Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
288
calculations consider a period of ten years because our aim is to derive prices which
enable effective competition from efficient operators that are prepared to make a
substantial investment in pay TV rather than to enable weak entrants to earn short
term profits at Sky’s expense. We would also expect entrants to innovate, providing
additional sources of value not captured in these calculations. Furthermore, our costplus
cross-check is designed to ensure that Sky would continue to earn a reasonable
return on its investment in providing Core Premium channels.
9.113 Adopting a DCF analysis differs from the approach taken by the OFT in its 2002
margin squeeze case. There are several reasons why we propose not taking a
similar approach to the OFT.
� We believe our approach of looking at a potential competitor’s business over
time, taking into account likely subscriber growth, fixed / variable costs and
subscriber acquisition costs is a more accurate way of working out whether a
competitor would be able to build a business based on particular wholesale
prices. Given the competition concerns we are seeking to address, this approach
is likely to be more appropriate.
� The OFT’s analysis was carried out in a very different context from the context in
which we are carrying out our modelling. The OFT was examining Sky’s past
behaviour, in order to establish whether Sky had contravened competition law.
Our analysis is intended to ensure fair and effective competition by establishing
the price that a likely competitor could afford, and therefore looks into the future.
We have mirrored the type of assessment such a competitor would be likely to
make, taking a view on the likely future cashflows of a competitor’s business and
the need for competitors to be able to earn a reasonable return 534 .
9.114 This approach requires taking a view on how retail prices and retail costs evolve over
the period. We assume that these remain constant in real terms. Note that the retailminus
calculation does not involve assumptions about how rights costs evolve over
time – rather, this issue is relevant to our cost-plus calculation (see paragraphs 9.153
to 9.158). However, our retail-minus approach also requires us taking a view on the
path of wholesale prices over time. There are numerous possibilities for how
wholesale charges change over time, each of which can be consistent with the
principle that the NPV of cashflows is equal to zero over the business’ lifetime. We
have assumed that the per subscriber retail margin remains constant in real terms,
and as a result that wholesale charges remain constant in real terms. We considered
other possible profiles of charges, including charges that are fixed in nominal terms
and charges that retain a fixed absolute difference from retail prices. However, we
have adopted the assumption that wholesale charges are constant in real terms in
the interests of simplicity and practicality. It is not clear that an alternative approach
would be more appropriate: for example, rising prices over time might encourage
inefficient early entry.
Appropriate discount rate and treatment of returns
9.115 Within the context of a DCF analysis, discounting future per-subscriber cashflows
effectively incorporates a return for the entrant as compensation for incurring risks in
534 This of course does not mean that it is inappropriate to adopt a DCF analysis in an ex post
competition context – for example, there may well be circumstances where a similar DCF analysis to
the one we have adopted is appropriate in ex post investigations of margin squeeze abuse.