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09|03|05

Digital Britain: FT Broadcasting and New Media Conference

Stephen Carter, CEO, Ofcom

Good morning. I am pleased to have been invited to participate in today's debate. Because, at the core of Ofcom's statutory raison d'ệtre is the successful stewardship of Britain's transition from analogue to digital in the communications sector.

As today's session Chairman, David Docherty, has elegantly remarked, the impact of the transition to digital on media has much in common with the impact of the renaissance on art.

Ofcom is one of the few places where coverage meets technology, meets distribution, meets content. Though, as an observation, I note that when each of those tribes comes into Ofcom’s building, they still tend to wear different uniforms and meet in different rooms and talk different languages.

Today's conference flyer directs me to talk about delivering television to all in the digital age and the countdown to switchover, so I will focus most of my talk on the traditional broadcast media. But before doing so, I would like briefly to look at where we are in broadband, wireless, and radio and their implications for business models, content and otherwise.

In broadband, competition between cable and BT's DSL rapidly falsified the assumption of BT's previous Chairman that there would be 'no demand for residential broadband'. Prices have dropped to £17.99 a month. Speeds have risen from 128k to 1Mb. People are signing up at the rate of 60,000 a week. Broadband virgins are now the majority of new adds to online. In five years, broadband penetration will be where today’s digital television is: that is a strong majority of households. And, crucially it will be at blended average speeds of 4Mb plus- that is, easily video capable; on demand. The steps we are taking to cut wholesale prices and increase the provisioning of local loops should accelerate both pace and innovation.

Radio, the senior medium, is in digital, cheerfully jumping from device to device: streamed, on mobiles, on TV and with 1.2 million DAB sets sold. It is beginning to flirt with data and interactive services.

In wireless mobile, 2005 looks at last to be the 3G year. Today there are nearly 3 million 3G subscribers, with 5 competing networks; with 80% coverage by 2007 and between 60 and 70% now. And a wide range of handsets on the market, replicating the 2G migration path from heavy bricks to neat mp3-sized devices.

But in the new media world, simply slicing and dicing what went before, is not necessarily a recipe for success. The economics of each device are different; so must be the business models.

Broadcasting is high fixed cost, virtually zero marginal cost. Broadband is stepped fixed and marginal cost. Mobile is (under current auction rules) high entry cost and fixed cost but also high marginal cost.

This was borne home to me when I was in Japan recently. I had lunch with a range of mobile content providers. I had expected to see the certainty, bordering on arrogance, that I had encountered from the distribution and hardware sectors.

After all, 100 MBps broadband with VOD and (boringly) VOIP as killer apps, not a great surprise; 4G with 20 plus Mb on the move as the standard to aspire to; and, in broadcasting, HDTV, all looked good and unassailable. The hardware providers and distributors were smug. But the content providers were surprisingly subdued.

They had tried slice and dice of traditional content. It had bombed. The only smile came from the man doing ring-tunes: 'I offer one fifth of the time of a Single down-load and get five times the revenues'.

Now, that is a nice business model. But ring tunes are not the be all and end all. The issue for the market is about finding other ways to encourage the consumer to pay more for less.

The economics of 3G mobile are simple, but cruel. How much ARPU per Megabyte can I get? Voice - the so-called commodity - delivers 30p to £1 per Megabyte. By comparison, a low quality, 30 minute video generates 9 pence per Megabyte. In this environment, other applications have to deliver higher ARPU per Mb to replace the voice revenues. Today, only low-bandwidth, short video content, the Mobisode, Mobiphoto, or ad or novel application delivers that. All else is burning cash.

In the future the constraint is not the spectrum rather it is the air-interface technology, the infrastructure and the software in the handsets.

With that, let me turn to broadcasting. BSkyB has pioneered the way of turning a limited amount of premium content into high ARPU. The best part of a decade later, and after several false starts, other broadcasters are, successfully, beginning similarly to slice and dice their content to maximise value. Both the bar and the opportunities are being constantly raised.

