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

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1 “Content is King” - Vertical restraints in UK Pay-TV
(Work in Progress) Michael Harker CCP and Norwich Law School

2 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

3 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 Vertical and horizontal product differentiation

4 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

5 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 Sky entered first, leasing space on rival satellite, stealing the market March BSB commenced broadcasting Nov Both Sky and BSB in financial difficulties, merger results From 1992 – (near) exclusivity over top-flight sport and first-run Hollywood movies Sky Digital launched in 1998 – now with c.10m subscribers

6 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

7 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 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

8 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!

9 Television broadcasting value chain (Ofcom (2007): 27)
Exclusive rights agreements Margin squeeze / refusal to supply Alternatively – for the structure of the industry see OFT (2002) 6.

10 “Content is king” Proportion of consumers who cite elements of their TV as ‘must have’ (Ofcom (2007) 37) Sport is the most important….

11 Prices paid for FAPL rights (real 07/8 prices)
FTA – Sky enters in 1992 and has exclusivity from then on (subject to FAPL remedies) Dip in prices may be due to the EC – FAPL intervention which led to Sky loosing complete exclusivity (Ofcom (2008): 40)

12 Ofcom’s market investigation into UK pay-TV

13 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 Remedies – may be structural

14 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 Infringement of licence conditions – financial penalties 5% aggregate revenue (schedule 13)

15 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 ..of relevance to competition / consumer issues the desirability of encouraging investment and innovation in relevant markets; s.3(4)(d) In performing their duty under this section of furthering the interests of consumers, OFCOM must have regard, in particular, to the interests of those consumers in respect of choice, price, quality of service and value for money. s.3(5)

16 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 June 2009 – Setanta goes into administration – having failed to pay for the rights – ESPN takes up these rights (along with others) …..relating to Sky’s exclusive rights over FAPL/movies ….Scale of Setanta’s retail business, consumer preferences – one-stop shop etc 16

17 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

18 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) ….chicken and egg situation for new entrants…limited incentives for Sky to wholesale…

19 Sky’s strategic incentives: Ofcom’s “vertical arithmetic”
Strategic incentives to withhold wholesale supply protect customer base longer-term danger that stronger pay-TV competitors would be able better to compete for exclusive rights themselves Static incentive to supply (in order to maximise wholesale revenues) 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 [Whether wholesale channel provider restricts sale of channels depends on the following incentives: licensing of channels to multiple retailers in order to maximise subscription revenues – channels typically licensed on per-subscriber charge, while advertising maximised by number of advertising impacts – both maximised by making channels available to all retailers]

20 Availability of Sky over different platforms (as retailer / wholesaler)
Source: Sky (2009): 102, as of June 2009 BT could not at the time transmit linear channels; Tiscali is now TalkTalk

21 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”

22 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”

23 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 [Also said that it was not necessary to wait for exit of rivals - what is necessary is that the conduct in question “is liable to, or is likely to, eliminate all effective competition” on the secondary market; the fact that competitors were able to maintain a marginal / fringe presence was irrelevant; [563] [Maintaining incentives to innovate could never amount to a justification as this would mean that there could never be exceptional circumstances [Objective justification – burden of proof rests on the dominant firm – arguments need to be substantial - MS failed to substantiate it claims that licensing would reduce its incentives to innovate – merely putting forward “vague, general and theoretical arguments”; [698]

24 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

25 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])

26 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])

27 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]) Explain the last point….should make clear that Ofcom is not alleging an abuse of dominance – but the margin squeeze test is important from the remedies point of view since the question of the margin will determine the level of the wholesale price….

28 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

29 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 No intervention Address Sky’s market power at source by changing the way in which PC rights are bought and sold e.g., prevent aggregation (and related consumer benefits) and go beyond EC approach would be disproportionate given the availability of a less restrictive remedy – may revisit this issue in the future (esp. once the EU intervention expires for the FAPL auctions 2013/14 onwards) Structural remedy: separating Sky’s wholesale channel business from platform / retail business disproportionate - fail to take into consideration the fact that Sky’s current success is based upon a historic willingness in invest in what was initially a risky business operational separation would not address the incentive problem FRAND – look into sectoral powers to see what happen if there is a breach of a licence condition

30 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 Accepts this will not address directly the problem of excessive wholesale margins – cost-plus analysis will be used as a cross-check

31 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

32 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)

33 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]). Cave – acting on behalf of Sky “When access to one firm’s assets is mandated to a competitor, the parties – access seeker, access provider and regulator - become locked in a continuing relationship. For the access seeker, regulatory interventions become a key strategic resource upon which it relies heavily; the access price decision can literally make or break the entrant’s business. 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. This problem is recognised as being particularly acute when there is a duopoly comprising an incumbent and a single licensed entrant” (Cave (2009) [22]).

34 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.) - In Deutsche Telekom – the Commission found that DT was operating a margin squeeze, but the retail price being charged was regulated – nevertheless DT (as part of its special responsibility) – was required to request that the price cap be raised in order for it to avoid infringement of Art 102 - Remedies – Article 101 remedies, prohibiting certain agreements, may only do what is necessary to bring an infringement to an end Commercial Solvents – required to supply downstream rivals in the future – periodic penalties if in breach Microsoft – requirement to share codes in the future

35 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? A key plank of Sky’s appeal to the CAT will be that Ofcom’s sectoral powers must be exercised in a manner which is compatible with EU competition law – or competition law principles Sectoral regulation often has other important goals – energy – distributional, environmental concerns – media – plurality and diversity Regulation 1/2003 – supremacy clause does not apply to unilateral conduct (or other areas of law which pursue a different legitimate purpose)

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