www.ccp.uea.ac.uk

“Content is King” - Vertical restraints in UK Pay-TV

(Work in Progress)

Michael Harker

CCP and Norwich Law School

www.ccp.uea.ac.uk

Overview

Premium content – the new bottleneck in broadcasting

Exclusive rights agreements and downstream (vertical) foreclosure

UK Pay-TV in a nutshell – the first mover firm (Sky)

Case study – Ofcom’s UK pay-TV investigation

Substantive principles – the relationship between competition law and sectoral regulation

The co-existence of competition and sectoral regulation: complements or substitutes

Essential Input: Content is King

Growing acknowledgement that premium content (PC) is the new “bottle-neck”

Vertical not horizontal product differentiation

“Chicken and egg” problem for new entrants into Pay-TV retail

to gain market share / audience (and recoup costs) must have PC

but to have PC must have subscriber base (minimum efficient scale)

First-mover advantage

Setting the context…

Pay-TV in the UK – in a nutshell

Value chain

Premium content as a bottleneck

Pay-TV and the escalation of content rights’ monetary value

in Europe, football represents 30-65% of broadcasters’ total rights expenditure (Geradin (2005))

Sports programming accounts for 54% of Sky’s total programming expenditure (£944m in 2008/09) ; Sky’s expenditure on its own news and entertainment channels only 12% (Ofcom (2010) 74)

Alternative bullet point and text

Satellite: Sky’s history

First mover in pay-TV – risks then rewards

UK awarded frequency to broadcast by satellite in 1977; finally awarded licences to BSB (1986)

Feb 1989 - Sky entered first, leasing space on rival satellite, stealing the market

March 1990 - BSB commenced broadcasting

Nov 1990 - Both Sky and BSB in financial difficulties, merger results

From 1992 – (near) exclusivity over top-flight sport and first-run Hollywood movies

1998 - Sky Digital launched in 1998 – now with c.10m subscribers

Cable

Scale matters - 11 to 1:

following merger between ntl and Telewest, one significant market player: rebranded Virgin media

Relatively low market penetration (c.3.5m)

Protected position: BT’s delivery of audio visual media services constrained until 2001 – now likely to be a key player in IPTV

Free To Air -- Digital terrestrial TV (DTT)

Initial award to Granada and Carlton JV in 1998 (originally with BSkyB – forced to withdraw on competition grounds)

March 2002 – ITV Digital goes into administration

explained as being due to paying too much for the television rights for Football league – although other problems (technological, marketing and fierce competition from BSkyB)

October 2002 – Freeview launched (BBC, National Grid Wireless (ITV and C4 in 2005))

Top Up TV launched in 2004 – pay-TV retailer

2007 - BSkyB applied to Ofcom to replace its existing 3 FTA channels on DTT with 4 subscription channels – plans shelved

Around 11m users of the service / potential subscribers to Sky’s premium content

Ofcom appears to view this as the key entry point for competing retailer in PC

The future: fast moving, high innovation sector

Analogue switch-off 2012

The advent of IPTV

Project Canvas (JV between BBC, C4, ITV, Five and communications companies Arquiva, BT and TalkTalk)

provisional approval by BBC in December 2009

May 2010 OFT confirms no relevant merger situation

Increased use of VOD over open internet – BBC iPlayer; Sky Anytime etc.

HD TV; 3DTV!

Television broadcasting value chain (Ofcom (2007): 27)

Exclusive rights agreements

Margin squeeze / refusal to supply

“Content is king”

Proportion of consumers who cite elements of their TV as ‘must have’ (Ofcom (2007) 37)

Prices paid for FAPL rights (real 07/8 prices)

(Ofcom (2008): 40)

Ofcom’s market investigation into UK pay-TV

Ofcom’s competition powers

Concurrent competition powers under CA1998

applied consistently with EU jurisprudence (s.60)

Full appeal to CAT

Market Investigation Reference to CC under EA2002, s.131

reasonable grounds for suspecting that any feature [inc. conduct], or combination of features, of a market…prevents, restricts, or distorts competition

If CC makes a finding that a feature of the market has an adverse effect on competition, may impose remedies

Judicial review by CAT

Alternative bullet point and text

Ofcom’s sectoral powers

Licence modifications under Communications Act 2003, s.316

(1) The regulatory regime for every licensed service includes the conditions (if any) that OFCOM consider appropriate for ensuring fair and effective competition in the provision of licensed services or of connected services.

