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The future of Channel 4 Contents

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Chapter 2: C4C’s business model

10.C4C operates in a rapidly changing and competitive international market. Throughout our inquiry, witnesses identified the same threats to C4C’s sustainability: viewers migrating to digital services, declining linear (traditional broadcast) TV advertising revenue and increased competition—from subscription video on demand services (SVODs) such as Netflix and Amazon Prime, and from newly consolidated entities (such as Sky, acquired by Comcast, and 21st Century Fox, acquired by Disney).

11.C4C and the Government agreed that the key objective for all parties in the discussion of C4C’s future is its flourishing. Alex Mahon, CEO of C4C, told us, “Where there is definitely a shared objective, of everyone, if I can search for one, it is making Channel 4 stronger. That is definitely shared by us and the Government.”10 Julia Lopez, Minister of State at the Department for Digital, Culture, Media and Sport, agreed, stating that her interest “is the sustainability of a channel that the public values, that I value as a Minister, that has an important role in the public service broadcasting landscape and that we want to see thrive.”11

12.However, we found a lack of consensus among witnesses on the level of risk C4C faces.

Sustainability

13.C4C’s business model depends on advertising, which constitutes 90 per cent of its total revenue. Traditionally, this has been based on linear TV advertising, but linear TV viewership and revenues are in long-term decline. Ebiquity has forecast that an advert broadcast on linear television in 2022 will be seen by 14.4 per cent fewer people than one broadcast in 2018. Forecasted declines for the period 2018 to 2022 are most pronounced in the 16–17-year-old (60.9 per cent), 18–24-year-old (48.4 per cent) and 25–34-year-old (45.3 per cent) age groups, on which C4C focuses.12

14.Figure 1 shows how the percentage of adults viewing at least 15 minutes of Channel 4 on linear television in an average week has declined. The sharpest decline is among 16–24-year-olds: whereas 47 per cent watched 15 minutes of Channel 4 in an average week in 2010, only 20 per cent did in 2020 despite a slowing in the decline due to lockdowns.

Figure 1: Average Channel 4 weekly reach, 15 minutes

Source: Ofcom, ‘Media Nations 2021 interactive report’ (5 August 2021): https://www.ofcom.org.uk/research-and-data/tv-radio-and-on-demand/media-nations-reports/media-nations-2021/interactive-report [accessed 15 November 2021]

15.In February 2019, Ebiquity found that due to declining viewing among young people it is now much more expensive to run an advertising campaign which will reach them. The cost of running a TV advertising campaign seen by half of 16–34-year-olds had increased from £560,000 in 2013 to £1.07 million in 2018. The company forecast that this would rise to £2.6 million in 2022.13 However, the actual figure may be higher as TV viewing among younger people fell more sharply than Ebiquity had forecast in 2019.

16.To compensate for the decline in linear advertising revenue, C4C has made significant progress in transitioning its viewers to digital viewership. A higher proportion of C4C’s viewing takes place on its VOD service than ITV; in 2020 this was 12.5 per cent for All 4 and 2.9 per cent for ITV Hub.14 Enders Analysis notes that, compared with C4C, the commercially owned PSBs (ITV and Channel 5) have been “slow in streaming tech development as well as moving content exclusively online.”15 In its response to the Government’s consultation, C4C wrote:

“growth in digital revenues is compensating for linear challenges: Looking over the five-year period from 2017 up to and including our forecasts for 2021, we find that linear revenues have declined by only c. 2 per cent, whilst digital revenues have increased by c. 110 per cent; with overall revenues expected to be over £100 million higher in 2021 than in 2017.”16

17.Table 1 shows C4C’s financial results from 2016 to 2020:

Table 1: C4C financial results (£ million)

	2016	2017	2018	2019	2020
Group revenue	995	960	975	985	934
Linear advertising revenue	844	785	774	767	689
Digital advertising revenue	84	100	120	145	161
Non-advertising revenue	67	75	81	73	84
Sales house net advertising revenue	1,056	1,002	994	950	NR
Sales house total	1,203	1,166	1,183	1,161	1,047
Operating surplus/deficit	-18	-25	8	-27	71
Surplus/deficit before tax	-15	-17	5	-26	74

Source: Enders Analysis, Channel 4 privatisation: Here we go again (22 June 2021)

18.These figures show an 18 per cent decline in linear advertising revenue and a 91 per cent increase in digital advertising revenue from 2016 to 2020, amounting to an 8 per cent decline in advertising revenue before adjusting for inflation.

