House of Commons - Channel 4 Annual Report - Culture, Media and Sport Committee

Channel 4 Annual Report - Culture, Media and Sport Committee Contents

3 Annual Report for 2008

Profitability of non-core channels (E4, More4, Film4)

24. During our Annual Report session with Channel 4, we questioned the broadcaster on the investment in and profitability of its non-core, non-PSB channels (E4, More4 and Film4). We also explored this area further in written follow-up questions. Channel 4 refers to these as its "digital channels", although its core - and only - PSB service, Channel 4,[26] is also transmitted in digital on terrestrial, cable and satellite platforms as well as on analogue terrestrial television.

25. Channel 4 has stated that its digital channels:

"generate substantial profits to be reinvested in public service content, and are a vital part of Channel 4's strategy to address the structural financial pressure caused by digital switchover."[27]
"[are] an essential strategic investment designed to generate profits and diversify Channel 4's revenue base. The portfolio of digital channels currently makes substantial profits to be reinvested in public service content on the core channel."[28]

26. Critics, however, have claimed that Channel 4's expansion into non-core, non-PSB ventures has been wasteful and reduced its public service focus. Among these claims is that "Channel 4 has squandered the best part of £300 million on non-core activities: nearly all its accumulated post-tax profits since 1990."[29]

27. Channel 4 itself acknowledges in its 2008 Annual Report that while the growing contribution from the digital channels is mitigating the decline in advertising revenues "to some extent, it is not expected to replace lost revenues on the core channel."[30] Furthermore, it could be argued that if monies invested in the non-core channels were derived from the prior year profits and reserves of the core PSB service, Channel 4's cash reserves would be higher, enabling it to fund its PSB output for a longer period without deficit, albeit whilst still facing long term funding issues.

28. In its Annual Report for 2008, Channel 4 does not give a breakdown of the financial figures for E4, More4 and Film4 on a channel by channel basis. Instead they are grouped under the business segment "4Channels". For 2008, Channel 4 reported revenues of £175m for the non-core channels collectively and operating profits of £41.1m (up from £16.2m in 2007).

29. During oral evidence we asked whether the three channels "have now more than recouped their start-up costs."[31] Anne Bulford, the Group Finance Director, replied that "In terms of their development from when they went free-to-air, they are on track. They have some way to go in terms of turning the full corner in terms of recouping all their start-up costs. Some are further ahead than others".[32] When we went on to ask when these costs would be fully recouped, she went on to say that "It will be about another 18 months before all three come through against the free-to-air plans".[33]

30. This response from Channel 4 - replying in terms of when the channels went free-to-air rather than their inception - meant that we did not obtain the relevant information which we sought due to the fact that the channels, as Luke Johnson, the then Chairman of Channel 4, acknowledged, "only switched free-to-air relatively recently."[34] Film4, however, was originally launched (as FilmFour) eleven years ago, in November 1998, and only went free-to-air in 2006. E4 was launched in January 2001 and only went free-to-air in 2005. Losses incurred during the majority of Film4's life and half that of E4's existence were therefore excluded in Ms Bulford's response.

31. Ms Bulford agreed at the oral evidence session to provide more information on an individual channel basis "privately if that would be helpful because it is comparatively commercially sensitive at a more detailed level."[35] We subsequently received from Channel 4 more detailed information on the revenues, programme budget and operating surplus of each of E4, More4 and Film4 in 2008, on a confidential basis.