First, the bar: PVR penetration is forecast to rise to 15 per cent of homes by 2015. Personally, I think those estimates grossly under-call the likely growth in penetration, particularly if relatively low cost Freeview boxes with inbuilt PVR really gain ground; and if digital cable vigorously markets subscription - VOD as its platform alternative to the PVR.

Second, the opportunity: new revenue streams are rapidly superseding the traditional revenue sources. In broadcasting, subscription overtook advertising for the first time in 2003. Today the traditional mainstream broadcasting revenues - advertising and the licence fee make up only 60 per cent of the pot. Alongside subscription, interactive, new media and other revenues now amount to more than £1 billion a year; and are forecast to rise to over £2 billion a year by 2008. After ITV and Channel 4, the next biggest commercial channel isn't Five, it is Sky Interactive.

Personally, I share David Docherty's belief that the small c Conservatism and investment aversion that followed the dotcom collapse is now in reverse; and that smart money is once again seeking out investment opportunities in new media and new ways of doing things.

Digital Switchover: the market, the process, the public

Let me now turn to digital television switchover - and address one of the questions in the conference flyer, namely:

“How can government, broadcasters and manufacturers drive up digital uptake?”

The first answer to that is that, to date, it has been essentially the private sector, in the form of BSkyB and the Cable Companies who drove digital take-up towards the first 10 million homes. By having the investment courage of their convictions and a product that a large number of consumers want and like.

To give the BBC credit, they had the vision from the mid-1990s to embrace digital; and the strategic ability (not to mention the earmarked public funds) to implement that vision.

ITV’s foray was both blessed and cursed by the regulator's intervention. No one knows whether the original beauty contest answer of a Sky/ITV consortium would have worked in practice. The ITC, driven by European competition purity, forced a divorce. At first amicable, then increasingly hostile and competitive. The DTT platform was driven to do what it was not suited for. It collapsed. At considerable cost to the component parts of ITV and to ITV’s strategy. The regulator, possibly by accident, got it right second time around. DTT was re-born as Freeview.

DTT is now a very viable platform. But, as regards full coverage, and thus switchover, that is both a political and an operational question.

The politics are rightly for Ministers. The operational question is one we are deeply engaged in. Not because of a departure from platform neutrality, but because the allocation of spectrum and its uses are at the core of Ofcom’s duties.

Today, in Dixon's there are 89 TV models being sold, from bog standard cheap analogue sets, to top of the range LCD and plasma sets. Of these only about 10 models are being sold as Integrated digital TV sets. The rest are either pure analogue or analogue with a Scart socket for a DTV set top box. 5 million sets a year as analogue. The hurdle keeps rising. That is why we have called for a clear political programme from later this year for digital switchover. Broadcasters and transmission companies need certainty about the basis on which they must re-negotiate their contracts. Ofcom would benefit from certainty on the basis on which it must negotiate internationally on the use and release of the spectrum. Consumers need certainty about how long their capital purchases are valid for. The industry needs certainty over where to invest: analogue or digital.

In short, all waits on the politicians to fire the go button. But thereafter it must be delivered effectively. That means an independent organisation: Switchco, not a Whitehall Committee.

The Government has already announced, in the BBC Green Paper, a bold decision in principle that the Licence Fee is to be used to establish and fund schemes to protect vulnerable groups during switchover.

Ofcom has set out in the commercial broadcasters' digital licences the commitment to switch off their analogue transmissions by the end of 2012. We are consulting on what should be the best combination of transmission power levels and mode for the broadcasters' networks. That has implications for the capacity of the digital terrestrial platform; at the margins, for the broadcasters' investment; and for coverage. The options range from a bit less coverage than today to a slightly higher reach. But we are very conscious that even 'a bit less coverage' would mean that upward of 100,000 homes that today get analogue television would not have the option of digital terrestrial. So our expressed preference is for those options which give the UK at least the 98.5% coverage achieved in analogue today.

