Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
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sports is so different; for example, a cricket match may attract more viewing
minutes over its duration than a much shorter football match, but the football
match might still be the bigger attraction. However, we have looked on an event
by event basis, and while we acknowledge that viewer hours are not a perfect
proxy for perceived value of content, it is the best information available and we
believe a reasonable proxy for this purpose.
� For movie channels, we examined Sky’s contracts with movie studios to establish
how payments relate to Sky’s subscriber numbers. [ � ]. This may lead to a
slight over-recovery of costs from subscribers to only the least popular of Sky's
channels. However, given that our objective in calculating cost-plus prices is to
serve as a cross-check against our retail-minus prices being too low, we think it is
appropriate to adopt a pragmatic approach.
9.152 As a final adjustment, Sky earns advertising and sponsorship revenues through its
premium sports and movie channels. Therefore the costs incurred in producing
wholesale premium channels support not only subscription revenues but also this
advertising revenue. We have taken account of this by allocating a percentage of the
wholesale channel costs to the advertising function, such that the advertising of
premium channels has the same operating margin as Sky’s total group operating
margin (about 15% for 2007/8). This adjustment results in a reduction in the cost
stack for calculating cost-plus wholesale charges.
Multiple year analysis
9.153 As for our retail-minus approach, we believe it is appropriate to consider costs over a
period of time, rather than looking at a snapshot in any one single year. We have
considered an explicitly modelled period of ten years followed by a terminal value (as
in our retail-minus calculation).
9.154 We have also adopted the same discount rate of 10.3% used in our retail-minus
calculations, as an estimate of Sky’s wholesale cost of capital, given our view that
wholesale and retail performance are likely to be strongly correlated.
9.155 Our approach is to calculate Sky’s wholesale costs from year to year within the
context of our discounted cashflow framework, including operating costs and capital
expenditure. We have treated the opening premium wholesale asset value
(consistent with the Oxera work) as a cost incurred in the first year, and calculated a
perpetuity-based terminal value, consistent with the approach we have adopted in
our retail-minus calculation.
9.156 A critical aspect of the modelling is our assumption about the costs of rights in future
years. We have assumed that sports and movie rights fees will increase over time
with both inflation and subscriber numbers. In other words, we have assumed that
these fees remain constant per subscriber in real terms. This treatment reflects the
purpose of the cost-plus calculation which is to ensure that our proposed wholesale
prices, derived on the basis of a retail-minus methodology, allow Sky to recover its
wholesale channel costs (including a reasonable return) in a range of possible
circumstances. There is uncertainty in how Sky’s content rights fees are likely to
evolve in the future: they may increase at a slower rate, or even fall. However, we
consider that our current treatment is appropriate given inherent uncertainties and
the role of cost-plus in our overall approach.
9.157 Note that we assume subscriber numbers are flat in the terminal value, so there is no
growth in costs accounted for by subscriber numbers after the ten-year period.