Digital TV squares off with content rules. (Canadian TV).

In September of 2001, Canada launched 55 digital channels simultaneously, each one specializing in a single area of interest such as cooking, literature, science, music, news or popular culture. (Subsequently, nine additional channels have launched.) But just over a year later, the success of Canada's digital TV initiative is a mixed bag, due in part to the stringent Canadian content regulations digital channel operators face.

Before the digital launch, Canadian operators were given the opportunity to apply for one of two licenses from the Canadian Radio-television and Telecommunications Commission (CRTC): the coveted Category One or the easier-to-get Category Two. The Category One license (no longer obtainable) grants guaranteed distribution on all major digital cable and direct-to-home (DTH) satellite services nationwide, whereas the Category Two license leaves the responsibility of securing distribution on the shoulders of the channel operator.

The up-shot of the Category Two designation, though, is that it only requires operators to carry a minimal amount of Canadian content (called "Cancon" for short), allowing the use of inexpensive foreign programming to flesh-out schedules. (RAI Canada, for example, was licensed for 20 hours a day of Italian programming and only four hours a day of Cancon.) On the other hand, those who landed the Category One license must meet a rigorous mandate: their schedules generally include 50-60 percent Cancon, even during primetime hours.

According to Wayne Sterloff, vice president of Toronto-based Craig Specialty Networks, which has thus far launched three digital channels, it was anticipated that operators granted Category Two licenses "wouldn't generate the same revenues" as those with Category One status. As such, the Cancon requirements for Category Two were designed to be "much less demanding."

However, as Sterloff pointed out, the costs of meeting the Category One Cancon stipulations are worth the benefits, especially "if you are a broad-based company. Cancon actually becomes an asset if you have the ability to finance programming, because if you are developing original content from scratch, you have the exclusive rights to broadcast that content, and you can tailor it to local markets and tastes." Smaller operators, on the other hand, might find Category One Cancon rules to be "a hindrance, a suffocating cost, even.

Indeed, a group of smaller digital channel operators who managed to obtain the Category One license are now questioning the feasibility of the Cancon mandate. According to operators like Vision TV and Stornoway Communications, the content regulations may be too severe, especially for those companies that are without the ability to subsidize costs across multiple operations.

Vision TV's Chris Johnson explained that, in general, the Category One channels are working with "economic models that are very flimsy. They are operating on tiny margins, trying to manage with only 12 people running a channel." Although Johnson believes Canadian operators customarily feel a responsibility to provide their audiences with home-grown content, he cautioned that "if the economics become too fragile, policies might have to change."

According to Sterloff, however, changes to Cancon regulations are not the answer to a channel's economic woes. "If you are [an operator] sitting with a Category One license... and you can't make that work, the easiest thing to do is to convert to a Category Two. That would immediately reduce your Cancon obligations by 75 percent or so, to 15 percent or less of your schedule."

But Martha Fusca, president and CEO of Stornoway Communications, argued that giving up a Category One license would hurt a small digital channel operator more than it would help: "The Category One license was the only thing we were given to help us try to become a player in the [digital channel] environment. Small [operators] have no negotiating power. The distributors are so powerful, and any number of them wouldn't carry you at all [if you had a Category Two license]. With the Category One [license], you have something you can use as a cornerstone to build your company."

Larger operators have countered that the increased capacity digital offers should make it easy to secure distribution agreements with the Category Two license. But while cable companies that have upgraded their technology can squeeze 10-15 digital channels into the same amount of spectrum needed for only one analog channel, not all cable providers have made these expensive and time-consuming upgrades. Moreover, some digital providers actually use a good deal of their spectrum on analog channels, leaving what is still a limited amount of space for digital services. Additionally, although only 64 channels have thus far been licensed by the CRTC, well over 300 have already been approved as potential future licensees, meaning that there is and will continue to be competition for distribution, at least until the entire cable system is upgraded.

Fusca added that "companies with lots of [channel] properties, especially the 'giants' who have analog channels to work with" have the infrastructure to meet Cancon requirements, while smaller independents are lacking in available resources. She suggested that perhaps "tax shelters or tax credits could be offered to encourage production" of Canadian content.

Phyllis Yaffe, CEO of Alliance Atlantis's Broadcasting Group, admitted that "it's hard for the little channels. But where did they think they'd get [their Canadian content] from? If people had unrealistic goals, then of course Cancon might prove insurmountable."

Despite the difficulties smaller digital channel operators are having with the Cancon mandate, Canada's digital initiative has certainly met with a good deal of success: the digital subscriber base increased by 16 percent in the fourth quarter of 2001, representing an immediate reaction by consumers to the new digital services. As of press time, the digital subscriber base was expected to hit about 3.4 million by the close of 2002, as compared with 2.8 million at the end of 2001, a 21 percent year-to-year increase.

Canada is now finding itself well ahead of the U.S. in terms of digital penetration. Boasted Sterloff, "The major U.S. studios and [operators] are looking to Canada as a model, to see what works and what doesn't."

Yaffe added that Alliance Atlantis has seen an 82 percent year-to-year growth in our audience. We're breaking through with our digital channels."

With these successes in mind, it may be hard to sway the CRTC to change anything about its Cancon policies. "If there is a regulatory issue at all," concluded Sterloff, "it concerns only how long the old analog system should be kept in place. The government needs to consider how best to complete the total analog to digital transition."