Letter from Lord Burns GCB, Chairman,
Channel 4 (C4 02)
RE: CHANNEL 4 EVIDENCE SESSION ON 28 JULY
2010
Thank you for your letter of 14 October 2010,
setting out a number of additional questions following our session
with the Committee on 28 July 2010. This also follows David Abraham's
letter to you of 24 August 2010 providing further information
on Channel 4's out of London commissioning and diversity policy.
As I stated in the evidence session, Channel
4 regards the Committee's work as an important part of its accountability
arrangements, and is happy to provide the Committee with relevant
information. I have therefore enclosed responses to the questions
you set out in relation to product placement, CRR, audience reach
and share, public service delivery and our digital channels. As
with the data provided last year, we are providing some of this
to the Committee in confidence, as disclosure could damage our
commercial interests. Confidential information is clearly marked
as such in the response.
I note the Committee's continued interest in
the role and financing of our digital channel portfolio. On reading
your Committee's report on the Channel 4 Annual Report 2008,
I had thought that this matter had been resolved to the satisfaction
of the Committee and I am surprised that these follow-up questions
again focus heavily on the digital channels. The enclosed response
fully answers your questions on these matters, but I thought it
would be helpful if I set out here briefly the role played by
our entire channel portfolio.
All of Channel 4's channels play a dual role
of i) providing interesting, diverse content which attracts different
audiences and ii) generating revenue to fund that content. The
main Channel 4 service has always had to strike this balance,
and the digital channels are becoming increasingly important not
simply as a source of revenue, but also in creative and public
service terms, providing valuable opportunities to innovate, experiment
and reach diverse audiences.
This role of the Channel 4 portfolio was confirmed
in the Digital Economy Act 2010, which broadened Channel
4's functions to include the provision of content on a range of
services, including digital television channels and on-demand
services. The Act does not give the digital channels public service
status—with commensurate public service obligations and
benefits—but it does provide a useful framework for recognising
the public service delivery of the entire Channel 4 portfolio.
I trust this information will be of assistance
to the Committee.
RESPONSE TO QUESTIONS
PRODUCT PLACEMENT
1. How helpful to Channel 4 is Ofcom's proposal
to liberalise product placement rules?
— Are the proposed restrictions
too limiting?
2. How much additional revenue do you estimate
that you will be able to generate from product placement under
the new regulations?
3. How much of the additional revenue would
you expect to spend on public service broadcasting content?
As a commercially-funded public service broadcaster,
Channel 4 is committed to the fulfilment of its public purposes
and to generating the maximum possible amount of revenue to invest
in UK-produced content. As commercial revenues are the primary
way of delivering Channel 4's public purpose end, Channel 4 is
interested in exploring new ways of generating revenues—such
as product placement—in order to invest in the delivery
of its public service remit.
Channel 4 believes that it is very difficult
to predict accurately the true value of product placement, given
that the practice is new to the UK and there are few, if any,
comparable overseas markets. A range of estimates have been cited
by the Government, from £25 million after five years, through
to much larger estimates of £140 million per annum. In Channel
4's view, additional revenues are likely to be at the low end
of these estimates. In addition, Channel 4 believes there is a
risk that revenue from product placement is substitutional—with
advertisers shifting money away from other audiovisual advertising,
such as sponsorship, towards product placement.
The introduction of product placement will involve
further regulatory and compliance costs for broadcasters. Channel
4 has seen it as a priority to help ensure that product placement
is implemented responsibly and therefore welcomes Ofcom's proposals
for a clear regulatory framework in the Broadcasting Code, with
industry guidance. Channel 4 has made a full submission to Ofcom
on implementation issues in response to its Broadcasting Code
consultation, and would be happy to share this with the Committee.
CONTRACT RIGHTS
RENEWAL (CRR)
4. The Competition Commission recently confirmed
that ITV's Contract Rights Renewal scheme—CRR—is still
needed to prevent the channel from exploiting its position to
the detriment of advertisers and other commercial broadcasters.
Do you agree with the decision?
The CRR mechanism is an important competition
remedy that was volunteered by ITV in 2003 as a condition of the
Carlton/Granada merger, in order to address the market power of
the merged ITV1.
