BSkyB Decisions: Margin Squeeze Mark Bethell BT Seminar 10 December 2004

Other Programme Inputs The TV Supply Chain Inputs into Programmes Channel Providers Wholesale Channel Supply DTH/SatelliteCableDTT Analogue Free-to-air Viewers Subscribers / Viewers Subscribers Subscribers / Viewers Channel Distribution Rights

Key Concepts  What is margin squeeze?  Price discrimination – but what’s the price?  Predation – losses? plan?  Excessive pricing

Key Concepts  Excessive pricing that prevents efficient company competing  What’s an ‘efficient company’?  Actual rival?  Virtual company?  Sky’s own costs?

Key Concepts  In fact: test of non-discrimination – company as efficient as Sky.  Price cap ‘mechanism’ ‘The Director considers that the correct test…should determine whether an undertaking as efficient in distributing as BSkyB can earn a normal profit when paying the wholesale prices charged by BSkyB to its distributors, and that this should be tested by reference to BSkyB’s own costs of transformation.’ Decision of 17 December 2002, Paragraph 356

Institutional difficulties  Information assymetries – test depends on minute examination of Sky costs  Complainant v Sky  OFT v Sky  Sky v OFT  Interim measures?

 Sky provides copyright licence  Duty to licence / essential facility?  Voluntary licence constrained? Key issue: Intellectual Property

DisCo - the Model  Sky (DisCo) not in a steady state  Launch of digital during period assessed  How should test recognise legitimate investments?  Historical Approach - amortise investment costs  NPV Approach - consider all revenues and costs associated with digital project

NPV vs Historical Approach  Historical approach adopted despite Sky objection over ‘arbitrary recovery schedule’?  Fundamental concerns with NPV approach  dependent upon subjective forecasts  a positive NPV may not imply no squeeze  Only historical approach identifies periods of squeeze

Required Rate of Return  DisCo must earn a “competitive return”  DisCo has a small and variable capital base - hinders cost of capital approach  Necessary to use return on turnover  Approach based on samples and precedent

Revenues  Sky dominant in wholesale of “premium channels” only  Sky packages bundled: cannot allocate revenue between basic and premium channels meaningfully  Therefore basic revenues and costs included in test  Sky cannot inflate the wholesale price of basic channels  No rationale for Sky to make losses on the retail of basic channels  Incremental price of channels not the relevant price for squeeze test

 Sky - any firm as efficient as DisCo could get maximum discounts on ratecards. Test based on observed prices ‘internally inconsistent’ – Sky costs but third party premium prices  But - Sky an integrated company with no recognition of ‘BroadCo’ and ‘DisCo’ – existing strategy is its most efficient and independent of discount  If DisCo cannot make normal profit when paying observed Sky charges - margin squeeze Key issue: Price of Premium Channels

Results

Analysis  Temporary and limited losses  Modeling assumption involves uncertainty  Influence of certain temporal factors  transmission duplication  excess calls  3rd party programming costs  Effect on competition? Cf Sky’s estimates  Sky strategy?