We also recently set out what, in engineering terms, is the optimum pattern of region-by-region switchover. This would see Wales, the West Country and Borders regions becoming all-digital in three years' time. It is a technical assessment; but a necessary one on the critical path for broadcasters' and transmission companies’ investment and long term contracts; and for the licence valuations for ITV which must be completed by the Summer. The transition to digital, and its associated costs and benefits are one of the significant variants in those licence valuations. (The other, to which I will come in a moment is the level of its PSB obligations.)

We have proposed that the task of managing and implementing digital switchover should be done by an autonomous body - Switchco. The search process for Switchco's chief executive is currently underway. It is a heavyweight job: pulling together all the various interests-broadcasters, retailers, manufacturers and, importantly, consumer groups and the voluntary sector and delivering the programme calls for project management, communications and leadership skills of a high order. But to be the person who successfully managed switchover would be a major achievement in anyone's CV.

One reaction to our technical roll out plan was: ‘people like digital, but why do we have to have switchover? So far the answer has been couched mainly in terms of abstract cost benefit analysis, and a sense of modernity. But the answer is becoming a more practical reality: as more and more households have chosen to go digital, so there is a rising level of frustration from those who currently cannot get it and will not be able to get it until switchover takes place in their region.

There is also increasing evidence of the potential - not just for the Exchequer- but also for consumers from the new services that the 112 MegaHerz of released analogue spectrum would make possible; from the mobile companies for video rich mobile services (where Germany is already taking a lead); to software developers, to the broadcasters keen to introduce High Definition TV, to compete with digital satellite and digital cable, to community groups who see digital local television as a better answer to citizens’ needs for local news and information than the big regions determined by an accident of engineering history 50 years ago.

So there is a rich range of possibilities. But to be able to enjoy any of them we must first complete the switchover process to release that spectrum.

What price the broadcasters?

Let us assume that switchover happens to time. My last theme this morning is its impact on the broadcasters. Ofcom published the final Report of its statutory Review into public service broadcasting last month. The central conclusion is that the transition to digital renders unsustainable the old public policy compact for the shareholder-funded broadcasters of analogue spectrum privileges in return for specific public service obligations. And that the forces of change are advancing more rapidly than is the understanding of their consequences.

By switchover, ITV will be almost entirely free to decide the fundamental direction of its future. It will be constrained by what is commercially possible and what it best does with the brand rather than by detailed prescription from the regulator. This is a truth unwelcome to many Parliamentarians and others. But it is a truth nonetheless

Audiences were clear about their broad priorities. A universally available, free to air, mass audience appeal channel, delivering a high proportion of UK - originated content from a range of centres - and thus viewpoints - from around the UK, and adding to plurality by delivering quality international, national and, if possible, regional news. The measures we are putting in place should help sustain that. We will revisit the landscape at our next statutory Review, mid-way through the switchover process. But in its essence it could and should prove a durable model. As should a smaller version of the same for Channel 5.

As a coda I should add that these decisions will of course impact on ITV’s licence valuations. That impact is being quantified as we speak. The changes we have proposed were driven wholly by the statutory remit underpinning our review - to maintain and strengthen the quality of public service television. The impact on licence valuation was a response to that not a stimulus. But I would simply observe that as the transition to digital erodes the analogue surplus in the ITV licences, shifts in their PSB obligations have a proportionately greater impact than in the past.

Turning to Channel 4, it is today in quite a strong position, able to continue to make its unique and important contribution to public service broadcasting well into the switchover process. The impact of audience fragmentation on its ability to deliver PSB is a medium term concern. We have said we will review Channel 4's financial position in 2006-07 to be able to respond to any challenges the channel may face before our next statutory review and will look at different options for regulatory support in the short to medium term which might underpin Channel 4’s longer-term ability to continue to deliver PSB.

One option - extending PSB status beyond the core channel - is an issue not confined to Channel 4. The rapid growth in the range and nature of digital channels has removed many of the consumer market failure arguments for PSB. But we believe that PSB will retain strong social purposes even in an age of spectrum plenty. But many of those new services, some of which, like Sky News, will be universally available in the all-digital world, deliver some of those social purposes just as effectively as the traditional broadcasters. Should there not, therefore, be some public policy mechanism which recognises and encourages that contribution from parts of the multi-channel sector?

