The Oakland CATV Franchise Bidding Experience

Although the case study reported below cannot claim to be representative, it does reveal that many of the franchise concerns disscused in Chapter 13 are not purely imaginary. The study both indicates the importance of evaluating proposals to scrap regulation in favor of market alternatives in more micro-analytic terms and discloses that, in practice, franchise bidding for CATV (and presumably other public utility services) has many of the qualities of regulation.

1. The Record

On June 19, 1969, the Council of the City of Oakland, California, passed a city ordinance that provided for the granting of community antenna television franchises. The main features of the ordinance, for the purposes of this appendix, were:²

1. The frachise award was to be nonexclusive.
2. The franchise duration was not to exceed twenty years.
3. The City was authorized to terminate a franchisee for non- compliance after thirty days’ notice and a public hearing.
4. The franchisee was directed to supply a complete financial statement to the City annually and the City was given the right to inspect the franchisee’s records.
5. The City had the right to acquire the CATV system at the cost of reproduction.
6. The City Manager was authorized to adjust, settle, or compromise any controversy that might arise among the City, the franchisee, or subscribers, although aggrieved parties could appeal to the City Council.
7. Failure to comply with time requirements of the franchise were grounds for termination.
8. Inasmuch as failure to comply with time requirements would result in damages that would be costly to assess, an automatic fine of seven hundred and fifty dollars per day would be imposed for each day beyond the three-year target completion date that the franchisee took to install the system.
9. Any property of the franchisee that was abandoned in place would become the property of the City.
10. A surety bond of one hundred thousand dollars was to be obtained by the franchisee and renewed annually.
11. Property of the franchisee was to be subject to inspection by the City.
12. The CATV system was to be installed and maintained in accordance with the “highest and best accepted standards” of the industry.

1.1. Operationalizing the Bidding Process 

The above constituted the basic legislative authority and ground rules. Rather, however, than solicit bids immediately, the Department of General Services engaged instead in a set of preliminary discussions with prospective fran- chisees.¹²⁹ Simultaneously, community groups were requested to advise the City on the types of services to be offered. The resulting dialogue was intended to elicit information regarding cost, demand characteristics, technical capabilities, and so on, and would help define the “basic service,” which would then be stipulated in the contract. Comparability among bids for a standardized service would thereby be facilitated.

Ten months later, on April 30, 1970, the City of Oakland apprised five applicants that the City would receive their amended applications to construct, operate, and maintain a nonexclusive CATV system franchise within the City. The main features, for the purposes of this appendix, of the invitation to bid were:

1. Two systems were to be provided:
   1. System A, which is the basic system, would permit the subscriber to receive the entire FM radio band plus twelve TV channels distributed as follows: nine local off-the-air channels; one or more newly created local origination channels; and one channel assigned to the City and School District. Payment of a monthly charge of “X” plus connection charges (see item 5 and 6, below) would permit the subscriber to receive System A.
   2. System B would provide special programming and other services. The mix of programming and other services were left unspecified, The charges for System B were to be determined later by the franchisee with the approval of the City Council.
2. All areas within the city limits of the City of Oakland were to be served.
3. Franchise duration was set at fifteen years.
4. The franchisee was to make annual payments to the City of 8 percent of gross receipts or $125,000, whichever was greater.
5. Connection charges for each of four customer classes¹³² were stipulated, and thus common for all bidders. It was further stipulated that no additional fee be charged to the subscriber for switches or converters needed to receive System A.

1.2. Bid Acceptance

Bids were made on July 1, 1970, the lowest being the bid of Focus Cable of Oakland, Inc., which stipulated an “X” (see items 1 and 6, above) of $1.70 per month.⁷ The next lowest bid was by Cablecom-General of Northern California, which set a rate of $3.48.⁸ The Tele Promp Ter Corporation bid was $5.95 (Libman, 1974, p. 34).