The Competition Commission found that ITV1 still
has continuing strength in the advertising market. The ITV Group
still has an extremely strong position in the market (45% share
of net advertising revenue in 2009). In addition, ITV1 remains
indispensable and unique to advertisers: in 2009, ITV1 had 982
of the top 1000 most watched programmes on commercial TV, and
ITV1 remains the only way for advertisers to efficiently deliver
any campaign seeking massive coverage. Channel 4 agrees that the
broad competitive position remains the same—ITV1 still has
dominant market power so there is a need for a competition remedy
to constrain ITV1 from exploiting its position.
— What would the consequences be
for Channel 4 advertising revenue if the Government were to relax
or revoke CRR?
The Committee is right to identify the impact
of any changes to CRR on investment in high-quality UK programming
from the broadcasting sector as a whole, rather than just on ITV.
The nature of the advertising market means that
removal or relaxation of CRR is very likely to increase ITV's
revenues as they exercise their market power to increase prices.
Gains that ITV might accrue from a relaxation of CRR are likely
to mean losses for other commercially-funded broadcasters—with
a negative impact on their ability to invest in UK content.
Channel 4 believes that the primary cause of
the decline in the TV ad market—and consequent fall in PSB
programme budgets—in recent years has been the structural
shift towards digital television combined with the economic recession.
Progress towards digital switchover has caused a 35% increase
in commercial impacts over the past seven years, and this increase
in supply has driven prices down. As the primary cause of the
reduction in programme budgets has not been CRR, Channel 4 believes
it is unlikely that the removal of CRR will boost total TV advertising
revenues and therefore content investment across the board.
Removal or relaxation of CRR would therefore
potentially reduce content budgets for other players in the market.
This would particularly affect Channel 4, whose unique model ensures
that all revenues are invested in the delivery of Channel 4's
remit. A decline in Channel 4's programme budget would have a
negative impact on Channel 4's public service delivery, affecting
viewers and resulting in less plurality and less diversity in
the UK creative industries.
AUDIENCE SHARE
AND REACH
5. How do you see your audience share and
reach evolving over the next five years both for the core channel
and the digital channels?
Broadcasters find it is very difficult to predict
accurately future audience share or reach. The state of the advertising
market, the relative programme budgets of different broadcasters,
scheduling decisions, and uncertainty about the rate at which
viewers will switch to new technologies mean that broadcasters
find it challenging to predict audience share or reach with any
degree of accuracy.
In recent years, the commercially-funded public
service broadcasters have all seen the audience share of their
main channels decrease. This decline has been the inevitable consequence
of digital switchover and the proliferation of multi-channel television
in a greater number of homes. In Channel 4's case, share of the
main Channel 4 service has fallen from 9.7% in 2004 to 7.5% in
2009, but the success of Channel 4's digital channels has resulted
in the audience share of the Channel 4 portfolio growing over
the same period, from 10.5% in 2004 to 11.5% in 2009. Going forward,
as the UK reaches the completion of digital switchover broadcasters'
audience share should become more stable.
In terms of reach, over the last five years
Channel 4's reach has stayed broadly constant and on some measures
has increased. For example, 15 minute average monthly reach for
the main Channel 4 service has grown from 78% in 2004 to 82% in
2009. Over the same period, 15 minute average monthly reach for
the Channel 4 portfolio increased from 81% in 2004 to 89% in 2009.
This suggests that the Channel 4 portfolio will continue to reach
a high proportion of the population in future, regardless of movements
in share.
6. What is the minimum audience share and
reach that you require to make a significant public impact?
Channel 4's content continues to reach a significant
majority of the population, with reach and share of the Channel
4 portfolio increasing in recent years. Channel 4 believes that
the reach and share of its television channels will continue to
be important measures for assessing public impact. That said,
Channel 4 does not specify "minimum audience share and reach
[…] required[d] to make a significant public impact",
as Channel 4 believes public impact should be assessed more broadly.
For example, Channel 4 News attracts an audience of around
only one million viewers each evening, but its impact in public
service and democratic terms is much more important than this
audience suggests.
Channel 4 has therefore recently innovated in
this area and developed a new framework—the Public Impact
Report—to measure the value and distinctiveness that Channel
4 brings to UK viewers. This report is published alongside Channel
4's Annual Report and Financial Statements and includes a range
of measures to help assess public impact. For example, Channel
4 is increasingly achieving impact through digital media—the
rise of on-demand service 4oD was one of the key developments
for Channel 4 in 2009, with 218 million full-length programme
views on-demand, a 60% rise on 2008 levels. Content on Channel
4's websites also continues to engage audiences—for example,
230 million visits to channel4.com and e4.com in 2009—and
deliver public impact.