Despite the proliferation of other channels, the BBC remains the cornerstone not just of PSB but of broadcasting as a whole in this country. Like I suspect most other people, Ofcom is still digesting the impact of the Government's Green Paper which came out last week. At the meta-level – what is the BBC for? – there is a high level of agreement. In our first PSB Report we set out a series of purposes and characteristics for PSB. We welcome the adoption of them by the BBC in its Building Public Value and their reinforcement in the Green Paper.

Of course the test comes in practice with programmes and scheduling.

As its current DG has said 'The BBC is rediscovering old-time religion'. How after 2006 Charter Review can all be assured that it will remain true to the old time religion in the face of an increasingly challenging and fragmented market?

At least in part the answer lies in governance. In our final PSB Report, we set out - I hope dispassionately - the pros and cons of what have been characterised as the Burns and Grade models.

The Government - this Government - has authored a Third Way solution, incorporating elements of both. Time will tell whether they are the best elements of both leading to a model that is workable, effective and keeps the BBC true to its purpose.

The Green Paper contains many other detailed proposals. And there is not time here to run through what we make of each of them. But I will say that some of the proposals that would have been, if not unthinkable, then unsayable in polite company a few years ago, have been put firmly on the table and remain on the table. We will make our input on these in the weeks and months ahead: including the questions around competition impact, relations with the independent sector and the clarification of questions around Tier 2 and Tier 3 regulation.

But let us imagine that we get to 2006 and the questions of the BBC’s governance, funding mechanism and remit are all settled in the Charter, what challenges will the BBC face in the next 5 years? I believe there are three.

Firstly its role as a content provider, particularly as on-demand content becomes more and more of a reality. The licence fee is in essence a fixed quantum. That is fine for the broadcast world where marginal costs are zero. But, at least today, in the on-demand world marginal costs rise with the volume of users. Either the BBC must adopt a less and less prominent role in content provision in that world or find other means of addressing the question, which is why if there is one aspect of the Green Paper that I believe is over-optimistic, it is the timescale within which the BBC will face the challenge of having to find supplementary revenue streams outside the licence fee. It is not a 2016 end of Charter issue issue, it is an early to mid-point Charter issue.

That leads to the next challenge - how does it get to be much more efficient? There is today an efficiency drive on. But just as the shift to digital required vigorous efficiencies in traditional activities, so the shift to on-demand will require an even greater step change.

The third challenge is the BBC's role in digital switchover; one recognised explicitly in the Green Paper. The issue is how it takes a leading role without being ‘The Leader'. Historically, the BBC has either ignored a project or taken it over. It has found co-operative working difficult - partly a function of the nature of its funding and governance. But digital switchover involves a wide range of other interests. The Switchover project cannot happen without the BBC, equally it cannot happen from the BBC alone with the other actors simply dragged along in the slipstream. That will require real collaboration in personnel, in role and in mindset.

My final point is the wider creative challenge for the industry as a whole. In radio and television broadcasting Britain's model has generated high volumes of quality UK content that speaks to us of ourselves. It is, in principle something we a pretty good at; and something that will be culturally ever more important in the globalised age. Will we be able to replicate that linear success in the on-demand world, and how effective will we be at the increasingly important skill of library/archive exploitation, and what will the impact of the BBC’s creative archive be on the other commercial players?

So in summary there has been much recent progress, accelerated broadband take-up, speed provision and falling wholesale access prices; 2005 will be a 3G year and 2G spectrum liberalisation is in discussion; a more liberal regime for the commercially funded broadcasters, a date, timetable and coverage plan for Digital Terrestrial Television roll-out in the public domain. Advertising back in growth, but exceeded by growing subscription revenues and the consumer appetite for communications services growing and growing - my back of the envelope calculation has a broadband pay TV home with a fixed line and average mobile usage spending 4%-5% of net household income on communications services. So if £1 in every £8 is going to Tesco, £1 in every £20 is going on communications and most of them increasingly digital. It is against this household reality that we are increasingly regulating.

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