32. After the session Channel 4 submitted a clarification to the transcript that "Channel 4's digital channels fully recouped their costs since moving free-to-air in 2008; in 2012 the digital channels are expected to fully recoup their start-up costs since inception."[36] Channel 4 reiterated this to us in supplementary written evidence.[37]

33. We considered that the provision of more complete information was relevant to the issue of the contribution of Channel 4's non-core channels, including information on the total investment on each of the digital channels since their inception, and when the start-up costs and total operating losses on each of the digital channels will have been fully recouped. Channel 4 claims that "Financial information on a channel-by-channel basis is commercially sensitive and disclosure of this information would put these channels at a competitive disadvantage."[38] It also states that "it is common practice to aggregate this type of information: neither of Channel 4's commercially-funded public service competitors - ITV and Five - disclose financial information on individual digital channels. Channel 4 already discloses a greater level of segmental information and financial detail than its competitors."[39]

34. Channel 4 has argued for a new legislative framework for public service broadcasting that would effectively give these channels (and other Channel 4 services in addition to the core channel) PSB status. Channel 4 has stated its clear "ambitions to operate as a public service network, covering the core channel and digital services,[40] and promotes a future regulatory approach that would take into account its "public service contribution across all relevant channels and services".[41] In the 2008 Annual Report, Andy Duncan describes the environment as one "in which Channel 4 is evolving from a public service channel to a more broadly-based public service network".[42]

35. Channel 4 has told us that it "operates all of its commercial activities, including its digital channels, subject to strict arrangements which ensure that public funds are not used to subsidise commercial activities."[43] It has also indicated to us that early losses in its digital portfolio have not been subsidised by public funds. It notes that these arrangements are set out in Channel 4's oversight framework for commercial accountability, outlined in Schedule 9 of the Communications Act 2003 ('the Schedule 9 Arrangements'), which requires Channel 4 to:

identify, evaluate and properly manage any commercial activities, so as to protect the primary functions of the channel (ie. the core Channel 4 service);
financially and organisationally separate commercial and primary activities; and
ensure transparent reporting where there is a connection between commercial and primary activities (for example, shared resources).[44]

36. Channel 4 states that these arrangements are approved by Ofcom, and are published on the Channel 4 website.[45] Channel 4 further states that it has put in place regular checks to confirm that it is complying with these arrangements, with Deloitte appointed to review compliance on an ongoing basis.

37. Nevertheless there is limited information in the public domain about the detailed workings of these arrangements in relation to Channel 4's digital channels (and its other commercial ventures). For instance, while Channel 4 states that public funds are not used to subsidise its commercial activities, it not evident whether the digital channels were initially financed in part or whole from surplus profits and/or reserves built up by the core PSB channel in prior years. Discussion during our oral evidence session, where Channel 4 referred to liabilities reflecting "monies owed back to Channel 4 in relation to the [digital] channels' share of transmission and other costs"[46] leads us to believe that this may be the case.

38. The Schedule 9 arrangements subsequently proposed by Channel 4 and approved by Ofcom include, among other things, a requirement that internal re-charges between the core Channel 4 service and the rest of its operations are set to ensure that revenues and costs are fairly apportioned, reflecting the cost of provision of the service or, where appropriate, comparable market rates.[47] Neither Channel 4 nor its auditors Deloitte, however, publish sufficient detail about how these work in practice. It is therefore not evident, for instance, how costs are allocated between the core channel and the digital channels with regard to matters such as programming that appears on both the core and digital channels, and cross-promotion. Nor is there any requirement for consultation on the arrangements proposed under Schedule 9, other than between Ofcom and Channel 4.

39. We are grateful to Channel 4 for the provision of the information which we sought, but we do not agree that withholding from the public the figures relating to its individual digital channels, E4, Film4 and More4, is justified. Channel 4 occupies a unique position as a broadcaster in the UK and should be transparent on the costs and benefits of its non-PSB channels. It is not obvious to us what, if any, commercial disadvantage Channel 4 could suffer if this information was in the public domain.

40. Moreover, we find this lack of transparency on its digital channels incompatible with Channel 4's ambitions for them to be part of a public service network, as proposed in the Digital Economy Bill.