Focus Cable apprised the City at the time of its bid that Telecommunica- tions, Inc. of Denver, Colorado, whose participation had been vital to the qualification of Focus as an applicant, had elected to withdraw from the Focus Cable proposal.⁹ Focus Cable reorganized the corporation under the laws of California and included a copy of the Articles of Incorporation, dated July 1, 1970, with its bid. Inasmuch as Focus had entered the lowest bid (by a factor of two), was the only local bidder, and represented an ethnic minority,¹⁰ the City was reluctant to reject their bid for lack of financial capability and technical qualifications. However, awarding the franchise to Focus plainly Ppsed hazards.

It appeared that these were greatly mitigated when Tele Promp Ter Corporation proposed on July 16, 1970; to enter into a joint venture with Focus Cable to construct and develop the Oakland franchise. As a part of the joint venture. Tele Promp Ter agreed to provide all needed financing for the project.¹¹ Why Tele Promp Ter was prepared to do this at a monthly charge less than 30 percent of its own bid was not disclosed. Presumably, however, the prospect of earning substantial returns on System B was a contributing factor. Focus Cable advised the City of Oakland, in a letter dated July 21, 1970, that ‘‘the proposed financing of Focus by Tele Promp Ter can and will provide the ideal maưiage of local investors, CATV expertise, and over-all financial strength to best develop the CATV franchise in Oakland.” The Focus contribution to this ideal marriage was its local investor attributes.

The agreement between Focus and Tele Promp Ter provided that each should have equal ownership at thế outset but that Tele Promp Ter would convert this to a majority interest immediately and could exercise options after the first year which gave it ownership of 80 percent of the capital stock outstanding.¹⁴ The joining of Tele Promp Ter with Focus was thought to warrant completing the negotiations. A report to the City Council from the City Manager and the City Attorney, dated September 28, 1970, concluded as follows:

Part of the concept of Systems A and B in the specifications was, by competitive applications, to obtain a rate sufficiently low on System A which would encourage the early development of System B. It is staff opinion that the low rate submitted by Focus would motivate such a development. Also, the low rate will assure the widest utilization of System A by families of all economic means.

Focus is the applicant which has submitted the lowest basic monthly subscriber rate. The question has been raised as to whether Focus meets the specifications due to changes in its organization. From a legal standpoint, the organizational change does not disqualify Focus from further Council consideration. It is staff opinion that the proposed agreements between Focus and Tele Promp Ter, with the additional guarantees by Tele Promp Ter, will result in a useful combination of Initial local respresentation with one of the largest and best qualified CATV firms in the United States.

Focus Cable and Tele Prompt Ter Corporation entered into a Subscription Agreement on September 21, 1970, in anticipation of being awarded the franchise. Two hundred shares at ten dollars per share were to be paid for by the organizers of Focus.¹⁶ Additionally, the Agreement provided:

The Corporation shall purchase equipment and products from TPT [Tele Promp Ter] for use in its business in preference to other sources to the extent thatthc quality and workmanship of such equipment and products are comparable to such other sources. If TPT shall sell any such equipment or products to the Corpora-tion, the price to be charged shall not exceed an amount which would be reasonably comparable to the charge for like equipment and products if obtained from an independent supplier dealing on an arm’s length basis.¹⁷

The Subscription Agreement also set out the Tele Promp Ter option to acquire an 80 percent ownership position at an option price per share of $10.¹⁸ The purchase of eight hundred shares at ten dollars per share would thus give Tele Promp Ter an 80 percent ownership position for an outlay of eight thousand dollars.

The Council of the City of Oakland awarded the CATV franchise to Focus Cable on November 10, 1970.¹⁹ Focus Cable accepted the franchise on December 23, 1970.²⁰

1.3. Execution of the Franchise

A rate for System B of $4.45 per month was requested by Focus Cable on March 10, 1971, and was approved on March 11, 1971.²¹ The combined rate for System A and System B thus came to $6.15 per month.

