Supplementary letter from Virgin Media
I am writing further to our recent appearance
before the Committee to give evidence to the above inquiry.
I hope that the evidence provided by Virgin
Media to date has helped to illuminate in some way the market
conditions that we experience and, in particular, our views on
the protection of plurality in the provision of news.
You will be aware that the Secretary of State
for Business, Enterprise and Regulatory Reform will shortly announce
his decision on what remedy is needed to address the adverse impact
on competition provoked by Sky's controversial acquisition of
a 17.9% stake in ITV. We remain firmly of the view that a comprehensive
sell-down of the stake is the only safe way to proceed.
Virgin Media took heart from the depth of the
Committee's insight into the competition issues raised by the
transaction. However, we are less convinced that the Commission
has properly interpreted the relevant plurality provisions of
the Enterprise Act 2002 (as inserted by the Communications Act
2003) and are concerned that the approach adopted by the Commission
is in inconsistent with the approach intended by the House of
Lords when it took steps to amend the Communications Bill during
its Parliamentary passage. Our view is that the Competition Commission,
while clinical and crisp in its capacity to diagnose restriction
or distortion of competition, is less comfortable with the plurality
test and, as such, may not have fully delivered on the legislative
aims of Parliament. It appears that a review of the provisions
regarding plurality might become timely once the present Sky case
has been determined and therefore warmly welcome your recent announcement
that the next phase of the Committee's inquiry will focus on regulatory
matters.
In addition, as noted during our testimony before
the Committee, the review of Sky's stake in ITV has taken considerable
time (in excess of a year). As a direct result, Sky has, during
the course of the review, been in a position to effectively block
(or substantially reduce the likelihood of) ITV engaging in a
strategic transaction. We would therefore suggest that the merger
approval process (and at a minimum, the time frames associated
therewith) are potentially problematic in such a fast moving industry.
Lastly, Virgin Media believes that, while media
ownership has a direct bearing on plurality of news provision
and the opportunity for a diverse range of voices to be heard
in current affairs media, there is also an urgent need to consider
broader issues of consumer choice, competition and innovation
at all levels of the TV industry. In this context, the Committee
will be aware that Ofcom has, since our appearance, published
several submissions on its ongoing market investigation into the
pay TV market. The links to the information it published are as
follows:
I also attach for your information a short summary
of the joint submission made to Ofcom by Virgin Media, BT, Setanta
and Top Up TV.
We would welcome any opportunity to share with
the Committee our views on the critical issues raised in these
documents. In the meantime, we appreciate the Committee's attention
to this issue and remain at its disposal to present our perspective
on what is needed to create a genuinely competitive pay TV market
that contributes to the diversity and dynamism of the broader
broadcasting industry.
17 December 2007
BACKGROUND BRIEFING ON THE MARKET FAILURE
IN UK PAY TV
INTRODUCTION AND
SUMMARY
1. Due to certain market features, competition
in pay TV in the UK is not working effectively. As a consequence,
consumers experience higher prices, reduced choice and diminished
innovation.
2. A pivotal aspect of these market features
is Sky's control of mutually reinforcing bottlenecks, both upstream
and downstream in the pay TV supply chain. Upstream, Sky's firm
grasp of the most attractive pay TV content enables it to consolidate
and expand further its leadership in pay TV distribution. Downstream,
Sky's control of access to the largest pay TV platform and the
largest base of pay TV subscribers enable it to outbid competitors
for the most attractive content.
3. Sky has the incentive and the ability
to leverage the existing market structure so as to marginalise
and even foreclose competitors. The entrenched nature of the market
failure means that any competition or other regulatory remedy
aimed at addressing one or other aspect of Sky's conduct will
not prevent it from exploiting the existing market structure in
other ways. Accordingly, this market failure cannot adequately
be addressed by piecemeal regulatory intervention which is aimed
at addressing individual instances of Sky's conduct.
4. Indeed, previous attempts by competition
authorities to address competition problems in the UK pay TV industry
and in particular to regulate individual instances of Sky's conduct
(for example under the Competition Act) have proved inadequate
to deal with the structural features which allow such conduct
to occur and the industry-wide market failure which results.
5. As a consequence, BT, Setanta, Top Up
TV and Virgin Media consider that the broad investigation of the
UK pay TV industry which Ofcom announced on 20 March 2007 is thoroughly
warranted. In the event that appropriate undertakings are not
offered and accepted to address the market failure, Ofcom should
exercise its discretion under section 131 of the Enterprise Act
2002 to refer the UK pay TV industry to the Competition Commission
for a full market investigation.