Children's programming

41. During our previous Annual Report session, covering Channel 4's 2007 Annual Report and Financial Statements, we noted that the broadcaster had proposed to strengthen public service plurality in children's programming by establishing a new pilot fund of £10m dedicated to programming for older children, with commissioning beginning in 2008. Andy Duncan confirmed that Channel 4 had commissioned the programmes, which he said were "currently being made".[48] However, he said that due to financial cuts: "we do not think we are in a position to play those programmes out [i.e. broadcast them] and we think we might have to hold off playing those programmes out until the following year".[49] Luke Johnson also highlighted financial issues: "We will have the programmes ready to go, in the stocks. We are waiting on affordability to play them out".[50]

42. We raised this during the 2008 Annual Report session, asking whether these programmes had yet been broadcast. Andy Duncan told us:

"They are on hold because of the budget situation that we are in, both last year and this. I believe, on the three projects, one of them got through script development stage and was ready to go but was put on hold at that stage. On another one, similarly the development work had taken place. I think we went into production in the end on just one. I would have to double-check exactly where that has got to but we are not in a position to play that out at the moment in terms of the transmission costs, because it affects the P&L at the time we transmit it."[51]

43. He went on to say that this was one of the areas where "it is obviously subject to the funding situation in digital and what comes through in the next few weeks […]. We remain of the view that we have a very important role to play with that group [10 to 16-year-olds] "but clearly the funding will need to be resolved first".[52]

44. We noted the contrast between Channel 4's representations during the 2007 Annual Report session of programmes having been commissioned and "currently being made", and "ready to go, in the stocks" (albeit with play-out affordability an issue), and its depiction at the 2008 Annual Report session of "three projects", of which only one was thought to have gone into production in the end, which Channel 4 still couldn't afford to transmit. We therefore asked Channel 4, in written follow-up questions, to clarify the expenditure and output of its children's projects to date, and what the estimated cost was to broadcast the children's programmes which were made.

45. In response Channel 4 stated that of the £10m pilot it had commissioned only one project - First Year at Big School, a series of twelve 30 minute episodes, which it planned to transmit "in 2009".[53] Channel 4's memorandum also stated that it has invested "around £200,000 in script and storyline development for half a dozen other children's projects" but that "all of these projects are on hold, given the financial challenges facing commercially-funded public service broadcasters".[54]

46. Channel 4's further replies have not alleviated our concerns. Of the planned £10m dedicated to programming for older children, it is clear that only a small proportion has been committed. This is not consistent with evidence given to us by Andy Duncan and Luke Johnson during our 2007 Annual Report session.

47. We also note that the rationale for the pilot fund, announced by Channel 4 in March 2008 in Next on 4 (the broadcaster's vision for its future), was "to strengthen Channel 4's relationship with younger audiences, and to demonstrate its capability to commission engaging content that connects with them. […] It will illustrate what more Channel 4 could do with further resources. We hope it will help make the case for the provision of sustained public support that would enable Channel 4 to include children's TV as a core part of its PSB role."[55] Channel 4 also stated that the pilot fund would "strengthen public service plurality in children's programming" and help address "the gap in the market identified by Ofcom for originated television aimed at older children", for which "there is a greater role for Channel 4 to play".[56]

48. As previously discussed, the Digital Economy Bill currently before Parliament is intended to update Channel 4's remit. This includes a requirement for Channel 4 to participate in the making of a broad range of high-quality content that appeals to the tastes and interests of a culturally diverse society, and broadcast or distribute such content on a range of different delivery platforms. Channel 4 must, in particular, participate in "the making of relevant media content that appeals to the tastes and interests of older children and young adults".[57]

49. While in principle we support the inclusion of a public service broadcasting requirement relating to older children in a revised Channel 4 remit, it is clear that Channel 4 did not achieve its aims of demonstrating via a pilot fund its capability to commission engaging content that connects with its intended audience, or successfully demonstrate what it could do with further resources.