(2) Those conditions must include the conditions (if any) that OFCOM consider appropriate for securing that the provider of the service does not— (a) enter into or maintain any arrangements, or (b) engage in any practice, which OFCOM consider, or would consider, to be prejudicial to fair and effective competition in the provision of licensed services or of connected services

Ofcom must first consider whether “a more appropriate way of proceeding” is to use their CA1998 powers – if they do they must use those powers (s.317(2-3))

Full appeal to the CAT – but choice of powers is excluded from its jurisdiction

Ofcom’s sectoral duties

Principal duty to further the interests of consumers, where appropriate by promoting competition (s.3(1)(b))

the availability throughout the United Kingdom of a wide range of television and radio services which (taken as a whole) are both of high quality and calculated to appeal to a variety of tastes and interests (s.3(2)(c))

OFCOM must have regard… [to] the principles under which regulatory activities should be transparent, accountable, proportionate, consistent and targeted only at cases in which action is needed (s.3(3)(a))

Must also carry out a cost/benefit analysis – subject to “profound and rigorous scrutiny” test by CAT (Vodafone v Ofcom [2008] CAT 22 [18])

Note these duties do not apply to CA1998 powers

Sky and exclusive premium content – previous interventions

1992 – Sky purchases exclusive rights to FAPL matches in UK – wholesales to some of the cable operators

1996 – DGFT conducts a FTA1973 review of the wholesale pay-TV market following complaints from some of the cable companies

Sky gave (non-statutory) undertakings to the DGFT including wholesale prices and discounts it would offer to cable companies

1998 – Ondigital/ITV Digital launched

2002 – OFT investigation under Chapter II CA1998 (equiv of Article 102) – alleged “margin squeeze”

since then Sky’s wholesale prices have been set by it at a level which Sky believes to be compliant with OFT’s margin squeeze test

2004 – EC Commission investigation into FAPL - no single buyer may purchase all rights – expires 2013

2007 – Setanta acquires rights to broadcast FAPL

Feb 2009 – Setanta wins only one of the six FAPL packages for 2010-13

June 2009 – Setanta goes into administration – having failed to pay for the rights – ESPN takes up these rights (along with others)

Timeline: Ofcom’s pay-TV investigation

Jan 2007 – Complaint by BT, Setanta, Top Up TV, Virgin Media 

March 2007 – Ofcom announced pay-TV market investigation

October 2007 – Picnic - Sky applies to retail its premium content channels on DDT (put on hold)

Dec 2007 – First Ofcom consultation on pay-TV

Dec 2007 – Sky enters into discussions with Ofcom – undertakings in lieu of market investigation reference to CC – talks stall

Sept 2008 – Second Ofcom consultation on pay-TV

rules out reference to CC, will use sectoral powers

wholesale, must-offer remedy proposed for premium content channels (sports and movies) 

June 2009 – Third Ofcom consultation on pay-TV

Jan 2010 – Ofcom announces it is minded to proceed with must-offer remedy

March 2010 – Final decision published

Wholesale remedy modified; will only apply to sports channels

Proposes ssue of premium movie channels will be referred to CC – sectoral powers do not cover sufficiently non-linear, VOD services

Sky’s proposal to enter DTT as retailer (Picnic) will be considered – any regulatory approval will be subject to Sky wholesaling all of its premium channels on DTT (inc. movies) 

29 April 2010 – CAT publishes interim relief

the wholesale remedy will be implemented, but retailers must pay into a trust the difference between prices charged to customers and Sky’s previous wholesale rate

Sky’s market power

Sky has market power in pay-TV markets for premium sport and movies:

consumers do not appear to view other forms of content as being readily substitutable for premium content

Unlikely, therefore, that Sky is constrained by the availability of other content

Sky has a high market share in the premium pay-TV subscription channels – presumption of market power strengthened by existence of high barriers to entry (inc. acquisition of premium content)

Sky’s strategic incentives: Ofcom’s “vertical arithmetic”