THE UK PAY
INDUSTRY
6. The pay TV supply chain can be divided
into three main tiers: (i) the acquisition of content, (ii) the
wholesale supply of channels and (iii) the distribution of those
channels by platforms/retailers. Among other things, Sky has leading
market positions at each of these three tiers of the supply chain
in respect of sports and movie content and channels which are
widely acknowledged to be the drivers of pay TV. For example:
(a) Sky holds approximately 80% (by value)
of the sports rights which are broadcast on a pay TV basis in
the UK;
(b) Sky has a 100% share of premium subscription
movie rights;
(c) Sky's share of the wholesale supply of
sports channels is approximately 96% (by revenue);
(d) Sky's share of the wholesale supply of
premium subscription movie channels is 100%; and
(e) Sky accounts for more than 90% of the
retail subscribers to premium channels in the UK.
7. These leading market positions have endured
over time due to the existence of the vicious circle described
below.
FEATURES OF
PAY TV IN
THE UK
8. At each of its three main tiers, the
pay TV industry exhibits significant barriers to successful market
entry, which are due in large part to the following distinctive
features:
(a) A finite pool of key content: in
previous investigations, the UK and EU competition authorities
have consistently identified high quality sports and movies as
being key content for entry into and competition in pay TV and,
in particular, the provision of premium pay TV services. The pool
of rights for live broadcasting of the most popular sports events
and the pool of rights for broadcasting (on a subscription basis)
the movies produced by Hollywood studios are, however, necessarily
finite.
(b) The limited duration of certain contracts
for key content: not only is the pool of rights to key content
finite but the rights to broadcast certain key content are, themselves,
often limited in duration. For example, some of the most valuable
rights (such as live rights to the FA Premier League) expire after
just three years. This means that (i) an acquiring firm has a
strictly limited time period in which to make a return on its
content investments and (ii) a firm with an established subscriber
base downstream enjoys a competitive advantage when bidding for
content as it can monetise its investments in content faster than
firms without such a subscriber base. This allows the former to
outbid the latter for future key content, thereby perpetuating
its leadership downstream.
(c) Staggered availability of key content:
content rights are also staggered in their availability, which
significantly increases the barrier to entry. For example, in
order to acquire a material subscriber base, a sports channel
will need to offer regular coverage of attractive sporting events.
Since contracts for key sports rights are staggered with several
years between the sales of those rights, current holders of key
content possess an advantage when bidding for additional rights.
(d) The exclusive licensing and selective
distribution of key content: pay TV broadcasters package content
into channels which are then wholesaled to downstream distributors.
The exclusive licensing of key content denies that content to
competing broadcasters. The selective distribution of that key
content (eg the refusal to wholesale channels to certain pay TV
retailers) inhibits downstream competition.
(e) Economies of scale in the distribution
of content: pay TV broadcasters and retailers enjoy significant
economies of scale. A larger subscriber base enables a broadcaster
to reduce its average content acquisition costs and this downstream
advantage provides it with an ability to outbid its rivals in
the competition for key content.
(f) Feedback effects: the pay TV industry
is also characterised by significant feedback effects along its
vertical supply chain. Pay TV broadcasters and retailers need
to be able to offer attractive content to retain existing subscribers
and to win new ones. But, as outlined above, the contest for content,
especially for exclusive rights to key content, will most likely
be won by channel providers with larger downstream subscriber
bases. The selective distribution of that exclusive content enables
them to enlarge their subscriber bases further, which in turn
will bias the contest for content even more.
THE CORE
ISSUE: A VICIOUS
CIRCLE IN
PAY TV IN
THE UK
9. The combination of the six features outlined
above distinguishes the pay TV industry from other industries
with "feedback effects" and has clear cut implications
for competition within it:
(a) The pay TV industry exhibits a tendency
for concentration and "increasing dominance" (ie leading
market positions become entrenched). A firm with access to superior
content is able to build a customer base advantage which consolidates
its ability to monopolise the acquisition of content and, in turn,
achieve a leading position downstream.
(b) Market forces are unable to offset this
tendency. Leading market positions become entrenched because consumers
will not subscribe (or switch) to new entrants unless their content
offerings are sufficiently attractive. But this is not likely
because new entrants will face the handicap of having to compete
for subscribers with inferior content and to compete for content
with fewer subscribers.