19.In order for the period 2017–21 to show a linear advertising revenue percentage decline of 2 per as C4C forecasts, linear advertising revenue in 2021 would need to be c. £769 million. For digital advertising revenue to increase by 110 per cent in the same period, as C4C predicts, such revenue in 2021 would need to be c. £210 million, an increase of 30 per cent from 2020. Alex Mahon told us that C4C’s “digital business” grew 30 per cent in 2020, but this refers to digital viewing, not digital revenues.17 The figures above show an increase in digital advertising revenue from 2019 to 2020 of only 11 per cent, and from 2018 to 2019 of 21 per cent. This leaves unanswered questions about C4C’s forecasts for 2021.

20.C4C was praised by several witnesses for its resilience throughout the pandemic and its strong financial results for 2020. In 2020, total revenues were down 5 per cent year-on-year, despite being the broadcaster most exposed to a downturn in the advertising market and suffering a 50 per cent fall in linear advertising revenues at the height of the pandemic in April and May 2020.18 However, the exceptional circumstances under which these results were achieved make them an unreliable indicator of C4C’s future financial health. C4C cut content spending by 21 per cent, which Enders Analysis described as “in no way sustainable given the explosion in programming spends of the streaming services.”19

21.We were surprised that in both written and oral evidence, when C4C were asked to describe any potential benefits to privatisation alongside potential risks, C4C described only risks, such as the possibility of its public service remit and investment in content being eroded under a private owner.20 Alex Mahon told us that in response to the Government’s consultation C4C “tried to be very factual, rather than theoretical on what other options could be.”21

22.C4C faces intensifying competition. Although 41 per cent of people told Ofcom in Q1 2021 that they used All 4—and 2 per cent subscribed to All 4+—viewing of broadcaster video-on-demand (BVOD) services is low. Overall viewing increased over lockdown. However, total viewing of BVOD services remained 11–12 minutes per person per day from 2019 to 2020 among both 16–34-year-olds and the general population. This compares unfavourably with growth in viewing of subscription video on demand (SVOD) services such as Amazon Prime and Netflix. Viewing of such services rose from 34 minutes a day in 2019 to 65 minutes in 2020 among the general population. Among 16–34-year-olds, it rose from 65 to 91 minutes.22

23.Part of the challenge of determining C4C’s sustainability in the face of competition is the lack of detailed viewership data available for direct comparison. While Ofcom assesses overall BVOD viewing minutes per age group, and is able to detail this for BBC iPlayer, Netflix and Amazon, it told us that it is not able to do the same for All 4 because it does not receive the relevant figures from C4C. Ofcom told us it is “working with [C4C] to agree what All 4 data would be suitable for publication in the future.”23 Enders Analysis has noted: “the Corporation should be proactive and instigate some evolution here to better reflect its performance within the entire viewing landscape … This may well provide some sobering reading but would provide a more accurate assessment on where Channel 4 is positioned.”24

24.C4C told us that All 4 has been watched for an average of 168 million viewer-minutes per day in 2021, with 76 million viewer-minutes per day for 16–34 year olds.25 This suggests that the average UK adult watches All 4 for between 2 and 3 minutes a day, rising to between 4 and 5 minutes for 16–34 year olds.26 In 2020 the average 16–24-year-old watched Channel 4 on linear TV for 4 minutes a day, compared with 13 minutes in 2010. Viewership among 25–34-year-olds and all individuals (ages 4+) also fell in this period, from 16 to 8 minutes and 15 to 10 minutes respectively.27 All 4 viewing does not appear to have compensated for this decline.

25.Enders Analysis thought that privatisation could significantly improve C4C’s BVOD performance:

“Given the likely buyer will be a large international media company with a significant content library, another major benefit of privatisation could be All 4 becoming a much more formidable competitor to BBC iPlayer and AVOD [ad-based video-on-demand] services”28

26.Dr Helen Weeds, former Chief Economist at Ofcom, and Mark Oliver, co-founder and Chair of Oliver & Ohlbaum Associates, suggested that under C4C’s current business model, net growth in its revenue will likely remain flat in the long term. Mark Oliver told us that “whereas digital media and the platforms have more than decimated the press, they have really left TV as a flat growth sector, with a bit of nominal growth and probably not much real growth for the last five to eight years in most developed markets.”29