Channel 4 and the BBC

PROJECT KANGAROO

50. The cost of Channel 4's write-off on Project Kangaroo, the proposed video-on-demand (VOD) joint venture between Channel 4, BBC and ITV that was referred by the Office of Fair Trading (OFT) to, and subsequently blocked by, the Competition Commission, was confirmed to us during the 2008 Annual Report session as £6.4m.[58]

51. Andy Duncan told us that the OFT reference "was a surprise to most people"[59] and that "the general view within the industry was that it would be a good thing. It was clearly in the public interest",[60] although he acknowledged that "one or two competitors had clearly complained".[61]

52. In fact, the OFT stated that it had received 30 submissions from third parties involved in the supply of content, the supply of Video-On-Demand services and advertising and that:

"The majority of third parties were concerned about the joint venture and expressed concerns about both the horizontal and vertical aspects of the transaction, anticipating that the joint venture would give rise to market power at the wholesale supply level and the potential for increased incentives to foreclose downstream rivals. It should be noted, however, that due to the confidentiality of the joint venture arrangements, third parties were not usually fully clear as to how the joint venture would operate. Consequently, the concerns put to us were based on a worst case scenario".[62]

53. In announcing its final report, the Competition Commission stated that none of the remedies proposed, other than blocking the venture, could remove the threat to competition in the VOD market and that:

"We looked closely at the possible benefits to viewers which this joint venture might bring. We found that these and other benefits could come just as well from other projects that were less damaging to competition. We expect these alternatives to be much more likely to develop in the light of our decision."[63]

54. We find it difficult to accept Channel 4's claim that competition authority reference of Project Kangaroo "was a surprise to most people" and that "the general view [of Project Kangaroo] within the industry was that it would be a good thing and clearly in the public interest", with "only one or two" complaints from competitors. This is contradicted by the number and weight of representations to the competition authorities, and their findings regarding the threat to competition in the VOD market.

55. Channel 4 also made it clear to us on a number of occasions during the session that the BBC Executive led them to believe that Trust approval should automatically follow any clearance by the competition authorities.[64] Andy Duncan told us:

"[…] it was clearly backed by the BBC Worldwide Board and it was also backed by the BBC Executive Board. So we knew that effectively John Smith in Worldwide and Mark Thompson in the BBC fully supported it and our understanding - I do not know exactly what we had in writing or not but our very clear understanding was they had a series of sessions with the BBC Trust along the way and it was very clearly understood that if the Competition Commission gave it the green light, it was also expected that the BBC Trust would give it the green light."[65]

56. In our Report on the BBC Annual Report and Accounts 2007-08 we discussed the background and concerns we had regarding Project Kangaroo oversight at the BBC and concluded:

"We find it difficult to reconcile the BBC Trust's claim to have given only limited authorisation for the Executive to "talk to other players in the industry" with information on the subsequent development of Kangaroo and statements in the provisional findings of the Competition Commission. It is apparent that the Trust reviewed proposals for the joint venture at a number of stages, including a detailed review on 19 June 2008, in advance of our oral evidence session. The statements by the BBC Trust Chairman to the Committee therefore appear, at best, incomplete and, as a result, potentially misleading."[66]

57. In a press release issued on the day of the publication of our BBC Annual Report and Accounts 2007-08 Report, the Trust rejected our findings on its consideration of Project Kangaroo.[67] Amongst other things, the Trust stated that when it first considered the Kangaroo proposition it agreed with the BBC Executive that "the proposition should be developed further, including work on fair trading compliance and consideration against the commercial criteria, and that formal approval would be required."[68] The Trust also stated that when the BBC Executive updated it on progress - the "sessions" referred to by Channel 4 - it made it clear that the proposition would still need to go through the Trust's formal regulatory processes.[69]

58. There is clearly a disparity between Channel 4's depiction to us of the BBC Executive's expectations for BBC Trust approval of Project Kangaroo (based on the Executive's reported dealings with the Trust), and the position of the BBC Trust. However, we believe that, given the level of investment involved, Channel 4 was unwise to rely on the assurances it received from the BBC Executive, and to make such heavy investment in advance of a decision of the competition authority. This is especially the case given the financial cutbacks by Channel 4 in other areas, such as its pilot fund for children's programming.

