Pay TV phase three document - Stakeholders - Ofcom

Effects on retail prices
Pay TV phase three document – non-confidential version
10.49 We have proposed in our pricing analysis to put in place a set of wholesale charges
that are lower than the current cable rate-card. In many markets, this would be
expected directly to lead to a reduction in retail prices, but in the case of pay TV, the
dynamics are more complex. Our overall view is that there is likely to be only a small
effect on retail prices compared with the counterfactual.
Sky’s retail prices
10.50 Sky currently sets its retail and wholesale prices in tandem. It sets retail prices based
on what retail prices consumers will bear. Our understanding, as we described in
section 6, is that Sky then sets wholesale prices so as to ensure the minimum
possible gap between retail and wholesale prices – i.e. it sets wholesale prices as
high as possible within the constraints of its interpretation of the OFT’s margin
squeeze test in 2002.
10.51 We are proposing in this document to increase the margin from its current level by
setting wholesale prices that are lower than the current cable rate-card. In theory this
might cause Sky to want to adjust its retail prices in some way. A large part of the
effect on retail prices depends however on which option we follow for how wholesale
prices change over time. If we were to allow wholesale prices to follow retail prices
with a fixed absolute margin, this would be likely to encourage Sky to increase retail
prices somewhat in order to increase wholesale prices. A fixed percentage margin is
likely to create the opposite incentive: Sky might seek to reduce retail prices if
wholesale prices reduced by a smaller amount, since that would constrain the ability
of its rivals to compete.
10.52 In practice, these kinds of effects are likely to be limited in any case by the
commercial realities of Sky’s business. Currently only a small proportion of Sky’s
business comes from wholesale relative to retail. It is therefore unlikely to make
sense for Sky to want to increase its retail prices in order to manipulate its wholesale
prices, because this would risk damaging its substantial retail subscriber base. A
wholesale must-offer remedy would change this balance somewhat, as it would add
to the number of wholesale customers, but the change in the short term would be
unlikely to be significant, given that Sky had [ � ] million residential UK retail
subscribers at the end of September 2008. Longer term, we might expect greater
competitive intensity to put downward pressure on retail prices – or at least enable
consumers to access cheaper entry level packages containing premium channels.
10.53 For the purposes of our quantitative analysis, we have assumed that there would be
no change to Sky’s retail prices compared with the counterfactual.
Virgin Media’s retail prices
10.54 The situation for Virgin Media is likely to be rather different since it faces a more
straightforward optimisation question in response to a change in wholesale prices. A
fall in wholesale prices constitutes a fall in its marginal cost. We might therefore
expect this to lead to a modest reduction in retail prices and an expansion in output.
However, we have assumed that Virgin Media’s retail prices are unchanged
compared with the counterfactual, which may understate the consumer surplus figure
of around £370 million.
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