PUBLIC SERVICE
CONTENT ON
CHANNEL 4
7. Is the total of £145 million invested
in key PSB genres on the core channel an adequate return of public
service content from a portfolio of channels and services generating
over £800 million a year?
Channel 4 believes that its public service delivery
should be assessed more broadly than by sole reference to total
expenditure on first-run originations in "key PSB genres"
on the main Channel 4 service. This measure is one of many included
in the Public Impact Report, which seek to quantify the scale
and impact of Channel 4's public service delivery. These measures
include, for example, Channel 4's expenditure on originated content
across all services—£373 million in 2009—and
Channel 4's investment in the independent sector outside London—£117
million in 2009.
Channel 4's statutory remit is also defined
in terms broader than specific "PSB genres". Channel
4's pubic service remit is "the provision of a broad range
of high quality and diverse programming which, in particular:
(a) demonstrates innovation, experiment and creativity
in the form and content of programmes;
(b) appeals to the tastes and interests of a
culturally diverse society;
(c) makes a significant contribution to meeting
the need for the licensed public service channels to include programmes
of an educational nature and other programmes of educative value;
and
(d) exhibits a distinctive character."
This remit was recently confirmed in the Digital
Economy Act 2010, which added requirements for Channel 4 to
participate in the making and distribution of: UK film; content
for older children and young adults; and digital media content.
It also required Channel 4 to promote alternative viewpoints and
support and develop new talent.
The updated remit recognises the public value
provided by Channel 4 beyond the main Channel 4 service. In particular,
it endorses the role of Channel 4's digital channels as not only
important sources of revenue, but also their role in creative
and public service terms, providing valuable opportunities to
innovate and experiment and reach diverse audiences, such as younger
viewers. E4, for example, has invested in a range of UK-originated
programming, including the award-winning E4 commissions Skins
and The Inbetweeners. More4 continues to provide high-quality
UK and international factual programming such as the critically-acclaimed
True Stories strand.
The Digital Economy Act 2010 does not,
however, give the digital channels public service status, with
commensurate public service obligations and benefits—it
simply provides a framework for recognising the Channel 4 Corporation's
public service delivery beyond the main Channel 4 service.
8. How does Channel 4 decide what is an appropriate
level of return of public service content on the core and non-core
(E4, More4 and Film4) channels?
Channel 4 currently sets out its public service
ambitions for the main Channel 4 service each year in its annual
statement of programme policy, which provides an overview of Channel
4's overall programme strategy, its licence commitments, its programme
offer in a range of genres, and additional matters such as cultural
diversity, media literacy and support for independent and regional
production. The statement of programme policy also mentions public
service highlights on the digital channels but, as discussed above,
these channels do not have public service status or obligations.
Investment in individual commissioning areas is determined as
part of Channel 4's annual budget process.
From 2011, under the new arrangements in the
Digital Economy Act 2010 Channel 4 will adopt an enhanced
accountability framework. Building on the measures developed in
Channel 4's Public Impact Report, Channel 4 will publish a statement
of media content policy, setting out its public service ambitions
across the entire Channel 4 portfolio. It will also review the
Channel 4 portfolio's public service delivery in the preceding
year. Channel 4 is working with Ofcom to develop an appropriate
framework for the annual statement of media content policy, and
believes this will be a useful tool in assessing its public service
delivery across all platforms in future.
DIGITAL CHANNELS
9. Further to the additional information that
Channel 4 provided to the Committee last year—partly on
an in confidence basis—the Committee would now like the
following information for 2009:
— the individual profitability
of its non-core (E4, More4 and Film4) channels, including each
channel's revenues, programme budget and operating surplus.
Channel 4's 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. As discussed in response
to question 7, the digital channels are also making an increasing
contribution in creative and public service terms.
In total, Channel 4's digital channels generated
operating profits of £54 million in 2009—an increase
of £13 million on 2008, which is notable given the economic
recession and advertising market downturn. Table 1 below shows
the operating surplus of the digital channels in 2009.