27.The greatest risk the advertising market poses to C4C’s sustainability is likely not, as the Government suggests in its consultation, the potential volatility of “market shocks”.30 C4C has highlighted its resilience in navigating short-term crises such as 2020’s pandemic-induced advertising downturn. Rather than a sudden “precipitous financial crisis”, Mark Oliver argued that the greater risk was that, in an era of rising production costs and international competition, flat net growth could put gradually increasing pressure on C4C’s budgets: “it might have to cut its cloth a bit more to what it can afford and that might start to erode the delivery of the remit, although not necessarily, because you can deliver the remit in cheap and cheerful ways.”31

28.Production costs continue to escalate in the UK, a trend we highlighted in Public Service Broadcasting: as vital as ever. Across high-end television, the average spent on purely domestic productions has remained well under £2 million per hour, whilst the budget for shows with international investment is now almost £6 million per hour.32

29.Kevin Bakhurst of Ofcom told us that C4C may not be able to compete with Netflix’s budgets in producing shows such as The Crown, but “there are long-running dramas such as Hollyoaks, which the audiences really value and are still watched by significant numbers. There is much less competition in those areas. You can choose to invest in other genres if you are getting priced out.”33

30.Other witnesses, such as Lord Grade of Yarmouth, former CEO of C4C, and Luke Johnson, former Chair of C4C, argued that allowing C4C to be priced out of certain areas would amount to letting it fall into relative decline. Luke Johnson termed the status quo “benign neglect”, arguing that C4C “is becoming, in a much more diverse, complex and competitive media landscape, gradually more and more irrelevant. At some point, the momentum will slow and you get into a vicious spiral.”34

31.Although the market is changing rapidly, Alex Mahon told us that the question of ownership is raised with a frequency and ad hoc approach that is destabilising for C4C:

“We created a very good strategy for changing the structure of the organisation and moving a significant number of personnel to the nations and regions, really shifting our focus in terms of what we are doing. We are part way through that plan… It worries me that the carpet would get ripped from underneath that when we have barely started.”35

32.When asked about the potential benefits of privatisation, C4C’s response listed only potential disadvantages. We would have been more reassured to see C4C, as a publicly owned corporation, openly demonstrate that the potential benefits of privatisation had been considered by its board, and judged to be outweighed by the risks.

33.If C4C remains in public ownership, we recommend that its board be required periodically to publish analysis of the sustainability of C4C’s business model. As part of this process, C4C would be expected to notify the Government of potentially significant threats to its sustainability, at which point the Government might choose to launch a review of C4C’s ownership. If the Government wishes to launch such a review without this notification from C4C, it should first be required reasonably to demonstrate the scale of the threat to C4C’s business model. The Government should remain circumspect about reviewing C4C’s ownership, mindful of the disruption this may cause the Corporation in fulfilling its remit and purpose.

34.Enhanced measurement and transparency of All 4 viewing would lead to greater confidence in the sustainability of C4C’s business model and enable a more detailed assessment of the competitiveness of the UK broadcasting sector. Ofcom should be able to compare the performance of publicly owned public service broadcasters’ video-demand services.

35.Improved monitoring and assessment of viewing data is a priority and we recommend C4C and Ofcom resolve the lack of standardised data as quickly as possible.

Alternative revenue streams

36.Throughout our inquiry, witnesses have suggested that the crucial question is not just whether C4C is sustainable in its current form, but what vision of its future should be adopted—what scale it should operate at, and in what markets.

37.Claire Enders, founder of Enders Analysis, told us that C4C was “demonstrably sustainable”, and that there was no urgent case for a change in its model. However, she outlined a vision for C4C “of much greater ambition than sustainability”, whereby private investment would enable it to compete and champion British content on an international scale.36

38.In its consultation, the Government outlined several potential benefits to privatisation:

• Improved and sustained access to capital
• The ability to take advantage of strategic partnerships and acquisition opportunities
• The ability to expand into international markets
• The ability to invest more heavily in an agile manner to ‘future-proof’ its business model
• The ability to diversify its revenue sources.37

39.C4C is already seeking to diversify its revenues, as outlined in its Future 4 Strategy:

• The Expansion of 4Studio (its Leeds-based digital content agency, established in 2020)
• Launching the Global Format Fund (a £30 million fund to invest in new British-created and produced content formats that have global potential, with all net receipts from producer exploitation shared equally between the producer and C4C)
• Scaling existing venture funds: the Indie growth Fund (which launched in 2014 to provide funding to UK-based indies and has since made 25 investments with 16 companies in the portfolio) and Channel 4 Ventures (which offers high-growth brands TV advertising in exchange for an equity stake in the business)
• Enhanced digital distribution partnerships (forging new arrangements alongside existing deals such as with Sky to broadcast Formula 1 and with Amazon to show the US Women’s Open final)38

