Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
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that it will be willing to take a risk on substantial innovation, and secure finance for
the necessary investment. As an example, [ � ].
7.102 We recognise Sky’s record as an innovator. However, our central concern is that,
despite the size and importance of pay TV in the UK, one firm is in a much stronger
position than any other to be a large-scale innovator, and that firm is a mature
business with a natural incentive to protect its existing business model and
distribution platform. As such it will tend to favour only those innovations – in platform
enhancement, and in pricing and packaging – which do not cannibalise its existing
customer base, and which tend to support its incumbent advantages over potential
entrants. This will tend to inhibit the development of other services and platforms
which could otherwise use Core Premium content to drive demand, such as next
generation networks, and mobile TV services.
7.103 We consider on the basis of the above that Sky’s approach to the wholesale supply
of Core Premium channels results, and is likely to result in the future, in an adverse
effect on the interests of consumers.
Consumer effects relating to high wholesale prices
7.104 As described in section 6 (paragraphs 6.170 to 6.207), our analysis indicates that
Sky earns high margins in its pay TV business – reflected in the difference between
its IRR and its cost of capital – and these high margins are particularly concentrated
at the wholesale level of the business, and in the supply of Core Premium movies. In
particular we found that Sky’s aggregate returns were almost double its cost of
capital.
7.105 In assessing the implications of this analysis for consumers, the distinctions between
wholesale and retail supply, and between the supply of sports and movies content,
must be considered carefully.
7.106 To begin with the distinction between wholesale and retail, the context is that Sky
supplies its Core Premium channels in two circumstances – directly via its own retail
service, primarily on DSat, and as a wholesaler to other retailers, primarily Virgin
Media.
� As the DSat retailer, Sky sets a retail price, and the allocation of its revenues
(from DSat retail sales) between the wholesale and retail sides of its business is
essentially a matter of internal accounting.
� As a wholesaler to Virgin Media and others, Sky sets prices according to the ratecard.
As Sky has told us (see paragraph 6.109), these rate-card prices are set
subject to satisfying the conditions of a margin squeeze test – our view is that this
implies at the highest level Sky can charge within the constraints of this test. The
highest rate-card prices which passes this test will depend on Sky’s own DSat
retail prices.
� [ � ].
� Our view is that in practice the margin squeeze test leads Sky to set its internal
wholesale prices at the highest possible level – i.e. to earn only the minimum
margin at the retail level, because this is a comparator for the margin it can allow
to Virgin Media.