Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
6.171 We have therefore carried out a considerable amount of further analysis of both the
aggregate and disaggregated profitability of Sky. In particular, we commissioned
Oxera, a consultancy, to carry out an independent assessment of the profitability of
Sky’s Core Premium content. Oxera’s report is included in Annex 9.
6.172 Oxera is a recognised expert in the field of economic profitability, and has direct
experience of carrying out this type of analysis in the context of market investigations
for both the OFT and the CC. In addition to advice on particular cases, Oxera
provided guidance to the OFT in its report “Assessing profitability in competition
policy analysis” 442 . This provided the basis of the approach that we sought to apply in
our Second Pay TV Consultation.
6.173 Oxera’s work for this consultation document has attempted to address the specific
difficulties we identified with analysing Sky’s aggregate and disaggregated
profitability that we set out in our previous consultations. The particular focus has
been on establishing an appropriate asset base by looking at intangible assets and
on addressing the challenges involved in selecting an appropriate time period.
Oxera’s analysis has looked at a number of time periods, and has found similar
results regardless of time period, which gives us greater confidence in the results.
6.174 In order to inform the analysis we requested – under Oxera’s guidance – a large
amount of detailed historical financial data from Sky, which were made available to
Oxera for the purposes of its analysis. Oxera has examined Sky’s aggregate
profitability by estimating the value of Sky’s asset base, including intangible assets
not listed on the balance sheet, such as subscribers. In addition, it has looked at
profitability for Sky’s wholesale and retail businesses.
Oxera’s methodology
6.175 Oxera used the same conceptual framework in this piece of analysis to that which it
has used in its work for the OFT and the CC. This centres on the use of NPV and
IRR profitability metrics and the ‘value-to-the-owner’ principle for valuing assets. In
our previous work, we highlighted the difficulties we had found with applying these
principles. However, we believe that Oxera has managed to overcome the various
difficulties, by virtue both of its expertise and of its access to considerably more
detailed financial data.
6.176 In a competitive market with freedom of entry and exit we would not expect the IRR
of a particular project substantially to exceed the cost of capital in the long run. An
IRR substantially above the cost of capital could indicate the existence of barriers to
entry and market power.
6.177 When looking at a specific period over the lifespan of an economic activity Oxera has
used a truncated IRR approach, in which the initial asset value is treated as a cash
outflow and the residual value at the end of the period in question is treated as a
cash inflow.
6.178 This approach tends to result in greater emphasis being placed on obtaining the
correct valuation of the asset base at the beginning and end of the period. If the
opening balance is understated or the closing value is overstated, then the resultant
IRR will be overstated, while the reverse is true if the opening balance is too high or
442 Available at http://www.oft.gov.uk/shared_oft/reports/comp_policy/oft657.pdf
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