Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
ii) What is a reasonable cost benchmark for an efficient retail entrant?
9.94 The first question concerns the treatment of incremental and common costs. One
approach would be to deduct only the incremental costs associated with retailing
(and basic content). This is effectively the approach suggested by the “Efficient
Component Pricing Rule” (ECPR 532 ) which broadly aims to ensure (under some
relatively strict assumptions) that a vertically integrated wholesaler/retailer is
indifferent between supplying its own retail arm and a competing retailer. Under this
approach, if a large proportion of retailing costs were common (for example common
across retail and wholesale businesses) then we would only make a relatively small
deduction for retailing costs. A competing retailer paying the resulting wholesale price
would therefore only be able to recover a small proportion of its retailing costs if it
were to match Sky’s retail prices, making it unviable unless it recovered all its
common costs from other lines of business. We do not believe that this approach
would meet our objective of promoting fair and effective competition in order to
address the detriment identified in section 7.
9.95 At the other extreme, we might deduct not only the incremental costs associated with
retailing but also all of the common costs. This approach would enable retail
competitors selling only Core Premium channels to match Sky’s retail prices whilst
recovering their full standalone costs of retailing. However, we do not believe this
approach would lead to an efficient outcome. Existing and prospective competitors
are likely to provide other products and services in addition to Core Premium
channels (rather than acting as pure resellers) and we would expect them to be able
to recover a proportion of their common costs from the sale of those other products
and services.
9.96 There is inevitably a degree of judgement in this choice, but we believe that it is
appropriate to deduct both the incremental costs associated with retailing and basic
content from our reference retail prices, as well as a proportion of common costs.
This requires us to consider the question of cost allocations.
9.97 The second question in paragraph 9.93 above concerns the source of our cost
information. Our focus is on deriving a set of wholesale prices for an efficient retail
entrant. We have used Sky’s own costs as the basis for our calculations. Our aim is
to promote competition on different platforms in order to address our identified
competition concerns. However, of the various relevant cost categories, most are
unlikely to be fundamentally different depending on the sorts of platform two different
operators use. For example, the cost of marketing is unlikely to differ purely as a
result of one operator choosing to set up a platform on DTT as opposed to IPTV. For
that reason, in these areas we start with Sky’s costs, as the best available proxy for
an efficient scale retailer. We address the notable exception of scale issues and
transmission costs in paragraphs 9.124 to 9.129 and 9.130 to 9.137 below.
9.98 We therefore consider cost allocation issues, and in particular the allocation of
common costs, in the context of Sky’s costs.
Cost allocation issues
9.99 As noted above, we start from Sky’s costs as the best available proxy for an efficient
pay TV retailer. In reviewing Sky’s management accounts, we need to identify which
costs should be allocated to the retailing of the different Core Premium packages.
532 See William J. Baumol, “Some Subtle Issues in Railroad Deregulation” (1979)
283