Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
effectively for all subscribers. The analysis shows that the cost of acquiring new
subscribers has increased over time, but by less than would have been expected in a
perfectly competitive market.
6.202 More specifically, Oxera’s analysis suggests that the value of Sky’s subscriber base,
and its IRR are higher than would be expected in a fully competitive market. Our view
based on Oxera’s analysis is that in a competitive market new entrants would have
reduced the profitability of the subscriber base and effectively competed for Sky’s
most valuable subscribers. This would have had the effect of pushing Sky’s
aggregate returns down considerably closer to its cost of capital. This does not
appear to have happened.
6.203 Indeed, recent comments by Jeremy Darroch suggest that Sky believes there is
scope for it to increase its profitability in the near future. At a recent conference, he
stated that the business “feels like it’s on the cusp of a turnaround in profits and
earnings” having “invested a lot over the last few years” 448 . This would suggest that
Sky’s view is that more recent returns have been depressed by investment – perhaps
in triple play, which is included in Oxera’s analysis – but that they are likely to
increase in the future.
6.204 Oxera’s results also suggest that profitability is higher for Sky’s wholesale business
than for its retail business. This is consistent with what we would expect from our
economic analysis of the incentives that Sky faces, and Sky’s own statements about
the way in which it determines its wholesale rate-card.
6.205 This result depends in part on the allocation of costs between Sky’s wholesale and
retail activities - an allocation that is also relevant to our discussion of pricing in
section 9 below. Oxera’s results are robust to using the same detailed cost allocation
that we have used as part of our pricing analysis. In conjunction with our
understanding of the way in which Sky sets its wholesale prices, the finding that
profits are higher at the wholesale level helps provide assurance of the
appropriateness of that cost allocation.
6.206 We recognise that further disaggregation of profitability beyond wholesale and retail
activities needs to be treated with caution, because of the difficulties of attributing
revenues to products that are sold in bundles, further challenges around cost
allocation and the difficulty of allocating assets to particular lines of business.
However, we believe that there is merit in looking at wholesale returns on sales for
premium sports and premium movie channels. These products account for relatively
few common costs and it is possible to identify the likely range of appropriate
revenue allocations. Furthermore, a margin calculation does not rely on a view on
asset allocation. It therefore provides an indication of the likely relativity between the
two categories of product.
6.207 Oxera’s results suggest that wholesale margins for movies channels are higher than
those for wholesale sports channels. This result holds even under the most extreme
revenue allocation assumptions that we would consider reasonable. As with our view
on wholesale returns versus retail returns, this result accords with our understanding
of the way in which the market works – namely that, other things being equal, the
rents associated with content aggregation are likely to accrue in large part to the
content aggregator.
448 www.broadcastnow.co.uk/5002087.article
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