ACQUISITION OF OVERSEAS PROGRAMMING

59. During our most recent annual report sessions with both Channel 4 and the BBC we discussed with the broadcasters their decision-making in bidding for overseas programming. As an example, we discussed the bidding by both broadcasters for the series Harper's Island, a horror thriller series first broadcast on CBS America, in which one or more characters was killed in each episode. We heard directly contradictory evidence when discussing the bidding for this programme.

60. Andy Duncan of Channel 4 described the outbidding of E4 by the BBC for Harper's Island, for transmission on BBC3, as "an outrage".[70] He went on to say that:

"BBC3 is entirely licence fee funded and meant to be all about innovation and original programmes for the British public […] we got to a rate beyond which we could not justify going commercially and the BBC paid about one-third more than that […]. Clearly no-one else was justified in bidding more […] Sky, ITV, Five, et cetera. To be outbid by BBC3 was ridiculous".[71]

61. This was in contrast to what Mark Thompson told us during the BBC Annual Report session: "My understanding about Harper's Island was that Channel 4 ultimately decided for editorial grounds that they did not want to pursue this particular programme and withdrew for editorial rather than economic grounds."[72]

62. We subsequently informed Channel 4 of Mark Thompson's statement and asked if Channel 4 stood by what it had said to us. It replied:

"Channel 4 stands by its statement that E4 was outbid by BBC3 for the acquisition of Harper's Island. Channel 4 would not have bid for Harper's Island if it did not believe the programme was likely to be a good editorial fit, and Channel 4 withdrew from the bidding process for economic reasons. As the final price that BBC3 paid for Harper's Island is not in the public domain, Channel 4 is unable to reliably estimate the amount by which BBC3's bid exceeded E4's."[73]

63. We note and welcome the BBC's own subsequently announced intention to reduce spending on programmes from abroad, stating that in the main they cannot be an editorial priority, in light of the BBC's "particular responsibility to invest the licence fee in the UK's creative industries, supporting talent and producers particularly when other broadcasters are finding it hard to sustain their commitments".[74]

64. There is a clear disparity between Channel 4's initial claim that the BBC outbid it for Harper's Island, and the BBC Director General's claim that Channel 4 withdrew from the bidding for editorial rather than economic grounds. However, we agree with Channel 4 that there does not seem to be any reason for the BBC as a licence fee funded public service broadcaster to acquire programmes such as Harper's Island, let alone outbid others using public money, thereby reducing the resources available for original UK production and talent.

Digital radio

65. During our first Annual Report session, covering Channel 4's 2007 Annual Report, the Committee noted that the broadcaster was ending its second foray into digital radio. We asked Andy Duncan what the total losses would be. He told us that "we are not in a position to put a final figure on it" because certain negotiations were still taking place, "but the total investment we think is less than 1% of turnover, so quite a modest sum of money, and considerably less, for example, than we have invested in other new business ventures like the launch of new channels or the acquisition of Box TV last year. It is a relatively modest amount […]."[75] The turnover of the broadcaster, he noted, would be over £900m in 2008.[76]

66. We returned to this issue in our written follow-up questions to Channel 4 following the 2008 Annual Report. Channel 4 told us that its total investment in Channel 4 Radio "amounted to less than £10m over three years, all of which was written off by the end of 2008."[77] We cannot agree with the assessment that such a loss represents a "modest amount". On the contrary, we believe that this represents a significant amount of funding that could more usefully have been used to maintain the public service content on Channel 4's core channel.

67. We also note that Channel 4's digital radio losses do not appear to be broken out in the 2008 Annual Report. A footnote to Note 1 of the financial statements on "Segment reporting" states that during 2008 the group made the decision to exit its 4Radio venture ("included within 'Other'"), and "As this undertaking has not started to generate revenues and does not constitute an individual segment on the basis of materiality it has not been disclosed as a discontinued operation."[78] The 'Other' column referred to comprises a number of different figures, including 'Other operating expenditure' of more than £15m and a total operating loss of nearly £20m. Note 2 on "Total operating expenditure" also contains a footnote stating that the figure of £8.1m for "Other business development" expenditure in 2008 "includes pre-trading expenditure relating to 4Radio and Project Kangaroo."

