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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.

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Presentation on theme: "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."— Presentation transcript:

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 – Ofcoms 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

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 Skys total programming expenditure (£944m in 2008/09) ; Skys expenditure on its own news and entertainment channels only 12% (Ofcom (2010) 74) Alternative bullet point and text

5 Satellite: Skys 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: BTs 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 Skys 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

10 Content is king Proportion of consumers who cite elements of their TV as must have (Ofcom (2007) 37)

11 Prices paid for FAPL rights (real 07/8 prices) (Ofcom (2008): 40)

12 Ofcoms market investigation into UK pay-TV

13 Ofcoms 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

14 Ofcoms 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

15 Ofcoms 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

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 Skys wholesale prices have been set by it at a level which Sky believes to be compliant with OFTs margin squeeze test 2004 – EC Commission investigation into FAPL - no single buyer may purchase all rights – expires – 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)

17 Timeline: Ofcoms 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 Skys 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 Skys previous wholesale rate

18 Skys 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)

19 Skys strategic incentives: Ofcoms 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 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)

20 Availability of Sky over different platforms (as retailer / wholesaler) Source: Sky (2009): 102, as of June 2009

21 Skys (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 Skys 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

24 Ofcoms 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 Skys 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 Skys 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 incumbents 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 undertakings 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 Skys 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 incumbents 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 OFTs test was one which the OFT judged suitable in the context of assessing whether Skys 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])

28 Determining the margin: Ofcoms hypothetical entrant Ofcoms initial approach is to require that the hypothetical retailer is as efficient as Sky (i.e., use Skys 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

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

31 Price regulation: potential adverse consequences Relationship between Skys wholesale and retail prices: if Skys 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 Skys 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 incumbents 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]).

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.)

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?


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