Table 1
DIGITAL CHANNEL FINANCIALS—2009 (£M)*
|
| Total |
|
| Revenues | 181 |
| Programme budget | (76) |
| Operating surplus | 54 |
|
| * Information for individual digital channels has been redacted.
|
| |
— total investment on each of the non-core channels
since their inception, and when Channel 4 expects the start-up
costs and total operating losses on each of the non-core channels
to have been fully recouped.
As discussed with the Committee last year, the financial
performance of Channel 4's digital channels is best considered
in two phases. First, the years in which the digital channels
were available only on pay TV ("the pay TV years");
and second, the years after Channel 4 took the strategic decision
to shift the digital channels to free-to-air TV ("the free-to-air
years"). Film4 was launched on pay TV in November 1998 and
was moved free-to-air in July 2006; E4 was launched on pay TV
in January 2001 and was moved free-to-air in May 2005. More4 has
been available free-to-air since its launch in October 2005.
During the pay TV years, Channel 4's digital channels received
insufficient revenue from satellite and cable platform operators
to generate profits. As a result, Film4 and E4 incurred losses
in the years prior to the channels moving free-to-air. Since Channel
4 took the strategic decision to move these channels free-to-air,
Film4 and E4 have been more successful than they ever were as
pay TV channels and have both generated net profits.
[Financial information on digital channels has been redacted.]
In 2008, the portfolio of digital channels fully recouped
its costs since moving free to air. On an individual basis, each
channel has also fully recouped all its costs since moving free
to air.
[Forecasts of financial performance of digital channels have
been redacted.]
10. Given that they are still paying back start-up costs,
how much profit have the non-core channels actually delivered
to the core channel for reinvestment in public service content?
[Financial information on digital channels has been redacted.]
In addition to generating profits, the digital channels also
play a key role in maintaining the Channel 4 Corporation's audience
share. While audience share of the main Channel 4 service has
fallen in recent years as the inevitable consequence of digital
switchover, the success of the digital channels has resulted in
the audience share of the Channel 4 portfolio growing from 10.5%
in 2004 to 11.5% in 2009.
11. How much of the surplus of the non-core channels is
returned to fund public service content on the core channel and
non-core channels respectively?
Collectively, the digital channels have generated surpluses
and positive cash flow since 2007. Digital channel profits have
grown every year since 2007—from £16 million in 2007
to £54 million in 2009—and Channel 4 expects the digital
channels to continue to deliver profits over its current planning
horizon.
Channel 4's unique model ensures that surpluses generated
by the Channel 4 Corporation are returned for investment in content.
Channel 4, as a publiclyowned corporation, does not have
shareholders—it therefore reinvests surpluses in content,
rather than having to pay them out in dividends to shareholders.
In terms of the distribution of expenditure on the main Channel
4 service and individual digital channels, Channel 4 operates
its budget and planning process on a portfolio basis. Channel
4's planning is therefore executed across the entire Channel 4
portfolio, and it does not hypothecate or designate funds from
individual digital channels to specific services—rather,
budgeting decisions are taken in the round.
12. Were the non-core channels initially funded by prior
year profits and reserves of the core Channel 4 service?
— If so, how is this compatible with the requirement
that Channel 4 operates all of its commercial activities subject
to strict arrangements which ensure that public funds are not
used to subsidise commercial activities?
The Channel 4 Board remains confident that the digital channels
were launched in accordance with the relevant regulations. The
legislative framework has, at all relevant times, expressly permitted
investment in commercial activities outside the main Channel 4
service.
Channel 4's digital channels were launched over a period
of seven years: Film4 was launched in November 1998; E4 was launched
in January 2001; and More4 was launched in October 2005. The legislative
provisions governing Channel 4 at each of those launch dates differ—for
Film4 and E4, the regulations were set out in the Broadcasting
Act 1990 ("the 1990 Act"), and for More4 the relevant
legislation is the Communications Act 2003 ("the 2003
Act").
THE 1990 ACT
The 1990 Act set out funding arrangements which allowed Channel
4 to sell its own advertising airtime—previously this function
had been performed by ITV, which then passed funds onto Channel
4. Under the new arrangements, Channel 4 had to divide its revenue
into various pots: "prescribed minimum income"; excess
over prescribed minimum income; and a "reserve fund".
Further, as part of the funding arrangements Channel 4 had to
make payments to ITV—between 1993 and 1999 Channel 4 paid
a total of over £400 million to ITV.
