programming, discretionary programming and non-programming services.
Secondly, having determined that these common costs cannot be allocated to the various services on the basis of cost causation, the Commission has decided that these costs should be recovered from basic and non-programming services on the basis of their share of total gross revenues. In reaching this decision, the Commission is of the opinion that, since the facilities are used in common to provide basic and non-programming services, as well as other services, it is fair and appropriate that non-programming services contribute to the recovery of the associated costs. In the Commission's view, a formula based on gross revenues is easy to apply and yields results as fair as any other measures proposed.
Finally, the Commission has decided not to require discretionary programming services to contribute, at this time, to the recovery of common facilities operating costs and the annual and historic cost of distribution plant and subscriber drops. The Commission is of the opinion that this cost recovery procedure will assist the financial viability of the many Canadian specialty programming and pay television services and thereby further the objectives of the Broadcasting Act.
Accordingly, the Commission has decided to adopt, for both Class 1 and Class 2 licensees, the CCTA's cost separation proposal as amended by the Commission and set out in the notice. Specifically:
1. The Commission will continue to apply the incremental costing approach to discretionary programming services.
2. The Commission will continue to apply the incremental costing approach to non-programming services. In addition, non-programming services will be required to recover a portion of the common facilities operating costs (i.e. system powering, plant leasing, pole attachment, duct rental, maintenance materials, salaries and asset based taxes), and a portion of the annual capital expenditures and total historical costs for distribution plant and subscriber drops in use at the end of a given year.
3. For the purpose of calculating the contribution by non-programming services towards the recovery of the common facilities operating costs and the annual and historical distribution plant and subscriber drop costs, a formula based on the ratio of gross revenues from non-programming services to total gross revenues will be used.
Gross revenues from non-programming services are defined as the total gross revenues, including any revenue from the rental of equipment related exclusively to the delivery of such services, that are earned directly or indirectly by a licensee or other entity, where the licensee and other entity are not dealing at arm s length within the meaning of section 251 of the income Tax Act, for any cable-delivered service other than a programming service. Total gross revenues are defined as the gross revenues from non-programming services, as above, plus the total gross direct and indirect subscription revenues, including any revenue from the rental of equipment other than converters related exclusively to the delivery of programming services, that are earned directly or indirectly by a licensee or other entity as described above for any cable-delivered programming service. Where revenues are earned from the delivery of a discretionary service package containing both programming and non-programming services, revenues from the package are to be allocated to non-programming services using a formula based on the ratio of the number of non-programming services to the total number of programming and non-programming services offered in the package.
4. For the purpose of filing the Statistics Canada Annual Return Cable Television and future subsection 18(8) fee increases, Class 1 and Class 2 licensees must identify total gross revenues by source, all incremental costs and the share of common costs related to the provision of basic and non-programming services, calculated in accordance with the cost separation and recovery procedures outlined above.
These procedures for the separation and recovery of costs will be implemented for the fiscal year commencing 1 September 1990.
2. Fee Deregulation of Small Systems
In the October notice, the Commission invited comments as to whether the principle of fee deregulation, currently applicable to Part III licensees only, should be extended to very small Class 2 licensees (e.g. those with systems serving fewer than 1,000 subscribers), and if so, whether the Commission should establish any mechanism(s) to enable it to safeguard subscriber interests, particularly as they relate to cable fees.
At the hearing, some representatives of the cable industry expressed strong support for the extension of fee deregulation to Class 2 licensees and encouraged the Commission to extend this principle beyond the 1,000 subscriber level proposed in the October notice. Some cable licensees suggested a level of 3,000 subscribers, while others proposed that all Class 2 systems (i.e. systems below 6,000 subscribers) be exempt from rate regulation.
The governments of British Columbia, Nova Scotia and Ontario expressed cautious support for fee deregulation of small Class 2 systems, and urged the Commission to implement a review mechanism which would allow redress in cases in which it was found that excessive rates were being charged.
In addition, a number of cable industry representatives suggested that the Commission also deregulate the signal carriage requirements for small Class 2 systems, and, in effect, treat them as Part III systems.
Representatives of the pay television industry were opposed to the deregulation of the signal carriage requirements for small Class 2 systems, arguing that all Class 2 cable licensees should remain subject to the Commission's priority carriage, tiering and linkage rules.