40.Enabling C4C to invest in intellectual property ownership would enhance its market power and enable it to expand further into international markets. Under the Terms of Trade—rules to protect independent production companies established by the Communications Act 2003 and negotiated between Pact (Producers Alliance for Cinema and Television) and the PSBs—C4C cannot make acquiring the secondary and international rights a precondition of buying the primary (first-run) rights to a programme. If they wish, independent production companies can therefore negotiate a better deal for secondary and international distribution with another broadcaster or SVOD. As a ‘publisher–broadcaster’, all C4C’s content spending must be invested in independent suppliers. C4C therefore lacks the long-term revenue from intellectual property which Netflix, Sky and others enjoy.

Box 1: Terms of Trade

The Terms of Trade are codes of practice adopted by public service broadcasters, regulated by Ofcom under the Communications Act 2003. The Terms of Trade give independent producers control over the ‘secondary rights’ to their content, and thus the ability to monetise content they have produced in international markets. Ofcom is required under Section 285 of the Communications Act to issue and maintain guidance to PSBs in drawing up their Codes of Practice for commissioning from independent producers. These arrangements apply to external commissions made by the main UK PSB channels (BBC1, ITV, Channel 4 and Channel 5) and the digital channels operated by the BBC and Channel 4 of programming from independent producers (companies that are wholly independent of, or up to 25 per cent owned by, broadcasters providing a service aimed primarily at the UK). Separate Terms of Trade arrangements are agreed between each of the PSBs and Pact (Producers Alliance for Cinema and Television) on behalf of qualifying independents. Part or whole ownership (over a 25 per cent threshold) by a broadcaster providing a service aimed primarily at the UK removes production companies from regulatory protection under the Communications Act 2003 and their status as qualifying independents under the Terms of Trade. Prior to the introduction of the Terms of Trade, which came into force in 2004, the independent production sector was highly fragmented and was highly dependent on the main PSB network groups. There was little scope for independent production companies to negotiate on production fees or take strong positions in rights against which to build up an asset base. The independent production sector has grown since the introduction of the Terms of Trade, with revenues rising from £1.5 billion in 2004 to £3.3 billion in 2019 (the disruption of the pandemic led to a decline in revenue for the first time since 2016, reaching £2.9 billion). The majority of the UK’s independent production sector is represented by Pact, which has 629 members of varying sizes. Data provided by Pact show that 575 of these members (91 per cent) have a turnover of under £5 million. John McVay OBE, Chief Executive of Pact, told us that “there is only one Pact member company whose turnover exceeds £350 million and does not benefit from any of the interventions or regulation introduced by successive UK Government’s to support the growth of UK SMEs.” However, Pact’s data indicate that there are three Pact member companies whose turnover exceeds £350 million, implying that there are two independent production companies with revenues of over £350 million who continue to benefit from Terms of Trade provisions.

Sources: Ofcom, Guidance for Public Service Broadcasters in drawing up Codes of Practice for commissioning from independent producers, https://www.ofcom.org.uk/__data/assets/pdf_file/0022/87052/statement.pdf [accessed 15 November 2021], Ofcom, Small Screen: Big Debate–a five-year review of Public Service Broadcasting (2014–18): https://www.ofcom.org.uk/__data/assets/pdf_file/0013/192100/psb-five-year-review.pdf [accessed 15 November 2021], O&O Associates, Pact 2021 Census and Supplementary written evidence from John McVay (FCF0054)

41.Changing the Terms of Trade, such as by placing a cap on the turnover of eligible producers, would enable C4C to negotiate for long-term intellectual rights of the content it commissions and therefore form profitable international content partnerships. Claire Enders told us: “The shape of global IP exploitation has changed beyond measure because of the global streaming businesses … There is a huge impetus on ownership of IP, which is manifest in the rising share prices of companies that exploit it successfully in digital at scale.”39

42.If C4C were able to develop in-house production capacity, this could help to diversify its revenues. BBC Studios and ITV Studios can produce programmes both for the BBC and ITV respectively and for other broadcasters, in the UK and abroad. ITV Studios has helped to insulate ITV from the advertising market, generating 42 per cent of the company’s revenues in 2020. If C4C were privatised, Mark Oliver told us that relaxing publisher-broadcaster model would almost certainly be a condition of sale: “ If Channel 4 is not allowed to own production, it becomes a poison pill to a new owner, so I suspect something will have to change.”40

43.In Public Service Broadcasting: as vital as ever, we recommended that Ofcom should consider whether the Terms of Trade unfairly disadvantage public service broadcasters in a competitive market. The Terms of Trade were originally introduced to protect independent production companies from the dominance of public service broadcasters, but the sector has since matured significantly. We consider the impact of reviewing the Terms of Trade on the independent production sector in Chapter 3.

