4. Thrilla in Manila

Despite the explosion of new content, most operators of cable systems paid little attention to programming; it was merely a commodity that brought in new viewers, not a value chain all its own. But John Malone quickly saw a more important role for all the new channels popping up—they had a dual-revenue stream: from advertising and from payments made by cable systems based on how many subscribers each system had. Someday, this dual-revenue stream might dwarf the single stream of ad revenue on which the Big Three broadcast networks relied. The new content providers promised both opportunity and risk: Their growth depended in part on getting steadily rising fee increases from cable operators like TCI. Through difficult negotiations, TCI had forced new networks into long-term, cheap contracts. But once those contracts ran out, Malone knew it would be tough to resist the price demands of an established, popular brand. Turning it over in his mind, he suddenly realized the answer: Rather than just owning the cable that delivered the new programming fare, TCI needed to own a piece of the cable channels themselves, thereby sharing in a whole extra upside. A big operator like TCI could give a new network a big head start, and as valuable as its laid wires were, if the cable industry kept growing, the new networks now launching could be even more valuable. By buying into networks, Malone thought, TCI could own both the pipe and the water flowing through it. The cable wire and the cable programming, if owned under one roof, could be leveraged off of each other to create innumerable efficiencies. Vertical integration of companies would become an awesomely powerful and controversial tool for Malone to use in building TCI.

Malone arrived at a simple conclusion: He wanted to own as much of the programming as he did of the wire. TCI, which would eventually reach 20 percent of the households, would seek to own 20 percent of every programmer that came calling.
Once upon a time, cable started out as a rural phenomenon. Now cities and urban areas, where cable operators weren’t needed or weren’t allowed before, were interested in cable TV.
A cable franchise was essentially a legal right to a local monopoly—operators had to answer to local government and win approval for rate increases; otherwise, they faced no competition in this booming business.
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Everyone was in the race—everyone, that is, but John Malone. At such frenzied prices, there was little he could do but sit on the sidelines and watch the bidding. Malone knew the game was too expensive for cash-poor TCI—but he also knew to be patient. Many of the investors who had suddenly fallen in love with cable were paying way too much and were backed by way too little experience: One day they would be begging TCI to buy them out. So while he waited for the buying frenzy to collapse, he aimed to improve TCI’s cash flow by building through much smaller bites. A typical purchase during those years at TCI was a $1 million cable system, in need of an upgrade, contiguous to another TCI system, whose sellers were the first and only owners. TCI would typically offer 20 percent in cash and a 10-year note. The assets of the company TCI had just bought secured the balance of the borrowed amount. In the process, TCI and other big cable operators made millionaires out of the cable industry’s earliest entrepreneurs, a ritual that would repeat itself over and over throughout the country.
The Cable Act took effect in 1986, and while it formalized a city’s right to grant franchises and require public-access channels and other concessions from cable operators, it essentially shifted oversight from states and cities to the federal government. Cable operators won on major points. The law capped at 5 percent of revenues the so-called franchise fees that a city could charge an operator for the pleasure of doing business in a town and using public rights-of-way. It also favored incumbent cable operators heavily in franchise renewals: Unless a cable company had failed dismally to meet basic service requirements, renewal of the 10-year franchise was almost automatic. The law also kept the giant phone companies at bay, forbidding them from owning cable systems in their service areas.

The new law’s greatest impact, however, was on cable rates: It effectively prohibited the federal and local regulation of cable rates for the first time in industry history. Rate increases allowed cable companies to stoke their cash flow, and that gave cable operators a source of cash to invest in new cable networks and made the cable business look all the more alluring to investors on Wall Street. It was an astonishing concession to the rapidly expanding industry. Cities had granted the cable systems protected monopoly status in exchange for a presumption that elected officials would hold sway over whether the monopoly could raise its rates. Now the feds had let cable remain a monopoly—but had freed it to raise prices at will, which cable did with unabashed alacrity.