In light of the views expressed in written and oral submissions, the Commission intends to deregulate the fees of all Class 2 systems serving fewer than 2,000 subscribers. In coming to this conclusion, the Commission notes that there have been very few complaints with respect to the fees charged by Part III licensees.
In order to ensure that subscriber interests are safeguarded, however, the Commission has determined that a review mechanism is warranted for all fee deregulated cable licensees.
As existing licences are renewed, and new licences issued, the Commission intends to attach a condition of licence allowing it to modify the basic monthly fee upon receipt of legitimate subscriber complaints.
The Commission is satisfied that this safeguard mechanism addresses the legitimate concerns raised at the public hearing respecting the need to ensure that subscriber interests are adequately protected under a regime of rate deregulation.
The Commission has decided not to deregulate the signal carriage requirements for Class 2 systems under 2,000 subscribers. In arriving at this decision, the Commission has taken into account the concerns raised by some pay television licensees, and notes that existing Class 2 systems serving fewer than 2,000 subscribers are currently abiding by the Commission's signal carriage requirements as well as the tiering and linkage rules.
3. Standards of Service
In the October notice, the Commission stated that it "is concerned that subscribers receive the highest standard of cable service achievable at an affordable cost and invites the industry and other interested parties to comment on the possibility of developing an industry code respecting standards of cable service .
Virtually all parties commenting on this issue were in favour of the establishment of an industry code concerning standards of service to be provided to subscribers. Most cable licensees supported the process currently under way within the CCTA to develop a code of service standards for ratification by its membership by June of this year.
According to the CCTA, once the standards have been approved, they will he submitted to the Cable Television Standards Foundation for adjudication purposes.
The Commission considers that this is an important initiative taken by the cable industry. The development of an industry-wide code of service standards will help ensure that all cable subscribers have access to the best possible quality of service. Further, as discussed in a prior section of this public notice, the expenditures reasonably incurred by a licensee to achieve these service standards will be taken into account by the Commission in assessing subsection 18(8) fee increase proposals. In this context, it is essential that the code ultimately adopted by the industry include specific, quantifiable criteria with respect to customer service.
In Public Notice CRTC 1988-13, dated 29 January 1988 ("Guidelines for Developing Industry-Administered Standards"), the Commission established guidelines to assist in the development of industry standards which would apply in either of the following two circumstances:
1. the Commission requests a particular broadcasting sector to develop an industry standard and indicates that Commission acceptance should be received; or
2. a licensee or related industry group submits a standard and requests the Commission's acceptance.
The Commission hereby requests the cable television industry, through the CCTA, to develop an industry code with respect to service standards and, in keeping with guideline 5 of Public Notice CRTC 1988-13, to submit the industry code to the Commission for acceptance.
Without intending to limit the scope of the code, the Commission considers that the CCTA should address the following matters, including measurable criteria or benchmarks where appropriate:
i) standards respecting customer service, such as office hours, telephone response and scheduling of service calls;
ii) billing and payment policies, including all options available for the subscriber;
iii) disclosure of detailed information to all subscribers with respect to connection fees, the basic monthly fee and its component parts (i.e. base portion, pass-through portion, capital expenditure portion), fees for discretionary services, charges for decoding devices or converters and charges for additional outlets;
iv) notification procedures with respect to fee increases, including information as to when subscribers should provide comments to the Commission;
v) signal quality and reliability; and,
vi) complaint procedures and follow-up.
The Commission expects that the service standards developed by the industry will apply to all systems. However, since there may be practical differences between the operating characteristics of large and small systems, the Commission recognizes that it may therefore be necessary to take such differences into account in certain specific areas.
The Commission requests the CCTA, in preparing the industry code, to address all relevant guidelines set out in Public Notice CRTC 1988-13. In particular, the Commission draws the CCTA's attention to guidelines 3 and 4, concerning the extent of public participation and the establishment of a fair consultative process in developing the standard. After the code has been submitted, the Commission will decide whether a further public process is warranted prior to the code being accepted.
In order to provide the cable industry with sufficient opportunity to address the various concerns out-lined by the Commission in this notice, the CCTA is requested to submit its code respecting service standards to the Commission no later than 31 December 1990.
Acting Secretary General
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