Why did Sky wholesale to Virgin (cable) and not TUTV (DTT)? Relative switching costs – if

low then static incentives are likely to be dominated by strategic incentives

Availability of Sky over different platforms (as retailer / wholesaler)

Source: Sky (2009): 102, as of June 2009

Sky’s (alleged) exploitation of market power

Refusal to supply wholesale premium channels to retailers on certain platforms

In particular, DTT – with the lessening of choice for c.11m users of that platform

Where it did supply, it engaged in a “margin squeeze”

In particular, against Virgin (cable), whose retail of Sky’s channels was said to be loss-making

Sky contend that the use of (ex ante) sectoral powers must be applied in accordance with “competition law principles”

Refusal to supply

Sky refuses to wholesale PC to other retailers – instead preferring to retail on their platforms

EU competition law generally respects freedom of contract and, in particular, the importance of respecting IPRs (including copyright)

competition law will only prohibit refusal to supply in “exceptional circumstances”

Exceptional circumstances after Microsoft

In the IMS (2004) case, the ECJ laid down three cumulative criteria to be satisfied before mandating compulsory licensing of IPRs under Article 102: 

(1) there must be a new product involved;(2) access to the protected material must be indispensable so that a refusal to

licence will exclude “any” or “all” competition on the secondary market; and(3) The refusal must be unjustified.

In the Microsoft (2004) case, however, the CFI departed from (1)

“[The new product criterion] …cannot be the only parameter which determines whether a refusal to license an intellectual property right is capable of causing prejudice to consumers within the meaning of Article [102](b). As that provision states, such prejudice may arise where there is a limitation not only of production or markets, but also of technical development” [647]

CFI appears to imply that less restrictive criteria apply to high technology (innovation) sectors, despite the fact that maintaining incentives to invest are particularly important in that context

Ofcom’s view on innovation

Recognises that record of innovation in the UK is “strong” (e.g., one of the highest penetration rates of pay-TV in Europe)

Sky has played a central role – Ofcom recognises Sky’s “role as an innovator” ((2010) [8.240]) (e.g., HD, PVR, 3DTV)

Looking forward

In a competitive market all pay-TV operators will have an incentive to innovate

With market power, Sky will seek to avoid innovation which might threaten its existing subscriber base (and its platforms)

Innovation is likely to be of a type which will not be suitable to Sky’s platform (e.g., VOD, IPTV)

New entrants without access to PC will be unable to reach sufficient scale to recover fixed costs of research and development

Ofcom did not consider the possible dynamic effects of its intervention – that an innovator (like Sky) will be deterred from innovating because it will be forced to share its products/assets with competitors

Margin squeeze

Sky only supplies core premium channels to one third-party retailer (Virgin)

Virgin actually makes a loss when selling Sky channels (margin squeeze)

The test for a margin squeeze:

“…instead of refusing to supply, a dominant undertaking may charge a price for the product on the upstream market which, compared to the price it charges on the downstream market, does not allow even an equally efficient competitor to trade profitably in the downstream market on a lasting basis” (EC Commission (2009): [80])

What is the correct test for a margin squeeze?

What is the appropriate “cost” benchmark?

vertically integrated incumbent’s costs or

costs of a hypothetical entrant

“…[A]lthough the Community judicature has not yet explicitly ruled on the method to be applied in determining the existence of a margin squeeze, it nevertheless follows clearly from the case-law that the abusive nature of a dominant undertaking’s pricing practices is determined in principle on the basis of its own situation, and therefore on the basis of its own charges and costs, rather than on the basis of the situation of actual or potential competitors” (T-271/03, Deutsche Telekom v Commission (2008, CFI) [188] – on appeal)

Ofcom appears to take the approach that the (smaller) “scale” of the entrant can be taken into account, i.e., a margin squeeze may occur even if it would be profitable for the incumbent to supply at the relevant wholesale price: “…relying on the current [wholesale] prices would not ensure fair and effective competition, as retailers with smaller scale than Sky’s would not be able to compete effectively” (Ofcom (2010): [1.59])

The OFT v Ofcom approach to margin squeeze

Non-infringement decision by the OFT in 2002 – alleged abuse of dominance under Chapter II CA1998 – OFT uses incumbent’s costs