Construction, which was due to be completed on December 28, 1973, did not go as quickly as the franchise specifications called for, fewer households subscribed to the service than anticipated, and costs escalated. Focus Cable appealed to the City to renegotiate the terms of the franchise. A reduction in the penalty period and the penalty fee was sought; a stretch-out of the construction period was requested; and a downgrading of the cable requirement was proposed. The Staff of the Office of General Services summarized the requested changes as follows:

Focus is requesting that: further construction be limited to a dual trunk/single feeder cable configuration; a two-year construction extension be granted; only 90% of the households be served at the end of the two years with the remaining 10% to be served only under specified conditions; activation of the dual cable system be deferred until adequate demand develops: damage payments for con-struction delays be waived; rates of $1.70 for basic services and $6.15 for extended services continue but that additional set rates be increased; extended service subscribers be reduced from 38 to 30 channels; and that reductions be made in the city and school spectrum allocations.

The Staff then considered four alternatives: (1) insist that the terms of the original franchise be met; (2) negotiate a revised agreement with Focus; and terminate the franchise, in which event (3) proposals from other commercial cable operators would be invited, or (4) shift the franchise to public ownership. The first was rejected because it would require great effort by the City “to obtain a satisfactory result from a recalcitrant operator. Citizen complaints about service will proliferate and require enormous effort to resolve. Litigation may result.”¹³⁴ The third was rejected because other operators were thought unlikely to provide any more than the “minimum requirements of the 1972 Cable Television Report and Order”—“28-Channel capacity, some two-way capacity, three channels for local use, and ‘significant’ local programming”—offerings which were characterized as “significantly less than would be provided by Focus’ recommended plan! revisions.”¹³⁵ Furthermore, public ownership was rejected for philosophical and financial reasons.¹³⁶ The second alternative, which the Staff characterized as the compromise solution, was accordingly proposed.¹³⁷ In the course of reviewing Focus Cable’s problems, the Staff reported that Focus claimed to have invested $12,600,000 to date and that Focus estimated that this would increase to $21,400,000 if the dual system were to be completed. The Staff disputed these figures and offered its own estimate of $18,684,000 as the completed capital cost of the dual system. The original Focus estimate, by contrast, was $11,753,000. The Staff attributed the increase over the initial estimate to “possible mismanagement of construction activities; inflation, which was compounded by Focus’s not meeting the original construction schedule; and an underestimate by Focus of the mileage and unit costs necessary to build the Oakland system.”

Since 437 miles, or 55 percent of the system, were already completed and furnished with dual cable, the Staff recommended that the system be completed as a dual cable system. The second cable, however, would not be energized until a later date. Since only the one cable was to be energized, a reduction of channel capacity on System B resulted, and a reduction of city and school spectrum allocations was proposed. The subscriber to the extended service (now designated A/B) would receive 12 channels on System A and 18 channels on System B.²⁸ Also, the Staff was agreeable to the proposal that a construction extension of two years be granted and that only 90 percent rather than 100 percent coverage be attempted.²⁹ Additionally, the Sfaff recommended that Focus pay the City S240,000 for lost revenues, due to the delay, during the period 1973 to 1976 and that any delays beyond December 1976 be assessed at the rate of $250 rather than $750 per day.³⁰ Finally, the Staff recommended that the monthly rate for the initial System A connection remain at $1.70 and that the initial System B connection remain at $4.45 (so that System A/B remained at $6.15), but that the monthly rate on additional outlets for System A be increased from $.34 to $1.70 and that the rate for additional System B outlets be set at $3.00.

The “compromise” that finally emerged and was approved by City Council had the following provisions.³² (1) A shift from the dual to a single cable system was permitted with the understanding that additional transmission capacity would be put in place within one year after it was ascertained that the “additional transmission capacity will attract sufficient revenues to provide a per annum rate- of-retum on the gross investment required, over a 10-year period, equivalent to ten percent.”³³ (2) The minimum franchise fee was increased by $25,000 in 1974 and each year thereafter. (3) Damages were assessed at the rate of $250 per day from December 18, 1973, until the first reading of the amended franchise—which resulted in a penalty of $36,000— rather than $750 per day for the entire period from December 18, 1973, until system completion—a penalty which would have been greater by a factor of 20 or more and which might have precipitated bankruptcy. (4) A deferred construction schedule was approved. Finally, (5) the monthly rate on additional connections was increased from $.34 to $1.70 per month on System A and was set at $3.00 per month on System B.

