The points of maximum cash outlay occur at year 4/5 in the case of programming and operations, and year 5/6 in the case of network construction. We conclude that, unlike in typical cable television environments, the risk characteristics of each of these two aspects of the business are similar.
In view of the large size of these investments, the argument that vertically integrated management is desirable has merit. It would not normally be good practice to divide into two separate businesses an enterprise which requires capital investments of these magnitudes in each component part, if the earning power of each part is dependent on the efficacy of the other.
The evaluation of the trade-off between these risk management considerations and the cost penalty of a separate network is not amenable to quantification using the methodology adopted for telecommunications competition analysis. Instead we present in Exhibit 5.10 a summary of the relevant economic data, indicating the relative importance of network cost and demand management factors in ensuring the viability of the proposed television service.
The columns on the left hand side of Exhibit 5.10 represent the structure of costs face by a cable operator using an HKT-built network (scenario 1) and a separately constructed network (scenario 2). In each case we have added to the network costs an equal amount corresponding to the cost of programming and other aspects of the service operation (studio and headend, marketing, customer administration). Maintaining consistency with the analysis presented throughout this document, costs are expressed as the Net Present Value in 1988 of expenditure to 2007. We observe that, while expressed as a fraction of network costs the penalty faced by an operator under scenario 2 is 18%, expressed as a fraction of total costs it is only 4.8%.
A simple summary measure of the impact of alternative scenarios on the risk associated with investing in a cable television service is the price which must be paid by the average customer in order to ensure financial break-even (including an allowance for the cost of funds). Exhibit 5.10 shows the sensitivity of this break-even price to two variables: the total cost of service provision (on the vertical axis) and the extent of penetration achieved (on the horizontal axis). The two broken horizontal lines on the exhibit indicates the impact of network choice on the first of these variables. The three vertical lines indicate the impact which, in our judgement, various non-network related factors could be expected to have on the second variable the penetration level. These latter factors include not only improved coordination of the business through vertical integration, but also the quality of programming, the level of management commitment to the enterprise, the intensity of the marketing effort, and various other measures of the overall effectiveness of the business effort.
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For the case of 43% ultimate penetration, the break-even prices marked on the exhibit were obtained by assuming a pattern of growth of subscriber base identical to that underlying the other analyses in this report; for
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