Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
9.120 While the theoretically correct approach is to consider return on investment, by
setting the NPV to zero at the relevant discount rate, if we were unable accurately to
reflect a return on investment, a fallback might be to use a return on turnover (ROT)
approach. In the OFT’s margin squeeze test based on Sky’s costs and Sky’s scale,
the OFT decided that it was very difficult to estimate and allocate the asset base with
any precision, so adopted a ROT approach as a proxy. The figure it used for ROT in
Sky’s retail business was 1.5% on the basis that 1.5% was a “conservative
assumption of the minimum that [Sky retail] might be expected to earn”. Note,
however, that the OFT’s test was a very different test to the one that may be
appropriate here, but one which the OFT judged suitable in the context of assessing
whether Sky’s behaviour had been illegal.
9.121 More generally, it is very difficult to know what the correct ROT figure should be,
given that a ROT approach effectively reflects a judgement about whether other
businesses have a similar capital structure to the one under consideration 536 . We
therefore believe it is more appropriate to adopt a DCF approach and to estimate the
opening intangible asset value, in order to consider return on investment.
9.122 Given the difficulties in incorporating a view on intangible assets, it may be
appropriate to fall back on a ROT approach, though not necessarily using a ROT
figure of 1.5%. Sky has told us that it sets its prices in line with the OFT’s
methodology in 2002, which assumed a return on turnover in Sky’s retail business of
1.5%. Within our analysis, we have calculated the prices that would result from
discounting future cashflows at the rate required to replicate such returns. These
prices are therefore an approximation to the OFT’s approach, and hence also an
approximation of the way Sky sets its prices to the best of our understanding given
the information available to us 537 .
9.123 There is also the question of how we should treat subscriber acquisition costs, for an
efficient entrant. We have done this in a manner consistent with Oxera’s approach
with respect to the allocation of subscriber acquisition costs to retail activities, noting
that as we are modelling cashflows rather than building up an asset base, it is not
necessary to identify intangibles in the model for scenarios based on an entrant’s
scale.
Appropriate scale of retailer
9.124 As already noted, in determining the magnitude of costs to be deducted from the
reference retail prices, a key question is the appropriate scale of the efficient entrant
as this affects the entrant’s average costs.
9.125 Our starting point is to consider Sky’s average costs and hence Sky’s scale. This
would imply basing our modelling on Sky’s current UK subscriber base. Given
economies of scale, a competitor that is as efficient as Sky at equivalent scale may
nevertheless, at lower scale, have average total costs which exceed Sky’s due to the
presence of fixed costs. Adopting Sky’s scale may not therefore result in a price
536 With this in mind, Oxera has carried out an analysis of suitable benchmark companies’ retail
returns. We should not automatically assume that these figures represent a good proxy for retail
returns in this case. However, Oxera’s results are substantially above 1.5%: within a range of results,
a group of TV comparators has a median return on turnover of 12% - see Annex 9 for more details.
The wholesale prices under our base case assumptions imply a return on turnover of around 3.9%.
537 We asked Sky to provide us with details of how it calculated its prices, however it declined to
provide us with any detailed information. [ � ].
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