The City passed an ordinance on May 30, 1974, to reflect most of those changes.³⁴ Attorneys for Focus forwarded Letters of Acceptance by Focus and Tele Promp Ter on June 14, 1974, and sent a check from Tele Promp Ter Corporation made payable to the City of Oakland in the amount of $36,000.

Focus Cable filed a progress report on November 15, 1974 which showed that 11,131 subscribers were connected. Of those, 770 took the basic service at $1.70 per month (of which 206 had additional outlets), and 10 361 had the extended service at $6.15 per month (of which 974 had additional outlets). That represented an overall penetration rate of 36 percent. The Office of General Services recommended that Cable Dynamics, Inc. of Burlingame, California, be retained as consultants to “devise and perform tests to establish the degree of compliance” with technical requirements of the franchise.¹⁴⁰ Cable Dynamics estimated that the costs from Autumn 1974 to June 1976 would be approximately $10,750. Focus agreed to reimburse the City for these costs up to an amount not to exceed $10 750.

2. An Evaluation

The franchising procedures employed by the City of Oakland, especially at the initial reward stage, are not without merit. As compared, for example, with those in New York City, which awarded noncompetitive, twenty-year contracts to Manhattan Cable TV and to Tele Promp Ter to supply CATV in Manhattan,¹⁴³ the Oakland exercise had the appearance of a genuine bidding competition. Franchise specifications were standardized and, with respect to System A at least, carefully described. Bidding competition in terms of a simple promise to sell cheaply (by designating the value “X” at which System A services would be supplied) was thereby facilitated. However, numerous problems, many of which were anticipated in the discussion of incomplete long-term contracts, developed. Thus, consider each of the previously described disabilities which sometimes infect franchise awards: (1) the artificiality or obscurity of the initial award criterion; (2) the development of execution problems in price-cost, other performance, and political respects; and (3) the absence of bidding parity at the contract renewal interval.

2.1 Initial Award 

Awarding the franchise on the basis of the lowest bid of “A”’ to supply System A service simplified the award criterion, but the promise to supply cheaply proved to be specious. The lack of attention to System B (which was treated as a futuristic service and, except for capacity requirements, was left relatively undefined) in both quality and price respects may well have contrib-uted to “adventurous” bidding on the part of Focus. Trafficking in the franchise award quickly ensued.

To have regarded System A, which essentially supplies improved off- the- air signals, as the “basic system” was misguided. Over 90 percent o subscribers took the combined A/B service, although the additional set thereby obtained was relatively mundane (mainly the import of distant nals). The rate on the combined service, however, was three-and-a-half times as great as the basic System A service. Surely a more careful effort to assess subscriber preferences at the outset would have revealed that System A lacked appeal. Indeed, inasmuch as most of the prospective franchisees were experienced in supplying CATV services in other areas, it is difficult to understand the preoccupation with System A services during the extended precontract discussion between the franchisor and the prospective franchisees. The pos- sibility that the Staff was gullible and deliberately misled during these pre- contract discussions cannot be dismissed.

Whatever the case—given the demand and technological uncertainties associated with CATV (CTIC, 1972c, pp. 5, 12) and the complexity of the service, in quality and product mix respects—reducing the award criterion to the lowest bid price for System A resulted in a strained and perhaps bogus competiton.

