Pay TV phase three document - Stakeholders - Ofcom

Pay TV phase three document – non-confidential version
known as the cellophane fallacy 57 . If we were to assess markets based on observed
switching in such circumstances, markets would be drawn too broadly.
4.26 In broadcasting markets it can often be difficult to identify the competitive price. In
economic models, the competitive price is often equated with (some measure of)
marginal cost. However, in broadcasting markets, a large proportion of production
costs are fixed, and marginal costs are very low. We would therefore expect
competitive prices to be well above marginal cost, but it is very difficult to assess just
how much higher they will be. Nonetheless it is conceptually correct to conduct
market definition at ‘competitive’ prices. Where it is not possible to estimate the
‘competitive’ price, we assess evidence of switching cautiously, as high switching is
consistent with both substitution to alternative products at competitive prices or prices
being above competitive levels.
4.27 In our Second Pay TV Consultation we assessed whether current prices may be
above competitive levels using a number of sources of evidence. This included our
assessment of Sky’s profitability, an examination of wholesale margins for Sky’s
premium channels, and finally consideration of whether prices might be above
competitive levels even absent evidence of high profitability for Sky itself.
4.28 Our assessment of Sky’s aggregate profitability was inconclusive 58 . The results were
consistent with either normal profits or the presence of supernormal profits,
depending on the assumptions used in the analysis.
4.29 When we looked more specifically at the margins on the wholesale supply of
premium sports and movie channels 59 , we found that gross margins appeared to be
in the region of [ � ]% to [ � ]% for Sky’s sports channels and [ � ] to [ � ]% for
its movie channels. Operating margins for Sky’s wholesale premium channel
business (combining both sports and movies) appeared to be around [ � ]%,
compared with a figure of around 20% for Sky’s pay TV business as whole. While not
conclusive, these margins appeared high for an asset-light wholesale channel
business.
4.30 We also explained that while high profits for Sky were likely to point strongly to a
conclusion that downstream prices were above the competitive level, they were not a
necessary condition. It is possible – and indeed likely – that some of the economic
rents associated with exploiting content in a narrow market flow upstream to the
rights providers.
4.31 In summary, we remained concerned that the cellophane fallacy was likely to be a
problem when assessing the switching behaviour of Sky customers.
Differentiated products
4.32 In markets which contain a variety of differentiated products, such as some
broadcasting markets, there may not be a clear-cut boundary between products that
lie just inside the market and products that lie just outside the market. The
assessment of market power does not rely on the precise drawing of market
57
This term arises from a US case involving cellophane products (US v EI Du Pont deNemours & Co
[1956] 351 US 377.)
58 See section 7 and annex 9 of the Second Pay TV Consultation for full details.
59 See section 6 and annex 9 of the Second Pay TV Consultation for full details.
57