Sky claims that it has subsequently set wholesale prices in order to satisfy the margin squeeze test

In differentiating its approach to the OFT, Ofcom states

“the OFT’s test was one which the OFT judged suitable in the context of assessing whether Sky’s behaviour had been illegal in the past [ex post]. This is a different objective from the one which is under our consideration, i.e. that of determining appropriate forward looking wholesale prices to enable innovation and inter-platform competition [ex ante]” (Ofcom (2010) [10.159])

Determining the margin: Ofcom’s hypothetical entrant

Ofcom’s initial approach is to require that the hypothetical retailer is “as efficient as Sky” (i.e., use Sky’s retail costs to calculate retail margin), subject to adjustment for:

Smaller scale than Sky [Sky has 70% of pay-TV market]

Adjusting for (1): An efficient competitor with 1.5m subscribers after 10 years, (higher) retail margin would reflect higher fixed costs

The wholesale “must-offer” remedy

–Wholesale price will be set by Ofcom for two SD Sports Channels - the margin to be determined according to the costs of the hypothetical entrant

Wholesale price for HD subject to FRAND requirement

Uncertainty in marketing/advertising cost for a new product – increased risk of regulatory failure

The regulated price: retail-minus, not cost-plus

Dangers of artificially suppressing content rights values:

“Firms are unlikely to bid vigorously for content rights if the result of doing so is to push up the future wholesale price of the channels they purchase from Sky. Indeed, if the outcome of a rights auction has a direct effect on the level of wholesale prices, then some individual firms will have a strong incentive not to bid, and there may even be an incentive for various forms of coordinated behaviour.” (Ofcom (2009) [8.81])

With retail-minus no direct relationship between wholesale costs and rights prices

Ofcom’s case for intervening is not high wholesale prices per se, but the need for greater inter-platform competition and innovation

Price regulation: potential adverse consequences

Relationship between Sky’s wholesale and retail prices:

if Sky’s retail prices rise/fall, wholesale prices should follow accordingly

Sky might increase its retail prices in order merely to raise rivals’ (wholesale) costs

Reduces the incentives of Sky to compete vigorously on retail price – any reductions in Sky’s retail prices will lower costs for rivals

Using the hypothetical entrant to set the minus element

Potential problems with the “minus element” being calculated on the basis of a hypothetical entrants’ costs (rather than being based on the incumbent’s costs)

entrant has higher costs than Sky – increase total industry costs / generate productive inefficiency

implicit regulatory end-state – which may itself stifle innovation (e.g., by favouring one platform over another)

The Cave submission

Fast-moving industry – dangers of predicting / shaping the future shape of the market – preference for encouraging growth for one technology (DTT) at the expense of others (e.g., cable and IPTV)

Likely to be only one entrant with sufficient scale to compete with Sky

May lead to a relationship of “co-dependency”:

“The embrace is particularly close in cases where the number of access-seeking entrants may effectively be limited to one. In this case the relationship between entrant and regulator becomes almost one of co-dependency, in the sense that both the entrant and the regulator want the entry to succeed, the latter to avoid the reputational effects of a failed regulatory intervention. This creates pressure for frequent discretionary intervention directed at a particular end state in terms of industry structure” (Cave (2009) [22]).

Sectoral and/or competition law powers

Not substitutes, but complements (see Deutsche Telekom)

Why competition law is an important complement to regulation:

May reduce the potential problem of (government or firm) capture

Correct for the weakness / incompetence of a regulator

May fill in the gaps

Are the necessary remedial tools available under competition law?

Article 102 remedies may relate to future behaviour (ex ante approach) (see Commercial Solvents (1974, ECJ), Microsoft etc.)

Should sectoral regulation be limited by competition law principles?

Benefits of using sectoral powers

Context specific – they do not create general precedents

Reduce the potential for errors / over-deterrence

Sectoral regulation often has other important goals

Sectoral regulators are often created precisely because there is a market power / incumbency problem, specialised expertise etc.

By analogy, remedies imposed under MIR do not depend upon an infringement of competition law

If sectoral regulation is limited by competition law principles, why have it at all?