2.2. Execution Difficulties

2.2.1. PRICE-COST RELATIONS

Whether the Focus bid of $1.70 per month for System A can be regarded as close to “per unit production cost” is doubtful in view of the tollowing factors: (1) The disparity among bid prices raises a question as to whether an economically meaningful competition was conducted; (2) System B prices, which appear to be the more relevant dimension, were negotiated subsequent to the bidding competition; and (3) true cost levels are difficult to ascertain— partly because the vertically integrated supply relation obscures them, partly because inflation rates during the construction period have been abnormally high, and partly because the Staff lacks an auditing capability. What is evident is that Focus and the Staff of the Office of General Services are, together with the City Council, involved in a long-term bargaining relationship over prices and costs in which political interests, bureaucratic interests, and franchise viability all play a role.

2.2.2. OTHER PERFORMANCE ATTRIBUTES

The stipulation that the CATV system be installed and maintained in accordance with the “highest and best accepted standards” of the industry coupled with technical specifications did not yield a well-defined quality outcome.⁴¹ Sufficient customer complaints over quality have been registered with the Staff of the Office of General Services⁴² that the Staff, unable itself to assess the quality of service, has arranged for a consultant to test the degree of compliance of service with technical requirements.

2.2.3. POLITICS

Whether the winning bid by Focus involved “buying in” is uncertain. An inference that buying in did occur is supported by the following considerations.

(1) The next lowest bid was double the Focus bid, while the Tele Promp Ter bid was more than triple the Focus bid. (2) The timing and nature of the Focus reorganization suggest a foot-in-the-door strategy—the object being that, once in, the franchising authority would be inclined to work with Focus and its affiliates in an accommodating manner. (3) Focus’s local bidder status was affirmatively regarded by the franchising authority and evidently supported ⁴³ Finally, (4) the extensive renegotiations undertaken by Focus, with evident success—the Staff acceded to most of Focus’s requests and the City Council approved a “compromise” in which energizing of the second cable was deferred (with a cutback in System B services to eighteen channels); the annual franchising fee was increased slightly; damages were reduced drastically; construction deadlines were extended; and rates on additional System A and B connections were increased—reinforce this judgment.

2.3. Frictionless Takeover or Transfer

Although the enabling ordinance provided for buying up of the plant and equipment of the franchisee, the City was plainly not prepared to upset the original award. The reasons appear to be that incumbents are strategically positioned to bargain—both in terms of service interruptions and the litigating and other expenses which franchise termination would entail-and, relatedly, because franchising agencies lack resolve. This lack of resolution appears to be attributable to the reward structure in bureaus. Unable to appropriate the gains that reassignment of the franchise would prospectively yield and unwilling to concede error, the bureaus favor “accommodation” whenever cont execution difficulties appear.

The interruptions and expenses which franchise termination would e> rience are presumably explained, in part at least, by physical and human problems of the kinds discussed in Section 3. Absent rules for valuing the CATV plant and equipment that are at once rational, unambiguous, and inexpensive to employ, physical asset valuation problems predictably arise.¹⁴⁴ Inasmuch as such rules had not been devised (and, realistically, perhaps could not have been devised) for the Oakland franchise, litigation expenses and delays would attend any effort to take over the physical plant in question.

The risk of service interruptions and related malfunctions would be com- pounded if the human assets associated with the franchise had acquired, in a leaming-by-doing process, nontrivial task idiosyncrasies. Given that the Staff lacked qualifications in the CATV area and was evidently unwilling to solicit bids from other experienced CATV operators (possibly because the Staff was unwilling to accept the risk of embarrassment should the new operator also prove to be deficient), the transfer of human assets would need to be worked out if City ownership were to be attempted. The incentive to displace the original franchisee would be attenuated to the extent that a frictionless transfer of such human assets could not be anticipated.

The upshot is that, good intentions to the contrary notwithstanding, unassisted franchise bidding for CATV conducted and executed under condi- tions of uncertainty has dubious properties. The franchising authority that assumes an accommodating posture is merely legitimating monopoly, while a concerted effort to exercise control requires the agency to adopt a regulatory posture. The purported dichotomy between “regulatory controls” on the one hand and “natural economic forces” on the other is accordingly strained. It confuses the issues to characterize market solutions as “natural” where these are actually supported by an administrative apparatus of considerable complexity.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.