10. As noted above, Sky holds the leading
market positions at the key levels of the supply chain and, in
particular, has a firm grasp on the most attractive pay TV content
and controls both the largest pay TV platform and the largest
base of pay TV subscribers. Sky's control of these mutually reinforcing
upstream and downstream bottlenecks results in a vicious circle
for its competitors.
11. Against this market background, Sky
is able to ensure that its leading position in the acquisition
of content upstream is perpetuated by preserving its downstream
advantage in pay TV distribution. Sky's past conduct vis a"
vis its competitors confirms that Sky has both the incentive
and the ability to foreclose downstream competition. For example,
Sky is able to use its leading position in the acquisition of
content upstream to deny key content to competing pay TV retailers
and thereby restrict downstream competition for its own retail
business. By refusing to provide third party pay TV retailers
with access to its premium channels on economically viable terms
and on a non-discriminatory basis as compared with its own downstream
distribution arm, Sky can place its downstream competitors at
a significant disadvantage which adversely impacts on the prices
and choices available to consumers.
12. Sky is also able to ensure that its
leading position downstream in pay TV distribution is perpetuated
by preserving its upstream advantage in the acquisition of content.
Sky's past conduct vis a" vis its competitors confirms
that Sky has both the incentive and the ability to foreclose upstream
competition. For example, Sky is able to use its leading positions
downstream in pay TV distribution to inhibit access to the largest
pay TV platform and the largest base of pay TV subscribers in
the UK and thereby restrict competitive bids for the most attractive
pay TV content.
13. Sky is also now seeking to reinforce
the effects of the vicious circle outlined above by extending
it into new distribution platforms and technologies. For example,
Sky imposes most favoured nation clauses on third party broadcasters
in its agreements with them for satellite distribution of their
channels. These MFN clauses result in either restricted access
to content for competitors seeking to use new platforms and technologies
or the imposition upon such competitors of commercial terms which
are appropriate for more traditional linear broadcast services.
Thus, these MFN clauses inhibit the development of innovative
services over new platforms and technologies.
CONSUMER HARM
14. Evidence indicates that consumers are
harmed by these adverse effects on competition in terms of higher
prices, restricted choice and reduced innovation. For example,
data published by Ofcom indicates that, on average, pay TV subscribers
in the UK pay more than their counterparts in other European countries.
15. LECG has undertaken an econometric study
which compares the average pay TV prices observed in the UK and
14 other European countries and investigates whether the differences
between these prices can be explained by benign factors such as
country-specific differences in demand, such as pay TV being of
a higher quality in the UK or the UK having higher income per
capita. LECG's econometric study strongly indicates that, even
when account is taken of these differences in demand, UK consumers
have to endure substantially higher average prices for pay TV—on
average 36% higher than the pay TV prices in the other European
countries in the sample.
16. Consumers in the UK also suffer as a
result of less choice and diminished innovation. For example,
Sky is inhibiting the take-up of HD services on competing platforms
by refusing to supply its HD channels to those platforms. Sky
has also inhibited the development of competing HD services on
the satellite platform by refusing to provide conditional access
services for such channels.
REMEDIES
17. The market investigation is necessary
to address both the mutually reinforcing upstream and downstream
bottlenecks and the conduct which is associated with the structural
features of the market. For the reasons explained briefly above,
intervention is needed at all levels of the supply chain in order
to enable effective competition in pay TV in the UK This should
include fair, reasonable and non-discriminatory access by third
party pay TV retailers to Sky's premium channels on economically
viable terms and appropriate remedies to address the adverse effects
which Sky's downstream advantages have on the contest for content.
18. Whilst such remedies would limit Sky's
ability to foreclose (or marginalise) competitors at the various
levels of the supply chain, Sky's incentives to do so would remain.
Trying to regulate a company against the grain of its incentives
will always be both costly and difficult. The solution to this
problem could be to modify Sky's vertical structure by separating,
in some manner, its channel and distribution businesses.
19. Overall it is clear that remedies are
available which can be implemented at a proportionate cost, particularly
given the increase in consumer welfare which would result from
the introduction and consolidation of effective competition in
the UK pay TV industry.
CONCLUSION
20. Ofcom has a discretion under the Enterprise
Act to make a market investigation reference to the Competition
Commission where it has "reasonable grounds to suspect"
that any market feature prevents, restricts or distorts competition
in the UK.
21. The evidence of market failure in pay
TV in the UK and the need for remedies to address the structure
and distinctive features of pay TV is overwhelming. Accordingly,
failing the offering and acceptance of adequate undertakings to
address the market failings in a comprehensive manner, Ofcom should
refer the pay TV industry to the Competition Commission.
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