44.There is a potential alternative for the Government to investigate—neither privatisation nor the status quo: relaxing the Terms of Trade and enabling C4C to negotiate for a greater share of intellectual property in the content it commissions, drawing on its existing capital to do so. Charles Gurassa, chair of C4C, told us:

“We have plenty of capital. We have money that we are not using. In fact, even under the current restrictions—and there are questions about why those restrictions exist—we could borrow another £200 million on top of our £500 million assets … We have plenty of cash. It is growing.”41

45.Kevin Bakhurst of Ofcom noted that C4C “is not totally precluded in its current licence from owning production rights. In the end, Ofcom can agree to it.”42

46.The Terms of Trade and the publisher-broadcaster model restrict C4C’s ability to derive long-term profit from commissions or from international content partnerships, outside of the rights it will retain from commissions launched through the Global Format Fund. Given the degree of consolidation in the market, in order to uphold their original purpose of protecting small and medium-sized independent production companies, the Terms of Trade should be modified for larger companies and the publisher-broadcaster model should be relaxed. Alongside enabling C4C to retain a greater share of intellectual property rights to the content it commissions, this would also make it possible for C4C to develop its in-house production capacity. We discuss this further in Chapter 3.

47.Enders Analysis cautioned that building a catalogue of intellectual property ownership would likely require substantial investment, as C4C would essentially need to “start from scratch” in purchasing secondary and international rights. Such a strategy could “take years to come to fruition or require much greater spend.”43 It is unclear whether C4C’s existing access to investment would be sufficient to render this strategy successful.

48.Mark Oliver was also sceptical, arguing that “if [C4C] wants to do anything significant, it needs more capital.” He added that a clear benefit of privatisation would be in providing this capital, enabling C4C “to diversify across different media with its youthful brand and iconoclastic image, and possibly diversify internationally.”44

49.Privatisation is not the only route to ensuring capital investment, however. For example, the Government could raise C4C’s borrowing limit, which is within its power. Alex Mahon told us that C4C would be in favour of investigating this.45

50.In its response to the Government’s consultation, C4C also highlighted the range of levers the Government may consider separate to ownership, including extending PSB prominence across digital platforms, revising licence obligations and reviewing the commercial relationships between platforms and publishers through the Digital Markets Unit. C4C believes: “these measures could have a material impact on Channel 4’s successful transition to a digital-first organisation.”46

51.In July 2019, Ofcom recommended that PSB prominence be extended across digital platforms.47 In Public service broadcasting: as vital as ever we supported this, arguing that Government should introduce legislation to implement a new prominence framework in line with Ofcom’s recommendations.48

52.Lord Burns told us that “without doubt the biggest issue for all the PSBs at the moment is prominence. It is about how you retain prominence on the new smart TVs in the way we have prominence of the normal, linear approach.”49 Julia Lopez MP, Minister of State at the Department for Digital, Culture, Media and Sport, confirmed that prominence was a key issue the Government was considering in tandem with its consultation into the future of Channel 4.50

53.Enders Analysis concluded in a previous report that while privatisation may enhance C4C’s access to capital, privatisation alone would not “command an improvement in market power to alleviate the existential difficulty of negotiating fair terms for access to FAANG [Facebook, Apple, Amazon, Netflix and Google] platforms, where much viewing is headed,” and that extending prominence was a “start” in formulating the legislation that would be necessary to ensure C4C’s sustainability alongside the other PSBs.51

54.The potential benefits of privatisation to C4C’s sustainability are increased access to investment in programming, content partnerships and technology through access to capital. This would enable C4C to diversify its revenues, enhance its sustainability and be more ambitious internationally.

55.However, privatisation is not the only way in which C4C could access capital. The discussion of C4C’s future threatens to become a binary debate between privatisation or the status quo. The Government should produce an analysis of alternatives to a change of ownership before proceeding with any sale, including a full and transparent account of projected revenues. The Government should investigate the possibility of raising C4C’s borrowing limit to give the Corporation more access to capital while still being publicly owned, and how this could be achieved.

56.Regardless of the question of ownership, the Government should implement in full Ofcom’s recommendations for PSB prominence. The Government should also review licence obligations and how to ensure fair terms of access to online platforms.

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