The 1990 Act provides in section 24(1) that the function
of the Channel 4 Corporation is "to secure the continued
provision […] of the television broadcasting service known
as Channel 4". Section 24(5) of the 1990 Act conferred an
express power for the Channel 4 Corporation to be involved in
the provision of television services other than Channel 4. Finally,
under Schedule 3 of the 1990 Act, the Channel 4 Corporation had
capacity "to do such things and enter into such transactions
as are incidental or conducive to the discharge of their functions".
Accordingly, the Channel 4 Corporation was permitted to invest
its income in not only the main Channel 4 service, but also in
transactions which were "incidental or conducive" to
the same.
There were a number of reasons why the Channel 4 Board considered
the new services, E4 and Film 4, to be conducive to the Channel
4 service. These included, but were not limited to: enabling Channel
4 to secure bundled offerings of television series from copyright
owners consisting of both pay TV and free TV rights to be played
across the new services, Channel 4 retaining audiences in the
emerging multichannel world, improving and building on the Channel
4 brand, and diversifying revenue streams.
The expenditure incurred in respect of the digital channel
launches was set out in the Annual Report and Financial Statements.
In 2001, David Elstein, the former Chief Executive of Channel
5 Television, questioned whether the Channel 4 Corporation's powers
did in fact extend to the provision of its digital services. Channel
4 obtained legal advice from Leading Counsel which confirmed its
position that the establishment of, and expenditure on, its digital
services was, at all times, a legitimate exercise of its powers.
Channel 4 remains satisfied that this is the case.
THE 2003 ACT
The 2003 Act updated the provisions relating to Channel 4.
It confirmed and endorsed the Channel 4 Corporation's express
powers to do anything which appears to it to be incidental or
conducive to the carrying out of its functions (including borrow
money subject to a borrowing limit; establishing subsidiary companies
to carry out such permitted commercial activities; and participating
with others in respect of the same). It also imposed new procedural
obligations on Channel 4, providing a clear framework for Channel
4's permitted commercial activities. These obligations, outlined
in Schedule 9 of the 2003 Act, require Channel 4 to:
— identify, evaluate and properly manage any permitted
commercial activities, so as to protect the primary functions
of the channel (ie. the main Channel 4 service);
— financially and organisationally separate permitted
commercial and primary activities; and
— ensure transparent reporting where there is a connection
between commercial and primary activities (for example, shared
resources).
These arrangements continue to ensure that any new services
are not launched in a way that jeopardises the delivery of the
primary function of Channel 4. In relation to the digital channels,
the 4Ventures balance sheet is charged with any interest for funds
received from other parts of the Channel 4 Corporation, ensuring
no crosssubsidy.
The Schedule 9 arrangements, which secure the above objectives,
have been approved by Ofcom, and are published on the Channel
4 website.3 Channel 4's compliance with these arrangements is
required to be audited on an annual basis and Deloitte has been
appointed for this purpose. Deloitte's reports are published in
Channel 4's Annual Report and Accounts.
13. How are costs allocated between the core channel and
the digital channels with regard to programming that appears across
the network, and cross-promotion?
As noted above, Schedule 9 of the 2003 Act sets out the oversight
framework for Channel 4's commercial activities. Cost allocation
is subject to the Schedule 9 arrangements—programming and
cross-promotion costs are allocated between the channels in accordance
with Channel 4's cost allocation policy, which has been audited
by Deloitte. The relevant sections of this policy for acquired
peak series, the most significant programming cost allocated between
channels, and cross-promotion, are summarised below.
ACQUIRED PEAK
SERIES
Channel 4 acquires the rights to transmit certain acquired
series during peak viewing times, to be shown on more than one
channel. Channel 4 allocates the costs of "shared" programming
by applying a standard percentage cost allocation to each channel.
This allocation is based on commercial impact analysis, where
commercial impacts act as a measure of the value attributable
to the relevant digital service compared to the core channel.
CROSS PROMOTIONAL
AIRTIME
Channel 4 cross-charges channels for on-air promotions for
programmes that appear on its other channels. The value of promotional
airtime is reflected fully, based on the level of impacts generated
by the promotions. The cross-charging method is applied across
all 4Ventures activities in the Channel 4 portfolio.
12 November 2010
3 http://www.channel4.com/about4/pdf/C4_arrangements.pdf
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