68. Whether or not accounting rules required Channel 4 to detail the costs and losses of its failed digital plans, we believe that public accountability requirements mean that it should have been clear and transparent as part of its annual reporting process. The opposite was the case. In fact, had this Committee not made its own enquiries, the total figures might never have been disclosed publicly.

Future of the Channel 4 Chairman and Chief Executive

69. During the 2008 Annual Report session we noted that the term of the then Channel 4 Chairman, Luke Johnson, was ending in January 2010, and asked him whether he had given any thought as to his successor. He replied "I am not necessarily involved in it. It is for Ofcom to decide."[79]

70. We also highlighted that that there had been widespread press reports about tensions within the boardroom, particularly between the Chairman, Chief Executive and Director of Television and Content, Kevin Lygo.[80] This was refuted by Luke Johnson[81] and by Andy Duncan, who said:

"It is a load of nonsense. We have had a succession of tittle-tattle, gossip and rumour certainly for the last five years, all the time I have been at Channel 4. I guess it will carry on. Some of it clearly comes from our competitors and is designed to cause mischief, presumably, at a key time for Channel 4's future but it is just not true. It is as simple as that."[82]

71. We asked Andy Duncan whether he hoped and intended to be in post of Chief Executive in a year's time, to which he replied:

"Absolutely! In my interview with Luke and whoever else interviewed me several years ago, my ambition in coming to Channel 4 was to really help Channel 4 fully transition successfully into the digital world. I think we have made very good progress over the last few years. I think there is still some way to go and I would like to finish off that job. There are some very key issues coming up in the next 12 months that I would like to see through, for sure."[83]

72. Despite his enthusiasm to us at the Annual Report session in May, on 16 September 2009, Andy Duncan announced his intention to step down from his post before the end of 2009 having confirmed his decision to the Channel 4 Board. He further stated:

"The publication of the Digital Britain report in June 2009[84] was also a natural moment for me to take stock and since then I have been in discussion with Luke and other board members about the future. Channel 4 is facing a further period of change, with a fresh regulatory cycle looming and with the cancellation of Big Brother signalling the most significant creative renewal in our history. We have mutually agreed that this feels like the appropriate moment for me to hand on the baton to someone else and to move on to a fresh challenge after more than five years at the helm."[85]

73. The media speculated that the real reason for Duncan's departure related to strained relations with Luke Johnson and the inability to secure a Government-brokered bailout amid concerns about its long-term financial security.[86]

74. On 5 November 2009 Ofcom announced the appointment of Lord Burns as the next Chairman of Channel 4, with effect from 27 January 2010, and his immediate appointment to the Board as Chairman-Designate. Lord Burns' appointment as Chairman for three years from 2010 was subsequently approved by the Secretary of State for Culture, Media and Sport, Rt Hon Ben Bradshaw MP.[87] One of Lord Burns' first tasks was to appoint a new Chief Executive. On 22 January 2010 it was announced that he had appointed David Abraham, Chief Executive of UKTV, to the role.[88]

75. It must be hoped that the appointment of a new Chairman and Chief Executive at Channel 4 will provide the stability which Channel 4 needs to transform itself successfully into the public service broadcaster envisaged in the Digital Economy Bill. We trust that they will work together effectively and look forward to holding them to account for the future performance of Channel 4.

26 Subsequently in the Report references to Channel 4 the main PSB television channel are to the "core channel" or "core Channel 4 service", with other references to "Channel 4" meaning the overall organisation, the Channel Four Television Corporation. Back

27 Ev 17 Back

28 Ibid. Back

29 Institute of Economic Affairs Beesley Lecture, David Elstein Back

30 Channel 4 Annual Report 2008, page 81, column 3, "Financial Review". Back

31 Q 57 Back

32 Ibid. Back

33 Q 58 Back

34 Q 53 Back

35 Q 54 Back

36 Ibid., fn 1 Back

37 Ev 18 Back